Material adverse event (MAE) and change (MAC) clauses can play an important role in commercial contracts and can be used to apportion risk between the parties. Such clauses may become relevant in circumstances in which it is obvious that a party's financial condition or business has deteriorated, and there are serious doubts as to whether it will recover. However, a party's entitlement to avail itself of the protection afforded by such clauses can be hard to gauge at any one point in time. States of affairs brought about by the SARS-CoV-2 pandemic may involve a particularly complex factual assessment. Indeed, relying on an MAE or MAC provision in order to be relieved from performing contractual obligations, or to exit a contractual relationship, is often a risky and litigious business. In this article, we highlight a few of the most salient practical considerations that a party may wish to consider prior to invoking an MAE or MAC provision. We also revisit some of the main English case law authorities interpreting such provisions and consider the implications for pandemic-related disputes.

Attorneys in the United States will find awareness of the English law principles on this topic to be of benefit (in addition to United States authorities) when negotiating MAE or MAC clauses, in particular in circumstances where a United States counterparty is contemplating agreeing to, or has accepted, an English governing law and/or jurisdiction clause—which, for example, is not uncommon in cross-border acquisition agreements.

What Should Parties Be Aware of Prior to Engaging MAE or MAC Clauses?

The concept of a material adverse effect or change under English law is not a term of art that has a specific, generally applied meaning. While there may be a common thread running through MAE or MAC provisions, their terms are subject to many variations, and they can appear in diverse contexts. The conceptual framework for analysing the MAE or MAC clause will be different if, for example, the agreement is a finance contract1 rather than an acquisition agreement.2 MAE and MAC clauses are also sometimes used in long-term relational contracts, such as partnership and joint venture agreements, where additional principles of law and a developing body of jurisprudence may come into play. It is therefore sensible to approach the limited English law authorities that exist (as discussed further below), as well any relevant international authorities, with fact-sensitive caution.

Construing and applying an MAE or MAC clause (whether general, specific, complex or short) to factual circumstances can be a formidably difficult exercise in which there is room for reasonable disagreement on a variety of matters. This includes, inter alia, debate as to:

  • The proper scope and interpretation of the subject matter of the clause, 3 particularly if the clause refers to commonly used (albeit nebulous) concepts such as an adverse effect or change on the "financial condition," "ordinary business," "operations" or "prospects" of the borrower, target, partnership, venture or insured etc.4
  • Questions of causation and remoteness. If there is an express exception to the MAE or MAC provision for effects or changes brought about by "pandemics," where does one draw the line between causes that relate to SARS-CoV-2 and those that do not? The pandemic currently affects almost every element of our everyday lives. There are an infinite number of ways in which the pandemic could impact a business, directly or indirectly, depending on the industry in question. Should effects or changes attributable to travel restrictions, social distancing measures or lockdowns, changes in markets and consumer choices, or even subsequent recessions be within or without express "pandemic" exceptions?5
  • The threshold for the "materiality" of the adverse effect or change, which unless defined by reference to objectively verifiable standards in the contract itself (for example, a fixed monetary amount), is subjective and capable of being imbued with different standards. Various pronouncements of a "materiality" threshold have been articulated by the English (and other international) courts over the years. As part of the enquiry, the English court may be expected to look at the consequences of invoking an MAE or MAC provision under the contract, particularly the seriousness of those consequences, in order to decide whether or not the materiality threshold has been met on the facts.6
  • The inherent difficulty and ambiguity in applying an MAE or MAC clause over time, and of evidencing the likely durational impact of relevant effects or changes, particularly if the clause refers to effects or changes that are "reasonably likely to occur" in the future.7 Such clauses are difficult to operate in the present context precisely because the parties and, ultimately, the court must grapple with an assessment of unknown and unfolding pandemic-related events and changes.8

In addition to issues of construction and disputes of fact, there are various potential procedural pitfalls that could arise. Parties are free to agree (or not to agree) on the inclusion of an MAE or MAC provision and to stipulate on what terms. This may include laying down certain conditions precedent or subsequent to the MAE or MAC clause. The contract could provide that the MAE/MAC must be notified to certain parties within a certain time period. Notification may be required by way of a formal document setting out prescribed information concerning the nature of the  MAE/MAC and may need to be addressed to particular persons at specific addresses and/or issued using a contractually stipulated mode of communication (post, facsimile, email, etc.). English contract law is traditionally strict when it comes to interpreting such formal notice requirements. However, pandemic-related considerations may make it harder, or even impossible, for those procedures to be followed to the letter, giving rise to uncertainty in the validity of the notice or forcing parties to rely on the implication of terms. Parties should carefully consider and follow to the letter (as far as practicable), any express contractual notice requirements. Failure to follow the contract may lead to invalid reliance on the MAE or MAC clause, or the expiration of a window of opportunity to invoke the clause.

Finally, a flagrantly wrongful or baseless invocation of an MAE or MAC clause in order to excuse one party from performing the contract could, in theory (if there is strong evidence), be construed as a "Material Breach" (assuming the contract contains such concept), or even a renunciation or repudiation of the contract, triggering certain consequences at English common law that may affect how damages are calculated. There could also be reputational consequences in the event of a wrongful invocation of the clause.

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This article was originally published in PLI Current: The Journal of PLI Press

Footnotes

1. An important example is the use of material adverse change in loan agreements, which relieves the lender of its continuing obligations in the event of a significant deterioration of the financial position of the borrower. There may be several or various provisions that fit together in such loan agreements. For instance, it is commonly obligatory that a representation as to material adverse change is repeated by the borrower at the time of each drawdown. In addition, a material adverse event or change may be stipulated as an event of default, entitling the lender to accelerate the loan repayment. Sometimes in loan agreements what constitutes a material adverse event or change under the representations and warranties may be expressed in wider terms than under the event of default (or vice versa).

2. In the context of acquisitions, contractual provisions are often included that allow the purchaser to walk away from the deal prior to closing, upon the occurrence of a material adverse effect or change affecting the target. In such acquisition agreements, the material adverse effect or change provision could appear in the form of a condition to closing, a representation or a warranty.

3. See further discussion in Rafal Zakrzewski, Material Adverse Change and Material Adverse Effect Provisions: Construction and Application, Law and Financial Markets Review, 344 ¶ 346 (2011) ("a change must be a change in something, and an effect must be an effect on something. This something is enumerated in the relevant provision and delimits the scope of its operation").

4. In one of the leading authorities, Grupo Hotelero Urvasco SA v. Carey Value Added SL (formerly Losan Hotels World Value Added I SL) [2013] EWHC 1039 (Comm), Blair J. found that "financial condition" established from interim financial information and/or management accounts. The assessment of the borrower's financial condition should normally begin with its financial information at relevant times, and a lender seeking to demonstrate a material adverse change should show an adverse change over the period in question by reference to that information. Notwithstanding this, the enquiry is not necessarily limited to the financial information if there is other compelling evidence. However, in an earlier authority, Re TR Technology Investment Trust plc (1988) 4 BCC 244, ¶ 265, Hoffmann J. had doubted whether a MAC in the financial condition of a borrower, which, per the contract, was to be determined by reference to financial statements, could have occurred in circumstances where the company was newly incorporated and no such statements yet existed.

5. Questions of this nature have arisen in ongoing parallel proceedings before the English commercial court brought by two groups of selling shareholders, eNett and Optal, against the purchaser of a B2B payments business, WEX, in the matter of Claim Number CL-2020- 000287 and CL-2020-000288. At the time of writing, a judgment addressing as preliminary issues a number of questions in relation to the proper construction of the particular MAE clause has been issued by Cockerill J. at first instance in Travelport & Ors v. WEX Inc [2020] EWHC 2670 (Comm). Among other issues, the judgment addresses the burden of proof as to establishing certain "carve-outs" contained in the contractual definition of MAE relating to various types of MAEs that are for the purchaser's risk (including a pandemic carve-out, and a separate carve-out for changes in regulatory or political conditions or law), as well as the burden of proof in relation to an exception to the pandemic carve-out (the "carve-out exception"), and the extent to which that pandemic carve-out exception can apply where "effects" that have arisen could be said to simultaneously fall within the carve-out for changes in regulatory or political conditions or law. On this point, Cockerill J. found that, as a matter of language, the carve-out exception does not apply to any such change in cases where the events, changes, developments or effects also fall within the carve-out for changes in regulatory or political conditions or law. In other words, the contract does not permit the purchaser WEX to cherry-pick among various overlapping matters in connection with which an event that may be said to have arisen.

6. See below discussion of the materiality threshold below. See also Decura IM Investments LLP v. UBS AG London Branch [2015] EWHC 171 (Comm).

7. For further discussion, see Zakrzewski, supra note 3 ¶ 347.

8. See further discussion below. See also Grupo Hotelero Urvasco SA v. Carey Value Added SL (formerly Losan Hotels World Value Added I SL) [2013] EWHC 1039 (Comm); Thomas Witter Ltd v. TBP Industries Ltd [1996] 2 All E.R. 573, ¶ 605.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.