Harsh Mittal
The author is a 4th-year student at Hidayatullah National Law University
Introduction
Material Adverse Effect (MAE) clauses are a key part of Mergers and Acquisitions contracts. The effects of MAE clauses in contracts signed before the Covid-19 pandemic disruption have been hotly debated throughout the world. In essence, MAE clauses are definitions that show how risks are distributed among the parties to a contract. MAE clauses have recently received new attention due to Elon Musk's attempt to terminate the agreement for the acquisition of Twitter on grounds of MAE. In this article, we will try to understand the contemporary relevance of the MAE clause with respect to Covid 19 and the Musk Twitter saga.
What Is Material Adverse Effect Clause?
A clause known as a Major Adverse Effect (MAEC) allows a party to terminate a contract if there is a material change after it is signed. Most business contracts are not negotiated, signed, or carried out in a single day. Contractual performance is a procedure that takes place over a set period of time and is highly negotiated, particularly in the context of mergers and takeovers. Because of this, it is possible that one side may attempt to break the contract because the circumstances under which it was entered have changed drastically over time. In these circumstances, a Major Adverse Change (MAC) clause is helpful in assigning and reducing the risk of such a fundamental change and in providing an escape strategy from the transaction, should the event occur.
Determining Materiality
What is a material adverse change, largely differs from case to case and it depends on what is the wording of the MAC clause. If the MAC clause specifies what is considered to be material, then we have to follow that clause but if it is not prescribed then it will be left to the court’s discretion to determine on the basis of judicially formulated principles. Some principles to determine what is materiality in MAC Clause are –
Both Quantitative and Qualitative factors are to be considered.
Long-term hiccup in earnings which brings a material change in the finances of the company.
Contractual language has to be read in the larger context of transactions to determine what is material.
MAEC in Indian Context
The SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 define grounds for withdrawing a public offer in the context of listed businesses in India. These grounds are outlined in Regulation No. 23 of the regulations. In the event that any prerequisite specified in the acquisition agreement is not satisfied due to events beyond the acquirer's control, the acquirer is permitted to withdraw a public offer on a variety of grounds, provided that the prerequisite is disclosed in the detailed public statement and the letter of offer. In order to restrict the circumstances under which a public offer may be withdrawn, the Indian securities regulator and courts have read this rule strictly. The language employed in such clauses has a significant impact on how MAE provisions are to be interpreted. There aren't many cases in India or in the UK that interpret MAE clauses. The Delaware Chancery Court in the United States has a substantial body of case law that interprets MAE clauses. In the matter of In Re IBP Shareholders Litigation, the Delaware Chancery Court held that for an event to be considered material it must substantially threaten the earning potential of the target.
Whether COVID 19 was a material change?
Every contract has a different MAC provision. A fact-specific investigation and an analysis of the MAC provision's express language will help us come to a conclusion because there is no single interpretation The acquirer must evaluate COVID-19's impact on the target to determine whether a MAC has happened and whether it can be read into the agreement's MAC provision if the MAC provision does not expressly mention thematic issues such as pandemics or epidemics. Even in these situations, parties invoking MAC should be prepared for the possibility of being drawn into litigation by gathering enough evidence to support their invocation. Parties invoking MAC should carefully examine when to do so and be conscious of increased lawsuit risks in circumstances where the harm has not yet happened but is clearly on the horizon. When agreements have been made after the Covid-19 outbreak, the parties invoking MAC should be ready to show that the amount of the detrimental effects on the target or borrower have been so great that they could not have been anticipated or thought of by the parties at the time the agreement was made.
In Akorn Inc v. Fresenius Kabi AG, the court held that the negative change in the target's business must therefore have a "durationally-significant" impact on its ability to generate income. In this case, the target firm suffered a collapse and its performance fell off a cliff (25% loss in revenue, 105% year-over-year decline in operating profitability), leading the Court to rule that a MAC had taken place and allowing the acquirer to walk away from the contract.
MAC Clause in Musk Twitter Saga
On 28th October when Musk finally took control of Twitter and confirmed the takeover, everyone breathed a sigh of relief because this saga has been no less than an on-and-off relationship. From agreeing to buy Twitter for $44Bn to Musk filing a countersuit with an argument that the company had suffered a material adverse change or substantial reduction in its value that rendered the deal invalid, there has been a series of events in this deal. What really fascinates one over here is if the case would have gone to the court whether Elon Musk would have been able to excuse the deal due to Material Adverse Effects. We will try to understand this by taking into account multiple factors necessary to constitute a material change event.
Generally, it is common for Material Adverse Definition to include what constitutes Target Company Prospects but in the Twitter scenario, we can see that the definition omitted what constituted company prospects. The Courts have laid down in different cases that for a event to be considered as Material Adverse Event it has to be a long-term issue. So unless there are explicit contractual terms to the contrary Musk would have had to demonstrate that the bot issue was “durationally substantial”. Material adverse change provisions should specify clear, measurable criteria for what circumstances may qualify as such. If Musk had always been concerned about the bot issue, it ought to have been mentioned in the definition but wasn't. Musk most likely would have had to demonstrate that the change had a materially negative impact on Twitter's EBITDA. After taking into account all the factors what we can conclude is that if the case would have gone to court it is quite doubtful that the court would have let Musk back out of the agreement, thus we presume he chose to remain with it.
Conclusion
Buyers will want more freedom to end M&A deals if unfavourable circumstances arise after a transaction has been signed during times of economic uncertainty, volatility, and disruption. The Musk-Twitter case amply highlights the need to carefully analyse MAE clauses and steer clear of boilerplate versions. Along with having clear deadlines and rigorous negotiation, the list of prerequisite conditions must also be agreed upon. It is abundantly obvious from the debate above that India's law governing the use of MAC clauses is still in its early stages. When determining whether a "substantial adverse change" has occurred, Indian Courts refer to the principles developed by courts in other jurisdictions, particularly the US. In order to fulfil the clause's intended goals and eliminate the necessity for outside jurisdictional assistance, India must enact the necessary laws. The MAEC Clause is included in the contract so that it can be terminated if there is a major change after signing. Still, purchasers are already utilising it to back out of transactions that ultimately hurt the interests of other businesses. Courts must make sure that these terms are properly construed so that they don't prevent deals from moving forward or create acrimonious disputes.