Deciding how material is an adverse event

By Raghubir Menon and Swati Sharma, Shardul Amarchand Mangaldas & Co.

The concepts of material adverse events (MAE) and material adverse changes (MAC) are widely incorporated into acquisition and investment documents. An MAE clause classically permits the acquirer to withdraw or walk away from a transaction after the execution of transaction documents. This is where events occur between signing and closing that render the completion of a transaction commercially unviable for the acquirer. In addition, MAEs may qualify and limit warranties provided by the seller or the target company.

Raghubir Menon, Shardul Amarchand Mangaldas & Co.
Raghubir Menon
Partner and Regional Head of M&A and Private Equity, General Corporate
Shardul Amarchand Mangaldas & Co.

While the scope and definitions of MAEs may be negotiated in detail by the buyer, an MAC clause is intended to cover any event or series of events that results or would reasonably be expected to result in a material adverse impact on the business, financial condition or prospects of the target company. While the determination or impact of an MAC will be assessed by the buyer, the counterparty will endeavour to incorporate clauses into the contract agreeing to the joint or mutual determination of MAE events. Sellers will often try to structure an MAC clause that limits subjective assessment by linking it to predetermined monetary thresholds using objective metrics such as earnings before interest, taxes, depreciation and amortisation (EBITDA) or profit after tax over a particular period.

In the governance of listed entities, the SEBI (Substantial Acquisition of Shares and Takeovers Regulations), 2011, prescribe that, “an open offer once made can be withdrawn if any condition stipulated in the agreement is not met for reasons outside the reasonable control of the acquirer”. The Supreme Court, in analysing this provision in the case of Pramod Jain & Ors. v SEBI, held that the withdrawal of an open offer may be permitted in cases where the circumstances leading to withdrawal of an open offer fall within the “realm of impossibility”. However, “economic undesirability” cannot be accepted as grounds for the withdrawal of an open offer. Based on its recent history, the Securities and Exchange Board of India (SEBI) does not currently consider an MAC as being an acceptable event for the withdrawal of an open offer.

Swati Sharma, Shardul Amarchand Mangaldas & Co.
Swati Sharma
Principal Associate
Shardul Amarchand Mangaldas & Co.

In a recent example, the SEBI in permitting the withdrawal of a buy-back offer by Thomas Cook (India) Ltd. (TCIL), decided that the covid-19 pandemic rendered it impossible for TCIL to go ahead with an announced buy-back offer, due to the impact of the pandemic on the tourism industry. Such impossibility “was beyond the company’s control”. Interestingly, in its order the SEBI directed that the permission to withdraw should not be construed as a precedent.

Global trends over the past few decades show that courts across a number of jurisdictions have held that an MAE should meet a high threshold of adverse impact on the proposed transaction. In the USA, the Delaware Court of Chancery has examined MAE clauses in numerous instances and has held that to constitute an MAE, the event in question must be significantly material and should have a durational significance. In the case of breach of representations, the court in another case held that such breach should reasonably be expected to result in an MAE. These cases make it clear that whether an adverse event is material depends to a great extent on the definition clauses the parties have agreed in the contract. In England, the leading case on MAEs, Grupo Hotelero Urvasco SA v Carey Value Added SL, decided that an MAE should significantly affect the company’s obligations. Such an event has to be proved by the party invoking the MAE.

To conclude, the interpretation of MAE clauses is fact and contract dependent and will continue to evolve through a combination of judicial pronouncements and fluctuating market conditions. If the invocation of an MAE is litigated, the courts are likely to uphold the concept of sanctity of contract. To avoid prolonged litigation over whether an acquirer may invoke an MAE, which may itself worsen the economic undesirability of the deal, the acquirer will have to define MAEs and their consequences carefully when drafting the contract. The acquirer must keep in mind criteria such as the events intended to be covered by any MAE; what anticipated adverse events should be classified as MAEs; who will determine that an event is an MAE, and what should be proposed as necessary exclusions to any MAE.

Raghubir Menon is partner and regional head of M&A and private equity, general corporate, and Swati Sharma is a principal associate at Shardul Amarchand Mangaldas & Co.

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Disclaimer: This article is intended to provide a general guide to the subject matter. Specialist advice should be sought on readers’ specifics circumstances. The views in this article are the personal views of the authors.