PRINT THIS PAGE MAC and MAE clauses: uncertain provisions in uncertain times?09/01/2008. Source: Dechert. Patrick C Lord 
In the midst of the credit crisis that began this summer, there are numerous reports of would-be buyers seeking to terminate or renegotiate signed acquisition agreements based on a claimed occurrence of a 'material adverse change' or 'material adverse effect' on the target, an event that would trigger what is commonly known as a 'MAC' or 'MAE' clause, says Patrick C Lord, an associate at law firm Dechert LLP. Perhaps the most prominent recent example involves the proposed acquisition of Sallie Mae. Five months after several private equity firms agreed to acquire Sallie Mae for in excess of $25 billion, President Bush signed new legislation that would cut subsidies to student-loan providers. Asserting that an MAE had occurred, the buyers then attempted to renegotiate the purchase price for the deal. Sallie Mae then sued the buyers to have the Delaware Chancery court declare that an MAE had not occurred and award Sallie Mae a $900 million termination fee. This dispute illustrates that while MAE provisions have become standard in acquisition agreements, the interpretation of these provisions is frequently controversial. Moreover, the dearth of case law interpreting these clauses only adds uncertainty in the event of a dispute.
The definition of “material adverse effect” or “material adverse change” in a typical acquisition agreement establishes the magnitude of a change in circumstances or a breach of representation or warranty concerning the target that will relieve a buyer of its obligation to close. While there is sometimes an effort to be precise as to the circumstances that may or may not constitute an MAE, MAE clauses are often necessarily drafted with some generality so that they embrace a range of potential unanticipated events.
Negotiating an MAE clause involves a balancing of the target’s desire for deal certainty with the buyer’s willingness to accept risks with respect to unknown events. MAE provisions have become subject to increasing focus in leveraged transactions since buyers have found it increasingly difficult to obtain “financing outs,” provisions that condition the closing on the buyer obtaining financing to complete the transaction.
Many private equity firms and other buyers believe that they cannot assume the full risk that financing will not come through if events occur that have not been anticipated by their financing sources. In the absence of a financing out, rather than have a buyer risk that a court would hold it liable for unspecified damages or specifically enforce the agreement, parties will often agree that the buyer will pay a “reverse break-up fee” in the event the buyers do not proceed to closing when other closing conditions (including the absence of an MAE) have been met. Recently in the context of leveraged buy-outs, some sellers ask for “two-tier” reverse break up fees: one fee that would be payable by the buyers if they were unable to close because of a lack of financing and another higher fee payable if the buyers do not close for any other reason.
The effort of buyers and sellers to allocate or limit risk with respect to the occurence of unanticipated events takes place against a backdrop of few cases that have interpreted MAE clauses. The leading case interpreting the meaning of MAE clauses is the IBP-Tyson1 case. In 2001, Tyson, the world’s largest chicken producer, signed an agreement to purchase IBP, the country’s largest beef producer.
Following two bad quarters for IBP, Tyson sought to terminate the contract, arguing that IBP had suffered an MAE because IBP had been hurt by the slowing economy and because IBP allegedly made false representations concerning several accounting problems. IBP sued Tyson for specific performance, and in June 2001, after a two week trial, Vice Chancellor Leo E. Strine, Jr. of the Delaware Chancery Court held that IBP had not suffered an MAE, and that accordingly, Tyson would be required to consummate the transaction. The ruling clarified that the party seeking to terminate an agreement because of an MAE has the burden to prove an MAE has occurred. Strine stated that an MAE clause will only protect a buyer “from the occurrence of unknown events that substantially threaten the overall earnings potential of the target” and concluded that whether an MAE has occurred must be determined “from the long-term prospective of a reasonable acquirer.”2
A “short-term hiccup in earnings” will not suffice to invoke an MAE.3 The few subsequent court cases to examine MAE clauses have followed the Tyson case’s basic premise that an MAE must be an unknown event that is more than a short term problem and accordingly cannot be used to rectify a situation of buyer’s remorse.
With these legal precedents in mind, a buyer seeking to claim an MAE faces a daunting task. A buyer expecting to invoke an MAE clause can expect a fact-intensive inquiry by a court to determine the genuine reasons for the termination and the parties’ intent in choosing particular language for the MAE clause. A buyer’s task is further complicated by the fact that sellers have been increasingly successful at limiting the scope of the MAE by negotiating a series of specific carve-outs to the definition of MAE to exclude certain global, industry-wide, and/or extrinsic events, such as any adverse effect on the target resulting from changes in general, political, or economic conditions or changes in law. In a deal where the parties have agreed to exclude such events, this summers’ market turmoil might not even constitute an MAE.
1 In re IBP, Inc. S’holders Litig. v. Tyson Foods, Inc., 789 A.2d 14 (Del. Ch. 2001).
2 Id. at 31.
3 Id.
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