Cases May Expand On U.S. Material Adverse Change Standard

An often troubling aspect of merger or acquisition agreements is that the buyer will usually not actually buy the enterprise in question until several weeks, if not months, after the purchase price has been negotiated and agreed upon. Events and circumstances may arise causing the value of the enterprise to diminish so significantly that the buyer risks acquiring something for which it did not bargain. As a result, most merger or acquisition agreements include provisions known as material adverse change or material adverse effect (together, MAC) clauses. These clauses are intended to allocate risk of loss in value of the enterprise to the seller. The idea is that the seller should bear the risk if an event or circumstance occurs, or becomes known, that materially changes the "bargained-for" agreement. As a general rule, MAC provisions are heavily negotiated, with the buyer seeking a broad MAC clause for maximum flexibility with regard to closing a transaction. Not surprisingly, the seller tends to prefer a narrow MAC clause to ensure that the transaction closes at the agreed-upon merger price, keeping in mind established expectations and market difficulties in subsequently trying to sell an enterprise following a "busted" transaction. In this regard, a seller will frequently seek to include generic exceptions to the MAC clause for known risks and uncertainties as well as general market events and circumstances, including specific exceptions for risks and uncertainties that are applicable either to the enterprise in question or the industry in which it operates.

When events and circumstances occur that affect valuation, determining whether a MAC has occurred is not always clear, even when the change in valuation is significant. The two leading court decisions interpreting the application of MAC clausesIBP, Inc. v. Tyson Foods, 789 A.2d 14 (Del. Ch. 2001), decided under New York law; and Frontier Oil Corp. v. Holly Corp., C.A. No. 20502, 2005 Del. Ch. LEXIS 57 (Del. Ch. April 29, 2005)provide some guidance. Under IBP, the inquiry is fact-intensive, and a party seeking to invoke a MAC clause and walk away from a deal faces the high burden of proving that the event or events claimed to be a MAC "substantially threaten the overall earnings potential of the target in a durationally-significant manner. A short-term hiccup in earnings should not suffice; rather the [MAC] should be material when viewed from the longer-term perspective of a reasonable acquiror" (IBP at 68)...