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Trending: Call for Papers Volume 3 | Issue 2: International Journal of Advanced Legal Research [ISSN: 2582-7340]

MAC Clauses In Commercial Contracts: Lessons To Be Learnt From Covid-19

INTRODUCTION

The Covid-19 pandemic has brought about a state of utter social, political, and economic uncertainty and instability across the globe. Since the outset of the pandemic, especially in the investment and acquisition transactions, the buyers have been continuously grappling with the deteriorating business operations and its earning potentials and therefore, looking hard at the deal protection mechanisms, and in these circumstances, Material Adverse Change or Material Adverse Effect (MAC/MAE) clause in the business contracts would be their most sought after recourse. MAC clauses are generally found in finance and acquisition agreements.

In the context of M&A transactions, when, in the interim period of signing and completion of a transaction, any unforeseeable event occurs having a significantly adverse effect on the target company’s business, its assets and liabilities, or overall financial markets and hence putting the buyer in a precarious position and preventing it from the consummation of its obligations under the agreement, in this event the buyers can cash in on the MAC clauses.[i]

A MAC clause provides the buyer with a mechanism to safeguard themselves from unpredictable transaction risks and allows them to re-negotiate and amend the terms of the agreement or enables them to pull out of the transaction. In effect, this shifts the risks of occurrence of adverse changes between the signing and closing of the transaction from the buyer to the seller, leaving it exposed to the happening of any unforeseeable event. Taking account of the effectiveness and practicality of the MAC clauses, it is considered as one of the most efficient contractual weapons form the buyer’s perspective.

COVID-19: A MATERIAL ADVERSE CHANGE?

As is evident, with the stringent restriction being placed on the movement of people, goods, and services across the globe, this pandemic caused an exceptional decline in the demand for travel, entertainment, consumer and retail spending, and petroleum among other things, and affected overall trade and commerce. The Covid-19 pandemic may not necessarily be enough to trigger a MAC as the application of a MAC clause is very fact-dependent and requires a substantially adverse effect on the other party’s business to enable him to fulfill its obligations under the agreement. Due to a great dearth of set guidelines in this regard, to determine which event may be considered as MAC, each case needs to be examined by the judicial bodies based on their unique factual position.

When considering whether an event constitutes a material adverse change, several factors need to be examined including the nature of the business, the contractual language, the gravity of the adverse event, and the circumstances in which the parties entered into the agreement.[ii] For example, in the Covid-19 situation, while the travel or entertainment industry might have got affected to a great extent, the IT companies, the healthcare providers and the companies providing video conferencing services, among others might have seen a boom. 

Similarly, if the language in the MAC clause specifically encompasses force majeure events, pandemics, outright impact on the market, and the economic condition, the chances for the party to rely on the MAC clause would be very high. In the same way, the knowledge of the parties about the event while entering into the agreement would play a great role in determining the applicability of the MAC clause. For example, if, at the time of signing the contract, the parties were of aware of any adverse event that might defeat the entire purpose of the transaction or if that event was reasonably foreseeable, then, unless that situation worsens to an enormous extent, it would be difficult for the parties to invoke MAC clause successfully. Therefore, a lot of factors determine the application of the MAC clause and it would not be justified of one to straightaway state that Covid-19 has triggered MAC or not. The results would vary from case to case and the extent of its application would be totally within the discretion of the court.

THE ROAD AHEAD

The Covid-19 pandemic has placed a renewed focus on MAC clauses and its significance in commercial contracts. Given the intricacies involved in the application of the MAC clause, Courts have been conservative while viewing and interpreting MAC clauses and generally do not allow parties to avail it as their way out of any transaction. Besides this, it is the party who seeks to invoke the MAC clause has the burden to prove its occurrence.[iii] This entails the contracts to be well written and drafted covering all possible deal protection mechanisms to save parties from any unforeseeable and adverse events happening in the future.

The current pandemic has given the parties an opportunity to introspect and devise a more robust and secure mechanism to protect themselves against any unpredictable circumstances, i.e. to have a more effective MAE clause, and in order to do that, there are a few things that need to be taken care of before one incorporates a MAC clause in any agreement. The first one is due diligence. Conducting thorough due diligence is considered as one of the key factors for the success of any business transaction. In terms of M&A, it is imperative for the buyer to familiarize himself with the values and risks associated with a transaction and find out any shortcoming or deal diluter which might be impacted and get worse in any unexpected event and then, in the end, consider getting that included in the MAC clause as a specific event.

The second one is negotiation. As is evident, the inclusion of a MAC clause in a contract shifts the burden of any unpredictable adverse event from the buyer to the seller. In this case, the broader the terms of the contract, the more vulnerable is the seller, and therefore, he would want the MAC clause to be as narrow as possible, whereas, the buyer would want the exact opposite. This is when negotiation comes into the picture to structure the deal in a way that addresses every kind of potential issues and share the risks of any business downturn at the same time. The third one is exploring insurance policies aimed at alleviating losses flowing from the loss of productivity or such other business interruption policies. Businesses should also consider developing effective risk management policies and business continuance plans.[iv]

CONCLUSION

The inclusion of the MAC clause in a contract facilitates the contractual exit for a party without actually breaching that contract. Given the restrictive application of the MAC clauses by the courts, invoking it is easier said than done and brings its own set of challenges. Though invoking a MAC clause may seem a facile option on paper, but, in practicality, it is difficult to materialize it considering the evidentiary burden and the overall cost of proving it. But, this clause definitely acts as a tool for the buyer to leverage the seller into renegotiating the terms of the agreement. Understanding the current economic realities and evaluating the protracted litigation process and the costs and reputational damage associated with the claim, generally, even the sellers are inclined towards renegotiating the terms of the contracts, which reaffirms that, especially for buyers, in the M&A context, MAC clauses will continue to be an efficacious contractual weapon. 

REFERENCES

[i] Richard Spink, Covid-19: Is it a Material Adverse Change in M&A Transaction?, Burges Salmon (March 27, 2020),
https://www.burges-salmon.com/news-and-insight/legal-updates/covid-19/covid19-is-it-a-material-adverse-change-in-ma-transactions/.
[ii] Suneeth Katarki et al., India: Coronavirus (COVID-19): Impact of MAE/MAC Clauses on M&A and Investments, Mondaq (March 26, 2020),
https://www.mondaq.com/india/maprivate-equity/908528/coronavirus-covid-19-impact-of-maemac-clauses-on-ma-and-investments.
[iii] Adarsh Saxena & Mohanakrishna C, Invoking Material Adverse Change Based on Covid-19: Easier Said Than Done, Cyril Amarchand Mangaldas (May 26, 2020),
https://corporate.cyrilamarchandblogs.com/2020/05/invoking-material-adverse-change-based-on-covid-19-easier-said-than-done/.
[iv] Supratim Guha et al., Can Covid-19 Amount to a Material Change?, Nishith Desai Associates (April 01, 2020),
http://www.nishithdesai.com/information/news-storage/news-details/article/can-covid-19-amount-to-a-material-adverse-change.html.
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Author: Raushan Kumar, Damodaram Sanjivayya National Law University, Visakhapatnam

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