November 8, 2018

Protecting Buyers in Uncertain Times – Court supports $4.3 billion deal walkaway

For the first time, a buyer has successfully relied on a MAC clause with a court’s support where changes to the target business were durationally significant. It is a timely decision for acquisitions during uncertain economic times.

What is a Material Adverse Change condition?

A material adverse change (MAC) condition or representation is a mechanism in an acquisition contract that assigns the risk between the contracting parties if there is a gap in time between the signing of the initial agreement and its completion. It is also referred to as a material adverse effect (MAE) condition.

One of the parties is responsible for any adverse events that may fall on the target business or company during this period.

It provides protection to acquirers during uncertain times or against unknown or unplanned events.

What qualifies as an adverse event?

The basic principle is that the MAC clause allows the buyer to terminate the agreement when an adverse event has made the acquisition unattractive.

What makes an acquisition unattractive varies between transaction. Each deal potentially has differing adverse events that could affect the transaction and what qualifies as an adverse event should ideally be customised based on the target business or company.

An example of an adverse event could be a loss of revenue in the target’s market or a downward trend in market conditions.

What happens if there is an adverse event?

If there is a qualifying adverse event, the buyer can walk away from the deal.

Alternatively, the MAC condition could allow the buyer to renegotiate the transaction. For example, acquirers have used this to negotiate a significant discount to the purchase price or valuation multiple.

Why has there been a recent focus on MAC conditions?

The downturn of the global economy has created an environment where buyers have sought to protect themselves in an uncertain economic climate.

How do courts interpret a MAC condition?

It will be interpreted based on contract law principles.

MAC clauses have mainly been considered by courts in the US.

There is no significant judicial guidance in Australia or from courts in the UK. The reasoning and decision of US courts provide useful guidance as to how other countries will interpret MAC conditions.

This makes the Delaware Court of Chancery’s decision to allow a buyer to successfully invoke a MAC condition interesting across jurisdictions.

What happened?

Fresenius Kabi AG (Fresenius) are a pharmaceutical company based in Germany.

They agreed to buy Akorn Inc., a manufacturer of pharmaceutical products based in Illinois.

In the merger agreement, Akorn indicated it had complied with the necessary regulatory requirements.

Further, the German company's obligation to complete the agreement was based on the representations of Akorn being correct both at signing and closing "except where the failure to be true would not reasonably be expected to have a material adverse effect on Akorns business."

Akorn's financial performance rapidly deteriorated after signing.

Fresenius then became aware that Akorn had some regulatory compliance issues.

Finally, Akorn sufferred rapidly declining operating income. Akorn suggested that this was due to unexpected competition, loss of a premium contract, problems with supply, and a reduction in prices.

Fresenius made Akorn aware in April 2018 that it was terminating the merger agreement. The agreement allowed Fresenius to terminate the agreement if any of the representations made by Akorn were untrue, "except where the failure to be true would not reasonably be expected to have a material adverse effect on Akorn’s business."

Consequently, a suit was filed by Akorn who alleged that Fresenius was attempting to terminate the agreement invalidly and sought orders that Fresenius close the acquisition.

The Court's findings

In a 246-page post-trial opinion, the Court permitted Fresenius to ditch the USD 4.3 billion acquisition.

The Court found that Akorn’s sudden and sustained drop in business constituted a general material adverse effect.

Furthermore, the representations made by Akorn relating to regulatory compliance were untrue. The conditions as represented by Akorn and its actual situation would also reasonably be expected to result in a material adverse effect.

Finally, Akorn had implemented operational changes which breached its covenant to operate in the ordinary course of business.

What does this mean for you?

  1. Make the definition work. You need to pay attention to MAC definitions. If the MAC clause is too generic or broad, it will be difficult to enforce and a buyer will be bound to complete the deal or face damages for erroneously relying on the MAC condition.
  2. Make it deal-specific. Taylor a MAC condition to the post-signing specific risks between the buyer and seller for the particular transaction.
  3. Handle post-signing issues carefully. A Court faced with a buyer who acts methodically, with the support of advisors and valuation analysts, when addressing post signing issues and making an assessment of the situation, may be more likely to view an assertion of a MAC as more credible.
  4. Not every adverse event is a MAC. A decline in performance or adverse event must be durationally significant, and performance should be measured on a year-over-year basis to avoid seasonal effects. A short-term blip is likely to be insufficient.
  5. Synergy means little. The fact that the target business may have synergies for the buyer is inconsequential if the business has itself suffered a MAC.
  6. A MAC is a negotiation tool. You can use the MAC clause as a tool to renegotiate the contract. Rather than terminating the agreement, you could seek to negotiate an aspect of the agreement, such as the purchase price or valuation multiple.
  7. Cater for specific events and risks separately. If a party wants to protect themselves from a specific event, rather than solely rely on a MAC condition, it could additionally insert it in the contract as a separate condition.
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