Trends in MAC Definitions and Carve-outs | Practical Law

Trends in MAC Definitions and Carve-outs | Practical Law

A review of trends in the definition of "Material Adverse Effect" in public and private acquisition agreements.

Trends in MAC Definitions and Carve-outs

Practical Law Legal Update 0-548-3385 (Approx. 7 pages)

Trends in MAC Definitions and Carve-outs

by Practical Law Corporate & Securities
Published on 07 Nov 2013 • Delaware, USA (National/Federal)
A review of trends in the definition of "Material Adverse Effect" in public and private acquisition agreements.
Trial began this week in the Delaware Court of Chancery in the dispute between Indian tire-manufacturer Apollo Tyres Ltd and Ohio-based Cooper Tire & Rubber Company. Apollo and Cooper entered into a merger agreement on June 12, 2013, for the acquisition of Cooper by a wholly owned subsidiary of Apollo. For a summary of the merger agreement, see What's Market, Apollo Tyres Ltd/Cooper Tire & Rubber Company Merger Agreement Summary. The transaction has been troubled almost immediately since signing, with Apollo's stock price dropping and an arbitrator ruling that unionized workers at two of Cooper's plants are entitled to consent to the deal. Adding to the complications, workers at Cooper Tire's factory in China went on strike soon after the announcement of the merger agreement to protest the transaction.
One of the issues in dispute before the court is whether the factory strike and its impact on Cooper's business can form the basis for a finding that Cooper has experienced a "Material Adverse Effect" under the merger agreement. Cooper argues that it cannot, as the possibility of a strike in protest of the agreement was specifically anticipated and carved out of the term's definition. The relevant language states:
""Material Adverse Effect" means any fact, circumstance, event, change, effect or occurrence that (i) has had or would reasonably be expected to have a material adverse effect on the business, results of operations or financial condition of the Company, its Subsidiaries and Joint Ventures, taken as a whole, but will not include facts, circumstances, events, changes, effects or occurrences to the extent attributable to [...] (F) the execution and delivery of this Agreement or the public announcement or pendency of the Merger or any of the other Transactions or the Financing, including the impact thereof on the relationships, contractual or otherwise, of the Company or any of its Subsidiaries with employees, labor unions, customers, suppliers or partners, and any litigation arising from allegations of any breach of fiduciary duty or violation of Law relating to this Agreement or the transactions contemplated by this Agreement, or compliance by the Company with the terms of this Agreement..."
Clause (F) would apparently cover, and exclude, the factory strike, which is an event attributable to the announcement of the merger agreement that involves an impact on the relationship of the company with its employees and labor unions.
In light of this current litigation and the possibility of new judicial guidance on MAC clauses, Practical Law Corporate & Securities team reviewed the most recent 100 public merger agreements and 100 private acquisition agreements summarized in What's Market for examples of other agreements that have specifically addressed labor strife in the definition of a MAC. This Update describes those findings and reports on other recent trends in MAC definitions to see how some parties are attempting to describe what qualifies as a "durationally significant" material adverse change.

Carve-outs for Labor Disruptions

Several recent private and public acquisition agreements carve out strikes, shutdowns and other labor disruptions from the events that can qualify as a MAC. Unlike the Apollo/Cooper agreement, however, these agreements do not tie the labor disruption to the announcement of the merger. Rather, the agreements flatly exclude all strikes and labor disruptions from the definition of a MAC, which allocates the risk of those events entirely to the buyer. As an example, the carve-out in the Kennametal/Allegheny Technologies purchase agreement, entered into on September 13, 2013, reads as follows:
""Material Adverse Effect" shall mean any change, event, development or effect that (a) has had a material adverse effect on the business, results of operations or financial condition of the Tungsten Materials Business, taken as a whole, or (b) materially impairs or materially delays the ability of TDY to consummate the transactions contemplated by this Agreement, other than, in each case, any change, event, development or effect that results from, arises out of or is related to [...] (iii) any labor strike, slow down, lockage or stoppage, pending or threatened, affecting the Tungsten Materials Business or any Business Employee [...] or (xi) the announcement or pendency of, or the taking of any action contemplated by, this Agreement and the other agreements contemplated hereby, including by reason of the identity of Buyer or any communication by Buyer regarding the plans or intentions of Buyer with respect to the Tungsten Materials Business and including the impact of any of the foregoing on relationships with customers, suppliers, lenders, officers, employees or regulators..."
Note that this definition contains two separate carve-outs relating to these possible labor disruptions:
  • Strikes and slowdowns in general.
  • Events occurring in reaction to the announcement of the acquisition that impact the company's relationship with its employees.
Because the Apollo/Cooper agreement is not drafted this way, Apollo could theoretically make a two-pronged argument:
  • That the strike at Cooper's factory is not a reaction to the announcement of the merger, but an event that would have happened on its own.
  • That the carve-out should not be read to exclude strikes that would have happened on their own but that are not reactions to the announcement of the merger.
If Apollo were to make that argument successfully, then the drafting approach taken in the Kennametal/Allegheny agreement would deserve serious consideration as the best and only approach to carving out labor disruptions from the definition of a MAC.
Other recent private acquisition agreements that carve out all labor disruptions from the definition of a MAC include:
Among public merger agreements, the Georgia-Pacific/Buckeye Technologies agreement, dated April 23, 2013, provides that any change that results, or would reasonably be expected to result, in a 60-day shutdown of operations that generate a majority of the target company's EBITDA at its Florida manufacturing plant constitutes a MAC.

Dollar and Term Thresholds

One of the lasting practical implications of the 2008 decision of the Delaware Court of Chancery in Hexion Specialty Chemicals v. Huntsman Corp. was that short-term effects on, or moderate downturns in, the acquired business will not constitute a MAC (965 A.2d 715, 738 (Del. Ch. Sept. 29, 2008)). Therefore, the most certain way to achieve contractual certainty regarding what does qualify as a MAC is to include specific objective thresholds of monetary or temporal deterioration that, when passed, constitute a MAC.
As has been noted widely, most acquisition agreements in both private and public M&A deals still do not include explicit triggers for a MAC. Some, however, do. For example, the Fusion Telecommunications International/BroadvoxGo!/Cypress Communications asset purchase agreement, dated August 30, 2013, provides that "any adverse effect of $200,000" affecting the acquired business is deemed to be a MAC, subject to carve-outs. Conceptually similar is the MB Financial/Taylor Capital Group merger agreement, dated July 14, 2013, which provides that any claim or penalty assessed or threatened against the target company that "would warrant" a reserve of $20 million under GAAP constitutes a MAC.
Among private M&A agreements, in addition to the Fusion/BroadvoxGo!/Cypress agreement, DCP Midstream Partners entered into two agreements on August 5, 2013, one for the acquisition of the LLC interests of DCP LaSalle Plant and the other for the acquisition of the LLC interests of DCP Midstream Front Range, each of which deems a $4.3 million adverse change to be a MAC.
In public M&A, in addition to the MB/Taylor agreement, two other recent transactions include monetary thresholds as triggers for a MAC:
  • The ProAssurance/Eastern Insurance Holdings agreement, dated September 23, 2013, provides (in bold type) that a MAC is "conclusively presumed" if the target company's shareholders' equity as of any month end before closing is 90% or less than its shareholders' equity as of June 30, 2013.
  • The Georgia-Pacific/Buckeye Technologies agreement, cited above for its carve-out for labor disruptions, carves out from the definition of MAC any capital expenditures that do not exceed $100 million reasonably expected to be spent to obtain a certain permit. By implication, expenditures above this level may constitute a MAC, though this is by no means definitive.

Durational Thresholds

Agreements with specific thresholds for the length of time that must pass before an adverse event qualifies as a MAC are even more rare than agreements with dollar thresholds. The Joe's Jeans/Hudson Clothing Holdings agreement, dated July 15, 2013, is one example. It provides that a change or event does not constitute a MAC until it has continued, or is reasonably expected to continue, for not less than 18 months.
It is more common, though, for agreements to specifically carve out seasonal changes in the business's operations or results. This is somewhat more prevalent in the retail sector, for obvious reasons. Recent examples among private acquisition agreements include:
Recent public merger agreements with carve-outs for seasonal fluctuations include:

Carve-outs for Government Shutdowns, Sequesters

Some parties have recently begun taking to carving out adverse effects brought on by any shutdown of the federal government or by the effects of the "sequester." What's Market first observed this in the March 2, 2011, merger agreement for the acquisition of Global Defense Technology & Systems, Inc. by Ares Management. That agreement carved out events caused by "the failure of the federal government to adopt a budget for the 2011 fiscal year, the extension of any effective continuing resolution under which the federal government is operating or the shut down of the federal government upon expiration of any continuing resolution."
Similarly, on August 26, 2012, Thoma Bravo and Deltek, Inc. entered into an agreement with a MAC carve-out for "any change in the U.S. federal budget or other governmental budget, any partial or other shutdown of the U.S. federal government or any other government (or similar event), or any event, occurrence, fact, condition, change or effect arising from or related to such budget change or government shutdown (or similar event)..."
Recently, in the private M&A sphere, EBI Holdings, LLC and Lanx, Inc. entered into an agreement, dated October 5, 2013, that exempts "any effects of the 'shutdown' of the U.S. government as a result of any impasse in the United States Congress over the budget or federal debt ceiling, including delays in payments by Medicare or Medicaid or other government agencies, delays or failures to act by any Governmental Authority."
Finally, in the Integrated Mission Solutions/Michael Baker agreement, dated July 29, 2013, the MAC definition carves out "changes in general economic or political conditions (including any consequences of the Budget Control Act of 2011, any successor or related legislation and executive orders, or the effects of any failure to increase or waive the effect of any limitation on the incurrence by the United States of public debt) or the securities, credit or financial markets in general."
For an in-depth discussion of the case law discussing MACs and drafting guidance for the term's definition and carve-outs, see Practice Note, Material Adverse Change Provisions: Mergers and Acquisitions.