As was the case for the terrorist attacks of 11 September 2001 and the economic crisis in 2008, the COVID-19 crisis is putting material adverse change clauses in M&A transactions back in the spotlight.
On 22 April, it was announced that Brigadier Acquisition Company Limited (Brigadier), controlled by Crew Clothing owner Menoshi Shina, is seeking a ruling from the Takeover Panel (the Panel) to invoke a condition of its recommended cash offer (£22.6 million) and lapse its offer for the entire issued share capital of Moss Bros Group plc (Moss Bros). Moss Bros has reported that Brigadier is seeking to invoke the MAC condition in its offer document.
In the announcement, Moss Bros notes the requirements of Rule 13.5(a) of the Takeover Code (the Code), which means that Brigadier may not invoke a condition so as to cause the offer not to proceed, to lapse or to be withdrawn unless the circumstances which give rise to the right to invoke the condition are of material significance to Brigadier in the context of the offer.
The board of Moss Bros confirmed that “it will take all necessary action to make its case that those requirements have not been met and that the offer should not therefore be permitted to lapse”.
This is a public demonstration of how the COVID-19 crisis is having an effect on M&A transactions, where a contractual commitment has been entered into prior to the lockdown, but the acquisition has not yet completed. If recent private acquisition documentation included a MAC clause, in a similar way to the Brigadier and Moss Bros scenario, the parties may now be arguing over whether the circumstances surrounding the pandemic are captured by that drafting.
What is a MAC clause
In the context of an M&A transaction, a material adverse change clause (MAC clause) is a buyer friendly provision which seeks to allow a buyer to walk away from an agreed acquisition if the target company's business, assets or profits suffer a material adverse change between a specified date (usually at the point a contractual commitment to purchase the target company has been created) and completion of the transaction.
In UK public M&A, it is standard practice for an offer document to contain a MAC clause as a condition to the offer. The MAC condition in the Moss Bros offer document reads “…since 27 July 2019, there having been no material adverse change and no circumstance having arisen which would reasonably be expected to result in any material adverse change in, the business, assets, financial or trading position or profits, operational performance or prospects of any member of the wider Moss Bros Group which is material in the context of the wider Moss Bros Group taken as a whole”.
Public M&A transactions are subject to the Code, which regulates offers for public companies in the UK. As noted above, the inclusion of MAC conditions in offer documents is common practice. However, as cited by the Moss Bros announcement in response to Brigadier’s application to the Panel, an offeror's ability to invoke a condition so as to cause the offer to lapse is significantly restricted by Rule 13.5 of the Code, which does not permit a condition to be invoked unless the circumstances that give rise to the right to invoke the condition are of "material significance" to the offeror in the context of the offer.
The Panel applies a high level of materiality and has shown itself to be unwilling to allow offerors to rely on MAC clauses save in exceptional circumstances. This is demonstrated in the Panel's 2001 ruling in relation to WPP Group plc (WPP), an advertising agency, which attempted to invoke its MAC condition in relation to its offer to acquire another advertising agency, Tempus Group plc (Tempus). WPP argued that the 11 September 2001 events had caused a MAC to Tempus’ prospects. The Panel held that WPP was required to proceed with its offer because, to be permitted under the Code, a material adverse change must be an adverse change "of very considerable significance striking at the heart of the purpose of the transaction."
The test used by the Panel in deciding whether a MAC condition can be invoked is:
“…whether the relevant circumstances on which the offeror is seeking to rely are of material significance to it in the context of the offer, which must be judged by reference to the facts of each case at the time that the relevant circumstances arise. Whilst the standard required to invoke such a condition is therefore a high one, the test does not require the offeror to demonstrate frustration in the legal sense.” (Practice Statement 5 dated 28 April 2004, last amended on 19 September 2011)
Many UK M&A transactions take effect with simultaneous exchange and completion. MAC clauses are only relevant in private M&A transactions where there is a gap between signing and completion. This is known as a “split exchange and completion” and is typically necessitated by the requirement for consent to be obtained from a third party before completion of the purchase of the target company’s shares or assets can take place. For example, if the target company is regulated by the Financial Conduct Authority, a consent will be required from the FCA to a change in ownership of the target company.
Sellers will generally look to resist the inclusion of a MAC clause because this would mean that they are exposed to the risk that events outside their control could result in the acquisition agreement being terminated by the buyer. There may however be circumstances where sellers are obliged to accept the inclusion of such a clause. For example, where the buyer’s financing arrangements are subject to a MAC condition, the buyer will be unable to complete if that condition is triggered and will seek to “back to back” this condition in the acquisition agreement.
There are limited English court decisions on the interpretation of MAC clauses and these are of course heavily based on the facts of the case and the specific drafting of the MAC clause. However, the following general guidelines have evolved:
- The court will apply the usual principles of contractual interpretation to a MAC clause, giving careful consideration to the wording agreed by the parties, in the context of the wider agreement and the facts known by the parties when they entered into it.
- The party seeking to terminate the agreement has the burden of proving that a MAC has occurred.
- There must be a causal link between the change and the adversity. A buyer will need to show that the change being relied upon has caused the alleged adversity. It is not enough, for example, to rely on the fact that the retail industry is struggling without considering the specific position of the retail target company in question.
- A buyer cannot invoke a MAC clause based on circumstances that it was aware of on entering into the agreement, unless these circumstances have themselves materially changed. An event that is continuing between signing and completion will not constitute a MAC as there will have been no change.
- The materiality test must be satisfied. This comprises two elements. First, the change itself must be "significant" or "substantial". Second, the change must be significant in duration - a change must not merely be temporary or short term.
- The meaning of "financial condition" will be interpreted narrowly. Any consideration of a target company's financial condition should start with an assessment of its financial statements at the relevant time. However, courts will consider other compelling evidence of a target company's financial condition, to show that an adverse change sufficient to satisfy a MAC clause has occurred. For example, ceasing to pay bank debts might be relevant to the question of whether a material adverse change had occurred in the company's financial condition. Distinction has also been drawn between a MAC clause that referred to the "financial condition" and one that referred to the "business or financial condition". The inclusion of events that had a material adverse effect on the target company's business covered a broader scope than the MAC that was limited to its financial condition.
In the private M&A context, whether the COVID-19 events could trigger a MAC clause will depend on the drafting of the clause, the specific circumstances and the impact that this has on the target company, taking into consideration the principles that have evolved through the courts as outlined above.
In practice, in the absence of agreement between the parties as to whether the MAC clause has been triggered, the only way to establish whether a material adverse change has occurred and is materially prejudicial is to apply to the courts for a ruling. This is likely to be time-consuming and costly. However, for those acquisition agreements that do contain a MAC clause and have exchanged but have not yet been completed, the circumstances surrounding the COVID-19 crisis may nevertheless provide the buyer with negotiating leverage.
In terms of the Moss Bros offer, the offer timetable confirmed that the Panel has informed Moss Bros that it will consider Brigadier’s request for a ruling and Moss Bros' rebuttal of the basis for any invocation of the condition (the MAC condition) but that process is unlikely to be concluded prior to the court meeting and general meeting to approve the scheme of arrangement (to give effect to the offer) scheduled for 29 April. These meetings took place as planned and Moss Bros announced that sufficient votes were received to pass the resolutions and approve the scheme.
We will have to wait to see whether Brigadier is able to demonstrate the high level of materiality required by the Panel and that the COVID-19 situation constitutes exceptional circumstances. The Panel may be sympathetic to the views expressed by Nick Burchett, fund manager at Cavendish Asset Management (which holds a 6% shareholding in Moss Bros). In a recent article in The Financial Times, Mr Burchett is quoted as saying that it would be “disgraceful” if Brigadier were allowed to abandon the deal. The FT article cites Mr Burchett as pointing out that the World Health Organization identified the spread of coronavirus as a pandemic the day before the offer was agreed on 12 March and comments, “If they woke up on the 12th and wanted to back out it would make sense, but it’s far too late for that now” and “if the Moss Bros acquisition falls through it could start a worrying trend for future deals”.
Takeover Panel Ruling
Following publication of this article, the Panel delivered its ruling on 19 May. The Panel held that Brigadier had not established that the Covid-19 pandemic gave it the right to invoke the MAC condition to its offer. Brigadier initially requested a review of the ruling, but subsequently withdrew this request, so the Panel’s ruling stands. The Panel is again demonstrating its reluctance to allow buyers to rely on MAC clauses to pull out of deals, which is particularly unsurprising in this case given the timing of the deal when the pandemic was a known factor to the buyer.