Managing disputes in Canada and the U.S.: MAE clauses

Andrew Bernstein (00:05): How can buyers in the M&A and private equity space protect themselves against significant negative changes in their target company before closing? I'm Andrew Bernstein from Torys’ litigation group in Toronto, and I'm here with my partner, Erica Goldman, who practices litigation at Torys New York, to discuss MAE or MAC clauses. So, Erica, what is an MAE or MAC clause?

Erica Goldman (00:28): So, an MAE or MAC means material adverse effect or event, or a material adverse change, which refers to a specific occurrence that decreases the value of an entity or interest typically in the context of a sale or a purchase.

Andrew Bernstein (00:43): And how is this reflected in commercial agreements?

Erica Goldman (00:46): So, it's a contract term which allocates risk of an adverse change impacting the seller between the time of the agreement signing and the closing. And effectively sets a threshold for what's acceptable in terms of negative impacts. So, if an event or occurrence rises to the level of a MAE under a particular contract, the buyer could be relieved of its obligation to complete the planned acquisition.

Andrew Bernstein (01:08): So, I assume that this is the kind of clause that would typically be quite heavily negotiated?

Erica Goldman (01:13): Absolutely. And their wording really depends on which party to the agreement you represent, the buyer or the seller. Buyers generally seek to include forward-looking language, broad categories and very few exceptions. While the sellers want removal of forward-looking language and the addition of carve outs. Andrew, how have you seen MAE or MAC clauses used in practice, in Canada?

Andrew Bernstein (01:36): So, in addition to what you were talking about, which is to talk about allocating the risk of non-closing, we often see MAE or MAC clauses used to qualify a seller's representations of warranties and insulate the seller from time to time from liability to reimburse a buyer for a busted deal. So, they're also often implemented as a condition to closing. Of course, the seller will bring down the reps and warranties at closing and that will include the MAE clause. So, you have to present a certificate at the closing of a deal to say there's been no material adverse effect since the time we signed the purchase agreement. How do the US courts interpret these clauses?

Erica Goldman (02:16): Sure. So, the bar for proving an MAE is extremely high and seller-friendly. In fact, in Delaware, long viewed as the gold standard for corporate law in the US, it wasn't until 2018 when the Delaware Supreme Court upheld for the first time the ability of a buyer to terminate a merger based on a finding that an MAE had occurred.

And there have now since been a handful of cases that have gone the same way.

Okay, and I'm guessing that the facts in those cases were pretty bad.

Correct. So, in that particular case, after signing but before closing, a whistleblower prompted the buyer to conduct an internal investigation which revealed that the target company had gutted its QC function to prevent the buyer from learning about its flaws. There was also an increased competition and also margin erosion. So, the court noted the magnitude and the extended duration of the financial impact to the target would have far-reaching and long-lasting effects on regulators and customers alike.

Andrew Bernstein (03:14): And would you say this emphasis on magnitude and duration was consistent with the previous case law on the topic?

Erica Goldman (03:20): So, it actually was. So, while the decision itself was groundbreaking, the court's analysis was fairly straightforward. It considered qualitative and quantitative factors.

Andrew Bernstein (03:29): So, there was MAE litigation during the pandemic, and in both cases, it went against the buyers and for the sellers adopting what we referred to sometimes as the “Delaware approach”. But it might have had to do more with the very specific language in those cases, and a little less to do with general approach towards MAE. On the other hand, and interestingly, the interim operating covenant issues went in a totally different direction, but maybe we'll do a different video on that sometime.

Erica Goldman (03:56): Deal. Andrew, can you give us some takeaways?

Andrew Bernstein (03:59): Sure. So, number one, busted deals are a big threat to sellers because the thing that was going to be sold can be viewed as tarnished goods in the market. The seller has got to do everything possible to make sure the buyer has to close the deal, including negotiating industry-specific carve outs, for example, adverse decisions by government agencies when those agencies are heavily regulated.

Number two, buyers should be cautious in allowing MAE qualifiers in their representations and warranties because they ultimately create hurdles to proving a breach. Whereas sellers can shift risk or unknown pre-closing liabilities to the buyer. And number three, because there's no bright line test for what qualifies as an MAE, a well-crafted definition is going to be important. This requires the parties to turn their minds to the risks.

I would say parties weren't so great at that before COVID, but of course since then have gotten much better.