Interpretation of "Material Adverse Change" in the Era of COVID-19

Dickinson, Mackaman, Tyler & Hagen, P.C.
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Dickinson, Mackaman, Tyler & Hagen, P.C.

The COVID-19 pandemic was a shock to many corporate systems and has changed the reality under which many deals where negotiated and executed. A merger agreement or financing agreement may include a material adverse change ("MAC") provision defining a substantial change in the target or the occurrence of an intervening event, either triggering a party's right to terminate the agreement, releasing a party from certain obligations under the agreement or qualifying certain representations and warranties.

A standard MAC provision includes a general definition of a change, effect, event or conditions that has, or with the passage of time could reasonably be expected to have, a material adverse effect on the target's business, assets or property or upon consummation of the contemplated transaction. Certain events are excluded from this definition: changes in general economic conditions of the target's industry, changes in applicable law, or acts of God (including natural disasters, terrorism or military actions, general economic downturns, etc.). At a high level, systematic risk is allocated the acquirer and risk specific to the target is allocated to the target. As such, the impact of COVID-19 will typically be placed on the acquirer as a systematic risk. However, some agreements will consider disproportionate impact to the target, caused by an excluded event, to be a MAC.

The party asserting a MAC provision has the heavy burden of showing an adverse change material to the agreement as a whole. While some agreements set a dollar threshold for materiality, the analysis of others will be dependent on quantifying the adverse impact to determine materiality. This quantification is typically a function of adverse impact of the target's financial condition/operations and duration. Despite quantification, there is no bright-line rule and a finding of materiality is highly context specific.

The question of whether COVID-19 presents a MAC is a question of contractual interpretation and dependent on the specific circumstances and terms set in the agreement. While MAC provisions are typically interpreted narrowly, the COVID-19 pandemic, and economic impact thereof, is unprecedented. Whether or not the case for a MAC could be successfully argued in court, the COVID-19 pandemic may present argument enough to spur renegotiation of agreement terms or settlement.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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