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Material Adverse Change - Questionable Enforceability

Meaning and Effect

Material Adverse Effect (“MAE”) or Material Adverse Change (“MAC”) clause confers the right in favour of a party to terminate a contract upon occurrence of any event which materially affects or materially changes the circumstances under which the transaction was originally agreed. MAC clauses usually find mention in inter alia mergers and acquisitions (“M&A”), financing contracts and securities purchase contracts, where the time period between the signing and closure of the transaction is very crucial such that by the time the transaction is given effect there could be a material change in the circumstances which prejudicially effects the interest of either party and as a result, the affected party might want to exit the contract.

MAC clauses are usually defined in general and broad terms so as to protect the parties against unforeseeable and unexpected circumstances which materially alter the premise of the transaction. A MAC clause usually enables buyers and lenders to exit the transaction if the underlying value of the transaction materially diminishes or the circumstances under which the transaction was agreed materially changes. At the same time, a MAC clause also encourages sellers and borrowers to protect the material value or fundamental circumstance of the transaction so that the underlying foundation of the transaction is reasonably preserved.

MAC clauses can therefore be equated with force majeure clauses which enable a party to exit a contract. However, force majeure clauses specify the events that will entitle a party to excuse inter alia the performance of the contract, whereas, MAC clauses do not necessarily specify the event(s) which entitle a party to enforce the clause. As a result, the interpretation of force majeure clauses becomes easier in comparison MAC clauses. Another difficulty when it comes to MAC clause is the absence of a definite threshold for quantifying materiality and the interpretive hurdle in determining the context/meaning of ‘materiality’ in the MAC clause. As a result of such generality in MAC clauses, the interpretation of the clause is a challenge and often leads to disputes centring around what constitutes “material” to the transaction or the parties involved.

It is in the above backdrop, especially the subjectivity of interpreting MAC clauses, that this article attempts to deal with the manner in which courts across different countries have interpreted MAC clauses when invoked for the terminating a transaction, including India.

Judicial Interpretation of MAC clauses in United States of America (“USA”)

Judicial precedents regarding enforceability of MAC clauses are very limited, globally. However, US courts have been at the forefront of adjudicating on litigations arising out of the MAC clauses. US courts have usually employed a high threshold for judging the enforceability of MAC clauses and the scope of the term “material”. As a result, the instances of successful enforcement of MAC clauses in US have been limited.

In IBP, Inc. vs. Tyson Foods, Inc.[1], Delaware Chancery Court while dismissing Tyson Foods, Inc’s claim for application of MAC clause on the premise that IBP, Inc’s performance for the period between signing and closing of the deal was poor and materially deviated from performance in past years and thus amounted to a “Material Adverse Change”, held that a "short-term hiccup" in a company's earnings would not qualify as material and that materiality should be viewed from a long term perspective. The court further held that in a complex, highly-negotiated merger agreement, a MAC clause should be viewed as a backstop protecting the acquiror from the occurrence of unknown events that substantially threaten the overall earnings potential of the target in a durationally-significant manner.

Following IBP, Inc. vs. Tyson Foods, Inc., in Frontier Oil Corp. vs. Holly Corp.[2], the Delaware Chancery Court, once again employing the principles enunciated in IBP, Inc. vs. Tyson Foods, Inc., held that the risk of adverse results and/or the costs of defending lawsuits filed against Frontier would not amount to MAE. This was a case of merger between Frontier Oil Corp and Holly Corp. At the time when Holly Corp. was conducting its due diligence of Frontier Oil Corp., it discovered that there was a reasonable possibility of a litigation being initiated against Frontier Oil Corp. Accordingly, the terms of the merger were modified to include the possible litigation in Frontier Oil Corp’s representation so as to amount to an MAE. Pursuant to the signing of the merger agreement, the contemplated litigation was initiated where Frontier Oil Corp. was made one of the defendants. However, the court found that substantial litigation costs were not a MAE and therefore the contract could not be rescinded by Holly Corp.

The above two cases were followed by Delaware Chancery Court in Hexion Specialty Chemicals, Inc. vs. Huntsman Corp.[3] where while reiterating the principles of “long term analysis” the court went on to lay down additional principles including that deviations from projections made by a seller is not to be relied upon for the purpose of invoking MAC unless specific representations or warranties have been given by the seller with respect to such projections. The court also held that carve outs in MAC clauses such as industry comparisons cannot be used for the purpose of ascertaining materiality. The court held that industry comparison (if present as a carve out) is to be made only after a MAC had been established and cannot be used to determine whether a MAC had occurred.

However, in Osram Sylvania Inc. vs. Townsend Ventures, LLC[4], the Delaware Chancery Court, while deviating from the strict and high threshold for enforcing a MAC clause, upheld the enforcement of the MAC provision. This was a case where Osram Silvania Inc. (“Osram”) agreed to purchase shares of Encelium Holdings (“EH”) from Townsend Ventures, LLC and others (“Townsend”) which were valued basis inter alia Townsend’s representations regarding EH’s sales for second and third quarter of 2011. However, Osram relied on the definition of Material Adverse Effect and Material Adverse Change in the agreement i.e. “any effect or change . . . that would be materially adverse to the Business, assets, condition (financial or otherwise), results or operations” read with the breaches by Townsend including incorrect and manipulated representations regarding second quarter 2011 financials, inflated third quarter sales projections which was eventually short by 50%, resignation of two key salespeople, failure on part of Townsend to observe its obligation to notify Osram of these amongst other circumstances that have a MAE etc. The court agreed that manipulation of second quarter 2011 financial figures and inflated third quarter 2011 projections which were substantially not met (upto 50%), amounted to MAC. However, the argument by Osram regarding resignation of two key salespeople amounting to MAC, the court did not agree. The court held that employee resignation is a regular occurrence in businesses and does not necessarily amount to MAC, specifically, in the present case because the significance of the two employees was based on their “projected” sales performances. The court also held that failure to negotiate the inclusion of the two salespeople as part of "Key Personnel" under the contract also weakened Osram’s argument.

Delaware Chancery Court again in Akorn, Inc. v. Fresenius Kabi AG[5] upheld the enforcement of MAC provision and rescission of an M&A contract by Fresenius Kabi AG basis the sustained decline in the business performance at the rate of 25% in revenue flows for a period of 1 year following the signing of the agreement, and also on the basis of inaccurate representations by Akorn, Inc. regarding regulatory non-compliances which on a quantitative and qualitative analysis was held to constitute a MAC.

Judicial Interpretation of MAC clauses in United Kingdom (“UK”)

UK also has limited precedents on enforcement of MAC clauses. The important ones being Grupo Hotelero Urvasco SA v Carey Value Added SL and another[6] and Decura IM Investments LLP and Others v UBS AG, London Branch[7], wherein the English courts have laid down principles similar to those laid down by US courts including that the change must be material, should be from a long term perspective and that heavy burden is placed on the party invoking MAC clause in proving that MAC has occurred. The courts also went on to hold, that unless the MAC clause specifically includes projections and/or external economic conditions, MAC cannot be established by referring to such factors. The courts also held that MAC clause cannot be triggered basis circumstances which the invoking party was aware of when entering into the agreement, unless the conditions worsen making them materially different in nature.

Judicial Interpretation of MAC clauses in India

As for India, courts are yet to adjudicate on the enforceability of MAC clause in M&A, financing and other similar contracts where a party is given the right to walk away from a transaction due to material change in circumstances or the underlying foundation of the transaction. However, courts have adjudicated on Regulation 27(1) of Securities And Exchange Board Of India (Substantial Acquisition Of Shares And Takeovers) Regulations, 1997 (“Regulation 27”), which can be argued to contain the flavour of a MAC clause. The said regulation prescribes that;

“Withdrawal of offer - No public offer, once made, shall be withdrawn except under the following circumstances:- (a) 1 [***] (b) the statutory approval(s) required have been refused; (c) the sole acquirer, being a natural person, has died; (d) such circumstances as in the opinion of the Board merit withdrawal.”

The above provision permitted the withdrawal of a takeover offer on satisfying the three conditions mentioned in the provision. In this context, the leading Indian case is Nirma Industries Ltd. and Anr v. Securities Exchange Board of India[8] (“Nirma Industries”) where the Supreme Court of India (“SC”), while interpreting the scope of withdrawal of an open offer under Regulation 27 by Nirma Industries Ltd., held that withdrawal was possible only where there is the element of “impossibility” and relying on the said principle, the SC did not find sufficient grounds to warrant an exit from the transaction for Nirma Industries Ltd. despite allegations of fraud against the company for financial manipulation, as it did not satisfy the threshold of “impossibility”.

Similar view was taken in by the SC in SEBI vs. Akshya Infrastructure Pvt. Ltd.[9] and Pramod Jain & Ors. vs. SEBI[10] where while applying the narrow principle laid down in Nirma Industries, SC held that economic difficulty to conclude an offer did not amount to an exception under Regulation 27 and inordinate delay of two years by SEBI to approve the draft offer and the target company resultantly becoming a sick company would not justify withdrawal of a public offer.

In 2011, SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 was replaced by SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011. Regulation 23 of the new regulation dealt with withdrawal of offer. This Regulation 23 of SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (“Regulation 23”) is reproduced hereinbelow.

"An open offer for acquiring shares once made shall not be withdrawn except under any of the following circumstances- (a) statutory approvals required for the open offer or for effecting the acquisitions attracting the obligation to make an open offer under these regulations having been finally refused, subject to such requirements for approval having been specifically disclosed in the detailed public statement and the letter of offer; (b) the acquirer, being a natural person, has died; (c) any condition stipulated in the agreement for acquisition attracting the obligation to make the open offer is not met for reasons outside the reasonable control of the acquirer, and such agreement is rescinded, subject to such conditions having been specifically disclosed in the detailed public statement and the letter of offer; or (d) such circumstances as in the opinion of the Board, merit withdrawal".

Specifically, clause (c) of Regulation 23 was an additional ground to those that existed under erstwhile Regulation 27 and enabled an acquirer to withdraw from an offer if a condition stipulated in the agreement for acquisition is not met for reasons outside the reasonable control of the acquirer. The said provision came up for judicial interpretation in the matter of Jyoti Private Limited[11] where the acquirer wanted to withdraw from its offer relying on clause (c) of Regulation 23 as no change in control and management of the target company was allowed due to the pendency of a BIFR proceeding. While it was argued before the tribunal that Regulation 23 was wider in scope in comparison to Regulation 27, in view of the inclusion of clause (c), however, the tribunal, while relying on Nirma Industries, held that Regulation 23 is similar in toto to Regulation 27 and accordingly the withdrawal was rejected.


While there is no Indian judicial precedent on the enforceability of MAC clause in M&A, financing and other similar contracts where a party is given the right to walk away from a transaction due to change in commercial circumstances, but considering the narrow view that the SC and tribunal has taken in interpreting Regulation 23 and erstwhile Regulation 27, it appears the courts inclination would be towards a narrow interpretation of MAC provisions also. This is keeping in mind the fact that consequence of triggering a MAC provision is termination of the contract/transaction, and it could therefore be argued that the principles of Section 56 of Indian Contract Act, 1872, which deals with frustration of a contract, would be applicable to such a scenario. Considering it is not necessary that a MAC event would necessarily cause for the performance of the transaction to become impossible, it could then cause serious issues with its enforceability, in light of the judicial interpretation of Section 56 of Indian Contract Act, 1872 and principle of frustration. In fact, the current Covid-19 and its resultant effect on transactions would also need to be measured on the principles of frustration under Section 56 of Indian Contract Act, 1872, when invoking MAC for the purpose of successfully terminating a transaction.

Accordingly, in the Indian context, unless courts take inspiration from the interpretations laid down by courts in US and UK, the party triggering a MAC clause might be required to demonstrate that the change that has occurred is so material as to be regarded by law as striking at the root of the contract so as to warrant a discharge on the grounds of frustration and that such change was indeed unforeseen to the triggering party at the time of concluding the contract. For this purpose, the wording of the MAC clause would also be important.

Kindly treat this as an information update and the same shall not constitute as an advisory by the firm.

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[1] 789 A.2d 14 (Del. Ch. 2001) [2] 2005 WL 1039027 [3] 965 A.2d 715, 738 (Del. Ch.2008) [4] C.A. No. 8123-VCP (Del. Ch. Nov. 19, 2013) [5] 2018 WL 4719347 [6] [2013] EWHC 1039 (Comm) [7] [2015] EWHC 171 (Comm). [8] AIR 2013 SC 2360 [9] (2014) 11 SCC 112 [10] Civil Appeal No.9103 Of 2014, Order dated November 7, 2016 [11] WTM/SR/CFD/39/08/2016

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