Material adverse change in Dutch M&A transactions
By Rudolph A. I. Snethlage, TeekensKarstens advocaten notarissen
Over the past 15 years, there have been several serious events which had a negative economic impact on a global scale. A few examples include 9/11, the bankruptcy of Lehman Brothers and the subsequent credit crunch and recession, not to mention the more recent threat of a Grexit. Imagine being absorbed in closing an important deal and pending completion when, quite suddenly, Greece announces it is leaving the European Monetary Union. Fortunately, your client, who is the purchaser, stipulated that the sale and purchase agreement (SPA) should contain a “MAC-clause”. Does the Grexit qualify as material adverse change (MAC), allowing your client to step back or modify the deal?
Typically, a MAC clause is structured as a condition precedent so that a purchaser is not obliged to complete in case a MAC occurs. Such clauses usually define a MAC as “a change that is materially adverse to the business, financial condition or results of operations of the business taken as a whole”. Another form of a MAC clause is the warranty of a seller that, at completion, no MAC has occurred, giving the other party the right to terminate in case of a MAC or to claim damages as a consequence of the non-fulfilment of that guarantee.
What is the statutory framework for this issue in the Netherlands? Under Dutch law, there is the notion of “unforeseen circumstances”, which can lead to an amendment or even termination of the contract. The criterion is: can keeping the contract unchanged be required without infringing the principles of reasonableness and fairness (Section 6: 258 of the Dutch Civil Code)? Another Dutch law principle refers to the legal concept of conformity, meaning the requirement that the subject matter of the contract “should conform to the agreement” (Section 7:17 of the DCC).
In case the SPA does not contain a MAC clause, the question arises as to whether serious events such as a Grexit could be used for successfully claiming termination on the basis of unforeseen circumstances or non-conformity.
Case law in connection with the unforeseen circumstances and nonconformity ascertains that it is almost impossible to successfully claim termination (or an amendment) of a contract in court for these reasons.
Consequently, as is the case in all common law jurisdictions, we use MAC clauses in our Dutch law SPAs, in order for the parties to be able to respond to substantial changes in the circumstances.
Dutch case law on MAC clauses
There is only one relevant Dutch case in connection with a MAC clause and that is Philips vs. Phoenix (Dutch Supreme Court 2007) regarding the sale to Phoenix of BCC. In this case, Phoenix tried to lower the purchaser price or even rescind the SPA on the basis that Philips had given the warranty that at completion no MAC had occurred. Pending completion, the operational profit of BCC dropped significantly, which according to Phoenix did qualify as a MAC. However, the Dutch Supreme Court ruled that BCC’s lower EBITDA levels as such did not qualify as a MAC. External market conditions, according to the Supreme Court, could qualify as a MAC, and lower EBITDA levels could be an indicator, but then only to the extent that material chances in the market conditions would have a material impact on the business, financial condition or results of operations of the business as a whole.
This way of thinking is in line with case law in the USA. In IBP, Inc. vs. Tyson Foods (2001), the Delaware Chancery Court ruled that lower results in the last two quarters pending completion could not be seen as a MAC, because a MAC clause is “a backstop protecting the acquirer from the occurrence of unknown events that substantially threaten the overall earning potential of the target in a durationally-significant manner”.
In The Finish Line, Inc. vs. Genesco, Inc.(2007), the Chancery Court of Tennessee ruled that although the EBITDA levels of Genesco dropped significantly pending completion, this was cause by general market conditions which had similar impact on competitors of Genesco. The MAC clause in this case specifically ruled out such general MAC events. In addition, the Tennessee Court pointed out that in case of a strategic buyer, the MAC can only be based on “a demonstrated, unexpected and
durationally-significant adverse event”.
Lesson learnt: MAC provisions are not boiler plate clauses
In conclusion, case law shows that it is dangerous to rely on a generally phrased, boiler plate-like MAC clause. Instead, a MAC clause should always be drafted bearing the specific value drivers of the transaction in mind.
If it is essential for the funding to keep the operational profit at a certain level, dropping below that level before completion should specifically be mentioned as a MAC. If a Grexit or similar
important event in the European Monetary Union should qualify as a MAC, the MAC clause should specify that kind of event as well.
Of course, any MAC clause should also contain the generally phrased catch-all provision as mentioned above, just in case.
Last but not least
Having been in the M&A business for many years, since 1986 to be precise, I have witnessed circumstances where clients panicked and sought to get out of a deal.
One particular MAC is unforgettable: we were trying to close a deal when the first plane hit the WTC in New York. The other party immediately withdrew from the transaction, claiming that a MAC
as defined in the SPA had occurred. As pointed out in this article, we could have tried to argue that 9/11 did not qualify as a MAC as defined in the SPA.
In fact, it turned out that it did qualify as such in the financing arrangements, as well as closing of the funding by the purchaser and the lenders being a condition indispensable to completion in the SPA. So it is quite essential to synchronise the definitions of a material
adverse change in the transaction documentation.
TeekensKarstens advocaten notarissen, Alphen aan den Rijn, Leiden, The Netherlands
published: September 2015