The Big MAC in M&A: Hold the Carve-Outs Please

What happens when your order lands on your tray and it doesn’t look like you are getting what you paid for?

Just as you are about to close your deal, you learn that the business you agreed to buy met only half of its projected sales forecasts for the last several quarters and its gross revenues are down almost 10%. Can you declare a “MAC” and walk away from the contract?

In M&A, not all surprises are big enough to trigger a MAC (or material adverse change) clause, especially if they relate to a target’s financial underperformance.

Dealmakers use MAC clauses to allocate risk between the buyer and target for unforeseen events arising in the period between signing and closing the deal.

MAC clauses are very common—albeit heavily negotiated. As a closing condition, a MAC clause defines circumstances (other than those explicitly “carved out,” such as national economic or political disasters) that allow a party to terminate an otherwise binding obligation to close after the purchase agreement has been signed.

It can also be the basis for a standalone target representation that the target business has not suffered a MAC in the run-up to closing. The MAC definition may also qualify other representations and warranties in the agreement (including those which must be true at closing, through the bring-down closing condition).

When it comes to a target’s poor financial performance, the courts have gone either way in deciding whether the target has experienced a material adverse change, sometimes allowing the buyer to walk out on the deal.

In every case, it boils down to this: what’s material?

In Canada, there is a dearth of case law on MAC clauses involving large or complex M&A transactions. Canadian courts will typically resort to the definitions of materiality in analogous contexts, such as accounting practice and securities law, in order to discern whether a particular development is material.

In the U.S., the courts have developed a clearer test with respect to the meaning of materiality. Relevant factors include the magnitude of the change; whether the change relates to an essential purpose of the agreement; and the duration of change.

In the past, Canadian courts have found that that a 9.4% reduction in gross revenue leading to a 56.1% reduction in operating revenue was “material,” whereas, in contrast, in the U.S., the failure to meet a projected quarterly target was not.

The interpretation of a MAC clause will ultimately depend on the language used by the parties in their agreement and on the surrounding circumstances relevant to the interpretation of the agreement. Rather than leave it to chance, and the relatively high standard that will apply to purchasers seeking to rely on a MAC clause, a buyer should attempt to be as broad as possible in defining a MAC event or circumstance and limit the number of carve-outs made by the seller to shift these closing risks onto the buyer.