Efficiency and Certainty in Uncertain Times: The Material Adverse Change Clause Revisited
Garrett, Michelle Shenker, Columbia Journal of Law and Social Problems
What role do material adverse change clauses play in merger agreements? This Note analyzes the increasing importance of material adverse change clauses in economic downturns and examines their evolution and judicial interpretation. The Note argues that the vagueness of these clauses leads courts to construe them narrowly and fail to effectuate the intent of contracting parties, ultimately creating uncertainty in merger agreements and failing to accomplish the goals of contracting parties. The Note concludes that replacing material adverse change clauses with reverse termination fees will better serve the parties' goals and uphold contract principles, yielding more efficient outcomes while reducing unnecessary litigation.
Material adverse change ("MAC") clauses have long been included in merger agreements and financing commitments.1 Such provisions allow companies - typically the buyer in the merger context - to exit an agreement in certain instances in which an unanticipated event or trend significantly impacts one of the merging entities. While MAC clauses traditionally were mere "boilerplate provisions," they have evolved to heavily negotiated and carefully drafted clauses.2
Since the credit crisis, MAC clauses have become tremendously important. Increased financial uncertainty and difficulty in syndicating debt has caused deals to fail more frequently, and buyers have attempted to rely on these clauses to end their commitments to acquire target companies under merger agreements.3 This Note analyzes the judicial standard for interpreting MAC clauses and argues that courts construe both traditional and complex MAC clauses similarly. The foundational cases in MAC jurisprudence demonstrate the failure of MAC clauses both to effect the parties' intent and to uphold basic contract principles of efficiency and certainty. This Note suggests that replacing these clauses with reverse termination fees will more successfully accomplish the goals of the contracting parties, while reducing unnecessary litigation.
Part II of this Note provides a brief overview of MAC clauses. Part III describes the courts' definitions of materiality in traditional MAC clauses and compares this approach to recent decisions interpreting complex MAC clauses in agreements that have unraveled due to the credit crisis. Part IV examines the failure of these clauses to accord with their goals and with basic contract principles. Finally, Part V of the Note advocates replacing such clauses with reverse termination fees.
II. AN OVERVIEW OF MARKET MAC AND MAE CLAUSES
This Part provides a brief overview of MAC clauses, which are also called material adverse effect ("MAE") clauses,4 and their role in merger agreements. The first section defines MACs, describing their evolution from traditional "boilerplate provisions" to complex and heavily negotiated clauses, and raises some potential issues with their interpretation. The second section explores the role of the MAC clause within the merger agreement as well as the theories supporting its inclusion, including correcting the asymmetries between the positions of buyer and seller.
A. DEFINITION AND EVOLUTION OF MAC CLAUSES
Mergers and acquisitions are among the most significant corporate events, impacting and altering not merely corporate structure and governance, but the lives of numerous people involved in the day-to-day operations of the merging entities.5 Thus, mergers are generally carefully contemplated; the parties spend substantial time and resources to ensure that their expectations are met.6 Merger agreements enumerate the parties' legal rights and obligations in four primary components - representations and warranties, covenants, conditions to closing, and indemnification.7
MAC clauses are among the myriad provisions found within merger agreements. These clauses are usually included in the conditions to closing portion of an agreement, predicating a party's obligation to complete the deal on the absence of a MAC. …