08/03/2009 03:41:11 PM EST
Accounting for the Unknowable: Risk Allocation & Current Insights on Material Adverse Change Clauses
Recent turmoil in credit markets and the economy has brought back the Material Adverse Change (MAC) clause into common parlance in negotiated transactions as purchasers in deals struck before the liquidity crunch are relying on such provisions to attempt to nullify transactions. This article examines the modern view of MAC clauses in the Delaware courts.
One of the challenging tasks that parties negotiating a transaction face is accounting for the unknown. Practitioners utilize a number of tools to accomplish this, such as deal protection and fiduciary out clauses to address potential intervening bidders, representations and warranties to confirm a purchaser's due diligence and allocate risk associated with the limitations of due diligence inquiries, caps and baskets to establish a threshold below which an unknown risk is deemed immaterial, and many others.
However, these provisions are designed to provide financial remedies for unknown events that may reduce the value of the transaction to a purchaser, or increase the value of another transaction to a seller. As recent turmoil in credit markets and the economy has highlighted, parties to a negotiated transaction must also account for "black swan" risks--the risk of an event that is so deleterious to the target company's value that the purchaser should be excused from consummating a negotiated transaction. Practitioners account for such risk using "material adverse change" (MAC) clauses. Because such provisions are the "nuclear option" in M&A transactions, they are rarely utilized and even more rarely litigated. However, the financial crisis has brought the MAC clause back into common parlance as purchasers in deals struck before the liquidity crunch have relied on such provisions to attempt to nullify transactions. This article examines the modern view of MAC clauses in the Delaware courts.
Focusing on Delaware Court of Chancery cases, three recent decisions have provided broad commentary on MAC provisions. While practitioners can draw distinct lessons from each of these decisions, several common themes emerge. First, Delaware courts have placed strong emphasis on the particular facts presented in a case and therefore are prone to consider extrinsic evidence in an attempt to discern the intent of the contracting parties. Second, the decisions reveal an emphasis on the doctrine of caveat emptor--and the corresponding allocation of risk to the purchaser--with respect to events and circumstances which the parties either knew (or were capable of discovering) at the time the contract was formed. Finally, Delaware courts evaluate the materiality concept contained in a MAC clause from the point of view of a reasonable purchaser with a long-term investment horizon. [footnote omitted]