This article is Part IV of the Musings on Contracts series by Glenn D. West, which explores the unique contract law issues the author has been contemplating, some focused on the specifics of M&A practice, and some just random.
A recent decision in the English High Court of Justice, BM Brazil I Fundo de Investimento em Participações Multistrategia v. Sibanye BM Brazil (Pty.) Ltd.,[1] is the latest judicial pronouncement by a common-law court on the meaning and effect of a material adverse effect (“MAE”) clause. In BM Brazil, Mr. Justice Butcher determined that a “geotechnical event” (basically a landslide), which occurred at a mine owned by the target company between the signing and closing of a Sale and Purchase Agreement (“SPA”), did not constitute an MAE permitting the buyer to terminate the SPA. And the MAE definition included in the SPA looked like it had been cut and pasted from a standard US acquisition agreement.
The Pattern of an MAE Definition
According to Professor Robert T. Miller, one of the oft-cited academics in MAE jurisprudence, including in BM Brazil,[2] almost all MAE definitions follow a similar pattern.[3] First, there is the “Base Definition,” which consists of (a) a listing of the “Underlying Predicate Events” (“events, acts, occurrences”), followed by (b) an “Expectation Metric” (“has, or would/could reasonably be expected to have”), followed by (c) an “Undefined Term” (“material adverse effect on”), followed by (d) the “MAE Objects” (“business, financial condition, results of operation”). Second, there is a list of “MAE Exceptions,” which eliminate the realization of certain generalized risks so that even if they occur and have a material adverse effect on the target, no MAE has occurred. And last, there is a “Disproportionality Exclusion,” which adds back to the MAE definition some or all of the MAE Exceptions to the extent that their occurrence has disproportionally caused harm to the target compared to a specified group of similarly situated companies.[4] The MAE definition under consideration in BM Brazil followed this common pattern.
Finding That an MAE Has Occurred Continues to Be a Rarity
That the judge determined that there had not been an MAE should surprise no one, even without knowing the facts. Judicial determinations that an MAE has occurred are exceedingly rare.
Indeed, in Delaware there has only been one such judicial determination, Akorn, Inc. v. Fresenius Kabi, AG.[5] In Akorn, Vice Chancellor Laster, in concluding that an MAE had occurred because of the “sudden and sustained drop in Akorn’s business performance,”[6] examined a number of metrics regarding the target’s performance following the signing of the merger agreement. This drop in performance was determined by making “period-to-period comparisons [that] . . . involved extremely large declines, with EBITDA always declining more than 50 percent.”[7]
Importantly, however, Vice Chancellor Laster separately concluded that an MAE-qualified “bring down” of a regulatory representation had also been breached where the cost of remediating the regulatory violation exceeded 20 percent of the target’s equity valuation. While that 20 percent did not necessarily establish a bright line, it has been viewed by many in the deal community that a 20 percent value decline is as good a benchmark of what will be deemed an MAE as any.[8]
The English Court Looks to Delaware Cases
Given the relative dearth of English cases discussing MAEs, Mr. Justice Butcher relied upon the more substantial body of cases from Delaware to guide his decision, taking a cue from a pandemic-era English MAE case, Travelport Ltd. v. WEX Inc.[9] In that case, Mrs. Justice Cockerill had noted that
[Delaware has a] better developed body of case law [on MAE clauses] . . . [and] to ignore the thinking of the leading forum for consideration of these clauses, a forum which is both sophisticated and a common law jurisdiction, would plainly be imprudent. . . . The same goes for the academic learning which is often cited in the Delaware Court.[10]
So, turning to that US authority, Mr. Justice Butcher looked first to the oft-quoted statement of then–Vice Chancellor Strine, in In re IBP, Inc. Shareholder’s Litigation,[11] as to the “strong showing” required to invoke an MAE termination condition:
[E]ven 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 the earnings should not suffice; rather the Material Adverse Effect should be material when viewed from the longer-term perspective of a reasonable acquiror.[12]
Mr. Justice Butcher then took a trip through the other Delaware authorities that have addressed MAE conditions since IBP, quoting or paraphrasing these authorities for a number of different propositions, including the following:
- “[D]efining a ‘Material Adverse Effect’ as a ‘material adverse effect’ [as nearly all MAE clauses do] is not especially helpful.’”[13]
- Use of the word would in the phrase “would not reasonably be expected to have [an MAE]” suggests “a greater degree (although quantification is difficult) of likelihood than ‘could’ or ‘might,’ which would have suggested a stronger degree of speculation (or a lesser probability of adverse consequences[)].”[14]
- “[T]he burden of proving that a MAE had occurred lay on the buyer, irrespective of the form in which the MAE clause was drafted (ie whether as a representation, warranty or condition to closing), absent clear wording to the contrary.”[15]
- “There is no ‘bright-line test’ for evaluating whether an event has caused a material adverse effect. To assess whether a financial decline has had or would reasonably be expected to have a sufficiently material effect, this court will look to ‘whether there has been an adverse change to the target’s business that is consequential to the company’s long-term earnings power over a commercially reasonable period.’”[16]
Mr. Justice Butcher also noted that, while the US case decisions indicated that the determination of whether an MAE has occurred “has both quantitative and qualitative aspects,” he was inclined to the view (consistent with the view of Miller) that “if there is no significant impact in financial, or ‘quantitative’, terms on the Group Companies or their business, then it is difficult to see that such ‘qualitative’ matters could on their own mean that the ‘change, event or effect’ was ‘material and adverse’.”[17]
Finally, Mr. Justice Butcher also agreed with Miller that the numerous MAE Objects listed in an MAE definition are not necessarily measuring anything substantively different from each other—and the MAE Objects listed appear to all be simply measuring whether there has been an MAE on the target company.[18]
The Losses Arising from the Landslide Did Not Result in an MAE
Noting Vice Chancellor Laster’s suggestion that a 20 percent decline in equity value would be sufficient to constitute an MAE (without intending thereby to suggest that a “reduction in the equity value of the target of anything less than 20% would necessarily not have been material”), Mr. Justice Butcher agreed that “in the present case . . . a reduction in equity value of 20% or more would indeed be material, but that a somewhat lesser reduction might also be material.”[19] And he was inclined to view 15 percent as the right number for this case. But to cover his bases, he then viewed the evidence presented (expert testimony, for the most part) about the significance of the geotechnical event from the standpoint that even a 10 percent reduction might be sufficient.[20]
In reviewing the evidence, however, he concluded that even at this lower level, no MAE had occurred (it would appear that credible expert testimony is critical in these cases, as well as establishing that invoking the MAE clause has not simply been a means to get out of a deal that has not fared as well as one might have hoped[21]).
A Preexisting Condition Is Not a “Change, Event or Effect”
There have been a number of recent MAE decisions that have focused less on the Base Definition and more on the existence of MAE Exceptions and whether the Disproportionality Exclusion applied.[22] And those decisions have raised questions about how the wording of the lead-in to the MAE Exceptions, which includes “arising from or related to,” may expand the exceptions to include unexcepted matters.[23] Those issues did not figure prominently in Mr. Justice Butcher’s decision in BM Brazil, so I will not delve into those matters here but simply refer the reader to footnote 23.
But one of the more interesting aspects of the BM Brazil decision was Mr. Justice Butcher’s discussion of whether a material adverse condition that is “revealed” as the result of a change, event, or effect after signing and before closing, but that in fact existed prior to signing (even though it was unknown), could constitute an MAE. One of the contentions made by the sellers was that the buyers were including in the material adverse effects of the geotechnical event not just the direct effects of the geotechnical event but also the alleged problems with the “underlying geology” that had been revealed by the geotechnical event. According to the sellers, any problems and costs associated with the underlying geology that had been revealed by the geotechnical event could not be included in any determination of whether an MAE had occurred—only the direct effects of the geotechnical event itself could be included. Mr. Justice Butcher agreed with the sellers on this point, even though he went on to decide the case as if everything were included. Regardless, I think this revelatory issue needs to be thought about more.
The argument that Mr. Justice Butcher was persuaded was correct was as follows:
The Claimants emphasised that the terms of the MAE definition looked to whether the “change, event or effect” itself “is or would reasonably be expected to be material and adverse”. They argued that, unlike the exceptions part of the MAE definition, the general part does not direct any enquiry into the causes of the relevant “change, event or effect”; rather that part directs enquiry to, and only to, the characteristics of the relevant “change, event or effect” itself: is it material and adverse? It would be an abuse of language to say that a “change, event or effect” occurring between signing and closing was “material and adverse” because it reveals some other problem or issue. And further, to construe the clause as meaning that revelatory events may be MAEs would enable the temporal requirement of the clause to be circumvented, in that it would allow a party to identify a relevant “change, event or effect” within the period between signing and closing even though the problem or issue predated the contract, and would or could have been picked up by the buyer’s due diligence, and the risk of which will have been assumed by the seller to the extent of the representations and warranties given, but which are otherwise for the buyer’s account. In the present case, the Claimants pointed out, the representations and warranties in Article 3 of the SPAs are exhaustive and do not include any relating to the geotechnical situation at, or the suitability of the mine design of, the Santa Rita Mine, or any general representations or warranties about the costs of, or operations at, the Mine.[24]
In other words, an MAE condition cannot save you from the failure to obtain a representation and warranty about any existing issue—MAEs focus on future occurrences, not existing facts. In this case, the underlying geological condition “had existed for millennia.”[25] And “[n]o ‘change, event or effect’ had occurred in [that underlying geological condition] by the happening of the [geotechnical event—i.e., the landslide].”[26]
One could imagine a situation where there is a boiler explosion that causes damages to a manufacturing plant after signing and before closing. But assume that those damages are insufficient in themselves to constitute an MAE. Nevertheless, assume that in reviewing the damages caused by the explosion, the buyer discovers other, more serious issues that relate to the plant’s equipment and the costs of deferred maintenance, etc. Can those costs be included in assessing whether there has been an MAE? Probably not.
According to Mr. Justice Butcher, Underlying Predicate Events in the Base Definition of MAE focus on what happened, not on what caused it to happen or the reason it happened. There is nothing in a typical MAE clause that would actually expand an Underlying Predicate Event such that it would include some preexisting condition that may have actually caused it (or is likely to cause future similar events) to occur.
And there you have it.
See Robert T. Miller, A New Theory of Material Adverse Effects, 76 Bus. Law. 749 (2021). ↑
This familiar pattern has previously been likened to the consistent ingredients of a McDonald’s “Big Mac.” See Glenn D. West & S. Scott Parel, Revisiting Material Adverse Change Clauses, Corp. Couns. Bus. J. (Sept. 1, 2006). ↑
Miller, supra note 2, at 755–57. ↑
No. 2018-0300-JTL, 2018 WL 4719347 (Del. Ch. Oct. 1, 2018). ↑
Id. at *47, discussed in Glenn D. West, A Delaware Case Has Finally Determined That There Is Such a Thing as a “Material Adverse Effect,” Weil’s Glob. Priv. Equity Watch (Oct. 8, 2018). ↑
Miller, supra note 2, at 775. ↑
See Glenn West, Richard Slack & Joshua M. Glasser, Just Because a Really Bad Thing Happens Does Not Mean a Material Adverse Effect Has Occurred: Assessing the Latest Delaware MAE Decision, Weil Sec. Litig. Alert 2 (Dec. 24, 2019). ↑
Id. at paras. 175–76. ↑
789 A.2d 14 (Del. Ch. 2001). ↑
Id. at 30–31. ↑
BM Brazil I Fundo de Investimento em Participações Multistrategia v. Sibanye BM Brazil (Pty.) Ltd., [2024] EWHC 2566 (Comm), at para. 196 (quoting Frontier Oil Corp. v. Holly Corp.). ↑
Id. (quoting Frontier Oil Corp.). ↑
Id. at 199 (quoting Hexion Specialty Chems. v. Huntsman Corp.). ↑
Id. at para. 203 (quoting Snow Phipps Grp. LLC v. KCake Acquisition Inc.). ↑
Id. at para. 222. ↑
Id. at para. 204. ↑
Id. at para. 253. ↑
Id. at para. 252. ↑
See Akorn, Inc. v. Fresenius Kabi, AG, No. 2018-0300-JTL, 2018 WL 4719347, at *3 (Del. Ch. Oct. 1, 2018). (“In prior cases, this court has correctly criticized buyers who agreed to acquisitions, only to have second thoughts after cyclical trends or industrywide effects negatively impacted their own businesses, and who then filed litigation in an effort to escape their agreements without consulting with the sellers. In these cases, the buyers claimed that the sellers had suffered contractually defined material adverse effects under circumstances where the buyers themselves did not seem to believe their assertions.”). ↑
See Glenn D. West, The MAE Clause, Mrs. Palsgraf and Events “Arising from or Related to” MAE Exceptions, Weil’s Glob. Priv. Equity Watch (May 11, 2021). ↑
See id.; see also Robert T. Miller, What Do Exceptions in MAE Definitions Except?, Bus. L. Today (May 20, 2021). ↑
BM Brazil, [2024] EWHC 2566 (Comm), at para. 230. ↑
Id. at para. 229. ↑
Id. ↑
