The Covid-19 pandemic and consequent economic downturn have often made it difficult for companies to perform their contractual obligations, from making rent payments to shipping goods across borders. Many have attempted to rely on force majeure clauses to avoid liability. In general, force majeure arises when an event outside the control of the parties impedes their performance of the contract. If successfully invoked, force majeure clauses usually relieve them of their obligations, but this will depend on how the specific clause has been drafted.
Whether the pandemic constitutes a force majeure event will vary from contract to contract. However, some M&A contracts – such as Share Purchase Agreements (“SPA”) and Asset Purchase Agreements (“APA”) – do not contain force majeure clauses at all. Instead, they often rely on a different mechanism to protect against unforeseen events: Material Adverse Change (“MAC”) clauses. This article seeks to explain why SPAs and APAs are not drafted with force majeure clauses, as well as the potential solutions offered by MAC clauses.
FORCE MAJEURE PROVISIONS
Force majeure is notoriously difficult to prove. In English law, the courts interpret force majeure clauses narrowly, relying on the specific words used to determine their meaning. Importantly, most clauses require force majeure events to prevent the parties from performing their obligations under the contract. In other words, there must be a strong causal link between the event and contractual non-performance.
This is particularly difficult to prove in the context of SPAs and APAs. This is because force majeure events do not usually prevent the parties from performing such agreements.
Usually, if an unforeseen and damaging event occurs, it is the buyer who will attempt to trigger the force majeure clause and withdraw from the agreement. For example, in the context of SPAs, the pandemic has dramatically reduced the earnings potential of many target companies, making them less desirable to buyers. To prevent the transaction from going ahead, buyers might invoke force majeure. However, this involves proving that the pandemic has prevented them from performing their obligations, such as obtaining regulatory approval or providing consideration at closing.
Regulatory approval is unlikely to be affected by force majeure events (note the changes to merger controls due to the pandemic, including the new public interest ground for intervention by the CMA). On the other hand, buyers might suffer economically and struggle to pay the agreed price for the target company’s shares or assets, but this will not prevent or sufficiently hinder them from doing so. If the transaction becomes unprofitable, this alone should not trigger the clause. Underlying this is a policy argument about risk allocation: buyers should carry the risk of ensuring that they can pay the purchase price, when the time comes.
THE ROLE OF MAC CLAUSES
Unlike force majeure clauses, MAC clauses cover situations where transactions become less economically desirable to the buyer, such as when the earnings potential of the target dramatically reduces. As a result, when parties in M&A agreements want to manage risks from events outside their control, they often do so via MAC rather than force majeure clauses.
Crucially, the buyer does not need to prove that they are prevented from performing their obligations. Rather, it is usually sufficient to show that an event occurred between signing and closing that was materially detrimental to the target. In the context of SPAs and APAs, this is much easier to prove than force majeure.
However, it is important to note that courts are still reluctant to terminate agreements due to MAC. Particularly if the effects on the target were reasonably foreseeable and industry-wide, then the buyer will not be able to rely on the clause. Consequently, the current pandemic will rarely constitute MAC, as it caused a global economic shock that continues to affect many market players and not a particular buyer or target. Besides, some MAC clauses even contain “carve-outs”: a list of events that are excluded from their scope and, therefore, do not trigger MAC. In the future, many sellers will tend to include pandemics on the list of such carve-outs, to safeguard their transactions in response to new waves of the virus.
M&A contracts, such as SPAs and APAs, are not usually drafted with force majeure clauses. This is because force majeure is very difficult to prove in those contexts. Instead, if buyers want to protect themselves from unforeseen and damaging events, they tend to include MAC clauses, which enable them to withdraw from transactions in certain circumstances. This includes events that significantly harm the potential earnings of the target. However, due to the universal impact of the pandemic and potential carve-outs, MAC clauses are unlikely to be triggered by Covid-19. As a result, neither force majeure nor MAC offer much relief to SPAs and APAs in the present context. Therefore, buyers should bear that in mind before entering into M&A transactions, as it is likely that they must stick to the agreement, even if global economic shocks occur.
For more information, and any guidance or advice on force majeure and MAC clauses in M&A contracts, Cleveland & Co External in-house counselTM, your specialist outsourced legal team, are here to help.