Material Adverse Effect or MAE Clauses ("MAE Clause") that allow a buyer to terminate a transaction in the event of a material adverse change in the business being sold between signing and closing of a transaction are commonly used in acquisition agreements as a condition to closing. Courts have recently made it more difficult for parties to rely on MAE Clauses as a means of abandoning a deal to which they have committed.
Frontier Oil [2005 WL 1039027] and other similar cases illustrate this recent shift in interpreting MAE Clauses. In these cases, the courts have focused on the following factors:
- The party seeking to terminate the agreement must show that a MAE has occurred or will occur—a very difficult burden.
- If parties are concerned about specific issues, they should not rely solely on a MAE Clause, but rather they should include these issues as separate closing conditions. For example, in Frontier, the parties knew that a mass toxic tort suit might be filed against the seller. Instead of creating a specific closing condition that no such lawsuit be filed, the buyer attempted to rely on the MAE Clause. The court held that buyer did not meet its burden in showing that the litigation would have a material adverse effect on the business.
- MAE Clauses should only be relied upon for unknown events that substantially impact the seller’s long-term earnings. In Tyson Foods [789 A.2d 14 (2001)], the court found that the buyer knew about the cyclical nature of the livestock business and also that one of the seller’s subsidiaries had accounting problems when it committed to the transaction. As a result, buyer was barred from claiming that the short-term drop in the earnings as a result of a MAE.
- The MAE definition should be carefully drafted because terms such as "has", "would" and "could" are interpreted as representing different degrees of certainty as to whether a MAE has occurred or is reasonably likely to occur.
The interpretation of MAE Clauses is a question of fact and will depend on the particular situation and the precise language of the MAE Clause. Known issues of concern should be included as specific closing conditions.
For further information, please contact a member of our Corporate Practice Group.