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COVID-19 in Estonia: Effect of coronavirus COVID-19 pandemic on M&A transactions

2020-03-16

In terms of the spread of coronavirus COVID-19, there has been quite a lot of talk about force majeure and the resulting non-performance of one’s contractual obligations. In addition to force majeure, contract law recognises also the concept of alteration of the balance of contractual obligations (§ 97 of the Law of Obligations Act). However, Estonian courts have stated that even in case the balance of contractual obligations is altered, amendment of the contract or withdrawal from the contract may happen only in very exceptional cases. Therefore, it is much more important to see what has been written in the contract between the parties, i.e. the so-called MAC clause (Material Adverse Change or Material Adverse Effect). Is it possible that the coronavirus COVID-19 will change the M&A market more purchaser-friendly, i.e. increase the use of MAC clauses in M&A transaction documents?

Within the context of M&A transactions, MAC clauses are typically used in share purchase agreements and provide the purchaser with the opportunity to withdraw from a transaction under certain conditions. For example, according to the latest Baltic M&A transaction statistics, the MAC clause had been used in 51% M&A transactions. Simply put, the MAC clause enables the purchaser to withdraw, after the signing of the sale contract but before the closing of the transaction (this period may even extend to half a year under various circumstances, e.g. in case of an obligation to obtain the permission for concentration from the Competition Authority),  from the contract without any sanctions, should any MAC occur. Normally the MAC clauses are worded in quite abstract terms – e.g. “the obligation of the purchaser to close the transaction is tied to the condition that there has been no material adverse change in the business, assets or financial condition of the company to be purchased“ (i.e. MAC), or in somewhat wider terms that “the economic environment in which the company to be purchased operates, has not changed materially“. Under which circumstances and conditions a purchaser will be able to use the MAC clause and withdraw from a contract due to the coronavirus COVID-19 pandemic, depends on the exact wording and interpretation of the MAC clause and on the direct or indirect effect of the virus on the company to be purchased and the value thereof. Theoretically it is possible that the coronavirus COVID-19 will affect the specific economic environment in which the company to be purchased operates (e.g. tourism) or the specific company itself (e.g. production has been halted due to a disruption of the supply chain), entitling the purchaser to withdraw from the transaction depending on the existence of the MAC clause or the wording thereof.

It is also important to distinguish the MAC clause and the alteration of the balance of contractual obligations which derives from the Law of Obligations Act, from the concept of force majeure. While the party’s liability is excluded in case of  force majeure, i.e. a claim for the compensation for damage is excluded in a situation where it is absolutely impossible (including temporarily impossible) to perform the contract, then the occurrence of MAC and alteration of the balance of contractual obligations affects the entire contract, and leads to the amendment of the contract or (in particular in case of MAC) withdrawal from the contract. Therefore, in order to ensure one’s right of withdrawal in M&A transactions, it would make sense to write the MAC clause into the contract, as force majeure and the concept of the alteration of the balance of contractual obligations is not an effective legal remedy in order to withdraw from the contract.  

There is speculation that the coronavirus COVID-19 may make the dynamic of the transaction market more purchaser-friendly. The reasons for this may derive from the general reduction of the number of transactions, cautiousness of the purchasers and their desire to obtain the opportunity for withdrawal from the transaction in the form of the MAC clause in the course of negotiations. In practice, it is also not precluded to use a MAC clause which would enable the purchaser to reduce the purchase price. However, in competitive auction processes where several bidders bid for the purchase of a company, generally the transaction documents do not include any MAC clauses for “deal certainty” purposes. Considering the situation today, the transaction market may change, and an increasing number of purchasers succeed to obtain the option to withdraw from the transaction. In order to interpret the MAC clause and prevent further disputes, it is recommendable to regulate between the parties in very specific terms what is considered and what is not considered to be a MAC (e.g. a drop in sales by x % during a period of time x, etc.).