Material Adverse Change (MAC)

What is a Material Adverse Change (MAC)?

A material adverse change (MAC) is a significant change or effect that may negatively influence the outcome of an agreement. Buyers, sellers, and creditors use MAC clauses in merger and acquisition (M&A) or financing agreements to protect their rights. MACs are also known as material adverse effects (MAEs).

Significant changes or events can arise after signing an agreement. It may be so adverse that the effect is considered enduring and that the terms under which the agreement was made are no longer thought to be true. 

For example, a company may become far less valuable than when a prospective buyer agreed to purchase it. In extreme cases, the transacting parties may agree that completing the contract is no longer in their best interests.

Material Adverse Change Uses

The period of time between when an M&A (or financing) agreement executes and when it schedules to close can be quite long. During this period, a variety of circumstances can affect the buyer, seller, or creditor. Some changes are severe and enduring, so much so that the outcome can shift the expectations of the agreement. Such an effect may be so undesirable that the parties may not have entered into an M&A or financing deal in the first place.

MAC (or MAE) clauses outline circumstances in which parties to an agreement may terminate a contract. As a result, there is a strong interest in negotiating these clauses of a deal. Their prevalence and enforcement vary by jurisdiction, often based on business norms and customs. MACs (and MAEs) tend to be very common in the U.S.

A MAC (or MAE) generally describes undesirable changes (or events). Of note:

• The broader or more subjective they are, the more open they are to interpretation by the legal system. It is less likely that a party can avoid completing the contract even if the change occurs.
• The more specific or objective they are, the less open for interpretation by Courts. It is more likely a party can terminate the contract if a change (or event) does occur.

Contracts are the foundation of business, and courts only void an agreement under extreme circumstances. A contractual party must prove to a court that an undesirable outcome had occurred and that it meets the MAC (or MAE) definition within the deal.

How are MACs Decided?

MAC (or MAE) clauses may cover the agreements’ representations and warranties or describe conditions precedent for completion of a transaction.

Courts tend to focus on three facts that a petitioning party must prove:

1. A circumstance is severe and enduring.
2. A change or event affects a business more significantly than its industry peers.
3. Lack of prior knowledge by the petitioning party despite proper due diligence.

As these are high burdens of proof, judgments are rare when disputes occur surrounding material adverse changes (or events). There is a strong interest for parties to negotiate before a final court ruling on breaking the agreement. 

Not only is voiding a contract usually considered the last resort, but the parties may also experience an undesirable court ruling even if the clause is triggered appropriately.

In summary, a MAC (or MAE) is more likely used to re-negotiate and reconcile differences between the contractual parties.

Example: IBP shareholders and Tyson Foods

In 2001, IBP, Inc. (IBP) agreed to be acquired by Tyson Foods (Tyson) for $3.2 billion. IBP was the largest U.S. processor of beef. Tyson is the world’s largest poultry producer. IBP had attempted a leveraged buyout by management and considered a buyout proposal by Smithfield Foods, a large pork producer and competitor to Tyson. 

Before closing, Tyson withdrew from the M&A agreement. Tyson cited a material adverse event due to an investigation of IBP’s accounting practices by the SEC. They stated that IBP did not provide full financial disclosure of accounting issues before the agreement. The SEC found accounting irregularities that caused IBP management to restate its financial results.

IBP disputed Tyson’s rationale for withdrawing from the deal. They took the dispute to Court. The U.S. Court, considering the matter, found the following:

• Although a 64% quarterly decline in sales was severe, it may not be enduring. Expert testimony did not support Tyson’s position that a MAC (MAE) occurred.
• The issue affecting IBP was industry-wide due to severe winter conditions causing problems for livestock.
• Tyson received communications from IBP of potential financial issues and had prior knowledge. It accepted the uncertainty at the onset of the deal.
• The motive for Tyson to use the MAC (MAE) clause was due to regret in overpaying for IBP. Tyson did not prove that IBP induced it to overpay by misrepresentation or omission.

As a result of the findings, the Court[1] decided that Tyson was required to complete the contract.

Example: Akorn and Fresenius Kabi

In 2017, Akorn. Inc (Akorn) agreed to be acquired by Fresenius Kabi AG (Fresenius) for $4.3 billion. Akorn is a U.S. drug company listed on the NASDAQ. Fresenius is a German drug company, a division of Fresenius SE & Co. KGaS.

Before closing, Fresenius terminated the M&A agreement. Fresenius stated that Akorn misrepresented its financial health and regulatory compliance. As a result of its investigation, a MAC (MAE) existed that allowed Fresenius to withdraw from the deal.

Akorn disputed Fresenius’s rationale for withdrawing from the deal. Both parties took the dispute to Court. The U.S. Court, considering the matter, found the following:

• Four consecutive quarters of revenue, operating income, and EPS declines were severe and enduring. Statements by Akorn’s management supported the finding of a prolonged effect.
• The issue affecting Akorn was specific to the company.
• There was severe doubt in the data provided by Akorn that Fresenius relied upon – Fresenius had no prior knowledge. There was evidence that Akorn’s submissions to the regulator (the U.S. Food and Drug Administration) were potentially fabricated. Akorn also stopped audits and inspections that would have revealed ongoing violations, contrary to their representations and warranties.
• Fresenius demonstrated both quantitatively and qualitatively that Akorn did not meet its representations and warranties. It was not obligated to conclude the contract.

As a result of the findings, the Court[2] decided that Fresenius’s termination of the agreement was legal and justified. It was not required to close the deal.

Additional Resources

• Free Fundamentals of Credit Course
• Due Diligence
• M&A Process
• Risk of Material Misstatement
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