420 12 Acquisition of Shares in a Privately-owned Company for Cash
According to US case-law, an objective test must be used. The perspective is that
of a reasonable acquirer. At least where the acquirer is a long-term investor, the
change must be significant and relate to the long-term health of the target’s busi-
ness.
In the US, IBP Inc. v. Tyson Foods, Inc. is a leading case interpreting material adverse ef-
fect (MAE). In this merger case, the acquirer had sought to rely on a broadly drafted MAC
clause. The Delaware Court of Chancery nevertheless ordered those two companies to
complete the merger. The court held that a merger party would be entitled to exercise a
standard MAE clause only when the other party had suffered a significant change in the
long-term health of its business.^46 In England, a significant drop in the value of the target’s
assets would not necessarily by regarded as a MAC by the court, unless the explicit terms
of the contract provide otherwise (see also Volume II).^47
The other party can propose materiality thresholds based on quantitative criteria
and exceptions (carve-outs) to qualify the MAC clause and to mitigate its effects.
In the US, the traditional MAC exceptions include: “change in the economy or business in
general”; “change in the general conditions of the [specified] industry”; “effect of an-
nouncement of the transaction”; “changes in GAAP”; and “change caused by the taking of
any action required or permitted or in any way resulting from or arising in connection with
the agreement”.^48
Pre-closing covenants. In addition to conditions precedent to closing, the parties
agree on pre-closing covenants. Pre-closing covenants are a series of promises
about how the parties will behave during the interim between the time the agree-
ment is signed and the closing.^49
The behaviour or the target is particularly important to the acquirer. The pre-
closing covenants of the vendor are intended to ensure that the acquirer gets the
benefit of its bargain. Furthermore, the incurrence of new debt, acquisitions and
capital expenditure are likely to influence the financing of the acquisition.
Typically, the target is permitted to take actions in the ordinary course of busi-
ness but prohibited from doing anything else. Normally, certain major acts will be
(^46) IBP Inc. v. Tyson Foods, Inc., 2001 Del. Ch. LEXIS 81 (June 15, 2001). The Delaware
Court of Chancery said: “Merger contracts are heavily negotiated and cover a large
number of specific risks explicitly. As a result, even where a Material Adverse Effect
condition is as broadly written as the one in the Merger Agreement, that provision is
best read as a backstop protecting the acquiror from the occurrence of unknown events
that substantially threaten the overall earnings potential of the target in a durationally
significant manner. A short-term hiccup in earnings should not suffice; rather the Mate-
rial Adverse Effect should be material when viewed from the longer-term perspective of
a reasonable acquiror.” For the effects of this judgment, see also Schlößer D, op cit,
p 896.
(^47) Apart from the practice of UK Takeover Panel, there is not much case law on the subject
of MAC clauses in England. See nevertheless Levinson v Farin [1977] 2 All ER 1149 (a
reduction in the net asset value of the target in the region of 20%).
(^48) Nixon Peabody LLP, Fifth Annual MAC Survey (www.nixonpeabody.com).
(^49) See Bainbridge SM, op cit, pp 175–177.