Many businesses may be finding themselves in the position of having a pending transaction terminate due to the impact of COVID-19. Buyers, for instance, might be seeking ways to avoid closing a transaction to merge with or acquire a particular target, whereas sellers might find themselves in the position of seeking to compel a reluctant buyer to proceed with closing. In other situations, businesses may be considering whether to pursue claims for indemnification or damages based upon the impacts of COVID-19. Accordingly, many are likely wondering whether COVID-19 qualifies as a “material adverse effect” (“MAE”) or “material adverse change” (“MAC”) under a variety of potentially applicable contract provisions.
MAE clauses are often included in “sign then close” contracts governing mergers and acquisitions to permit the buyer to terminate the transaction prior to closing in the event a MAE occurs. In other circumstances, contracting parties include a MAE clause, sometimes in the form a representation and warranty or covenant, to allow for indemnification or recovery of damages in the event a MAE occurs.
The first place to look when determining whether COVID-19 qualifies as a MAE under the contract is the language of the specific contract clause. In our experience, however, the majority of MAE and MAC clauses are incredibly broad and vague, such that merely reading the definition of “MAE” offers little help. On their face, many MAE provisions appear extraordinarily buyer friendly. But in practice, many courts have made clear that even broadly-drafted MAE clauses are difficult for buyers to invoke to avoid closing a transaction. Typically, courts have required a buyer seeking to avoid closing to meet a “heavy burden” of proving that the claimed MAE “substantially threaten[ed] the overall earnings potential of the target in a durationally-significant manner.” On the other hand, case law (at least in New York) suggests that invoking a MAE clause to pursue a claim for indemnification or damages (rather than to terminate a contract and avoid closing) might trigger a far lower burden of proof.
Whether COVID-19 qualifies as a MAE will almost certainly be made on a case-by-case basis, and will depend upon the specific circumstances involved. Given the case law, courts will likely require parties engaged in a dispute over a MAE clause to engage in discovery and hire expert witnesses to prove: (1) the significance of the impact of COVID-19 on the business in question; and (2) whether the impact would be long-term or short-term. Due to the fact-specific nature of the analysis, cases involving COVID-19 and MAE clauses are not likely to be decided at the motion to dismiss or motion for summary judgment stage.
For additional information, click to read our white paper on Material Adverse Effect clauses and our earlier legal alert on force majeure clauses.
