Coronavirus & MAC clauses: Devil in the details

The number of private equity deals pending closure when the coronavirus outbreak swamped Asia may be impossible to tally, but it is finite. This implies a kind of automatic containment to the use of material adverse change (MAC) clauses as a way of abandoning transactions where macro mayhem has spoiled business outlooks. Yet these contractual stipulations may represent the pandemic's most lasting and uncontainable impact on the industry.  

That's because this is one area where COVID-19 is changing not only the operating or investment environment, but also priorities and mindsets. Indeed, law firm Mayer Brown has identified MAC clauses as one of three core deal-making considerations in private M&A that are most likely to be permanently transformed by the pandemic, alongside due diligence and valuation processes. The central themes here are rethinking risk allocation and acknowledging that shakeups at a global level are not as unlikely as they may seem.

"The seismic impact of COVID-19 on the global M&A deal landscape is a first in many ways for this generation of deal-makers, but I don't necessarily think it will be the last time we witness such a cataclysmic event in our lifetime," says Steven Tran, a partner at Mayer Brown. "What the pandemic has shown us is how easy it is for economies around the world to be very quickly disrupted. This has been a wakeup call for investors and governments, and globally disruptive events like this could very well happen again."

Seeking patterns

Some of the higher-profile examples of MAC clauses being used to retreat from virus-dented deals in Asia include a BGH Capital consortium scrapping plans to acquire dentistry chain Abano and EQT's decision to walk away from an investment in aged care service provider Metlifecare. The former followed a government shutdown of all non-essential dental services, while the latter was reportedly related to concerns around coronavirus pressures on the lifestyle and economic outlook for the over-65 demographic.

It may be no coincidence that both these deals are in Australasia. Common law jurisdictions are generally less prepared for dramatic government intervention in the business sector than civil law domains such as mainland China. Otherwise, legal experts see few patterns in the rise of investor interest around MAC clauses. Deals where strategy is clearly unhindered by COVID-19 - such as investments in medical equipment suppliers or supply chain diversification - are not under the microscope. Everything else is. 

Still, there is little confidence in the idea that Abano and Metlifecare signal a looming landslide of disputes and broken deals. In most instances, a move to invoke a MAC clause is merely a precursor to an attempt to renegotiate terms, not a nixing of the whole transaction. Moreover, the way most MAC clauses are drafted – requiring businesses to suffer a disproportionate impact versus their peers – makes them difficult to implement based on an event that hammers the entire market. 

"Courts are not very interested in rewarding buyer's remorse and allowing investors to back out of a deal because it doesn't look as good as when they went in," says Timothy Blakely, Hong Kong managing partner at Morrison & Foerster. "That's not the purpose of MAC clauses anyway. Traditionally, they're designed for situations where there's been a severe impact on business for a significant duration, and this outbreak just hasn't been long term enough – yet. What we're going to see in the interim is a lot of negotiations around price and other aspects of deals."

Best practice for MAC clauses going forward will include a stronger focus on government intervention – even in relatively laissez-faire markets – and shrewd language. Buyers will push to define MACs as events that "could reasonably be foreseeable" to have an impact while broadening the scope of financial damage beyond monetary figures to include "assets" or "prospects." Sellers will seek more exemptions with specific terminology around pandemics, epidemics, policy shifts, and effected industries and geographies. 

Compromise solutions?

In an increasingly globalized economy, reaching a compromise will not be easy.     

"When you have a situation where all the supply chains are squeezed, you may not be able to find definite solutions in old-style, pre-pandemic MAC clauses, even with conditions about government actions," says Daniel Tang, a partner at Withers. "Buyers and sellers will have to think more carefully about coming up with clauses to cover their respective businesses. When it comes to risk allocation, both parties will need to be understanding and accommodating to come to an agreement."

Part of this balancing act may see MAC clauses incorporate more considerations associated with force majeure instruments, which usually outline walkaway provisions for ongoing commercial arrangements rather than M&A obligations. Other mechanisms seeing increased use could include break-free fees and prerequisites demanding a business continue to operate normally between signing and closing. 

Whether any such maneuvers result in a buyer-friendly or seller-friendly MAC clause will continue to be dictated by the bargaining positions of the parties involved. But there remains a sense that increasing specificity and complexity in M&A contracting is likely to hamstring both sides by slowing down a process already complicated by various lockdowns and travel restrictions, at least in the medium term. Cutting through the muddle will be, to a large degree, a matter of devising more quantitative risk allocation formulas. 

"We're talking to clients about MAC clauses with actual dollar-amount thresholds where you can objectively determine if the thresholds have been met," says Marcia Ellis, a partner at Morrison & Foerster. "If revenue is reduced by a certain percentage over a certain period, it will be deemed a MAC. For earlier-stage companies without stable revenue, there may be other metrics. There will be negotiations around the details, and they'll split the risk. When it's just a number, you're usually able to come to some agreement. I want three months and you want six, so let's do 4.5."

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• Topics
• Buyouts
• Regulation
• Asia
• covid-19
• coronavirus