Interpretation of Material Adverse Change Clauses in an Adverse Economy

Abstract

By all accounts, 2008 was an awful year for the financial markets, and deal-making activity has plummeted. Sellers in particular have had a tough time, and their negotiating power has been quite weak due to current market conditions. Over the last year, credit has been increasingly difficult to obtain, and markets have been full of uncertainty. Some sellers have even resorted to “reverse auctions,” where several sellers compete over one buyer. Meanwhile, buyers have found it easier to walk away from deals. Often, buyers who try to renege on previously agreed to deals will argue that the seller has experienced a material adverse change (“MAC”), sometimes also referred to as a material adverse effect (“MAE”). Seller plaintiffs in recent cases have contended that the real reason for assertion of MAC clauses by buyers is the increased difficulty in obtaining financing and enforcing commitments from lenders during these credit-scarce times. In the Sallie Mae litigation for instance, buyers that included J.C. Flowers, J.P.Morgan, and Bank of America tried to invoke a MAE clause to avoid paying a $900 million breakup fee for dropping the $25 billion deal. The buyers argued that Sallie Mae suffered a MAE due to the subprime mortgage crisis and the September 2007 passage of the federal College Cost Reduction and Access Act that reduced government subsidies to lenders such as Sallie Mae by $19 billion. In seeking to recover the termination fee, Sallie Mae claimed that the Credit Crisis was explicitly excluded from the MAE clause and that details about the potential legislation had been disclosed in its 10-K filing. Nonetheless, it settled the lawsuit in January 2008 in exchange for a deal to refinance about $30 billion in debt. Just like in other recent deals, the buyers were able to renegotiate without any serious financial penalty merely by asserting a MAE. Some commentators might expect the recent imbalance of negotiating power between sellers and buyers to result in broader, more buyer-favorable MAC clauses and greater scope given to those clauses by the courts. However, this Note will argue that the current credit crunch is not a MAC and should not be used to loosen MAC standards of materiality. The recent crisis better fits under a carve-out exception, included in 75% of MAC clauses, which excludes events resulting from changes in general economic or business conditions. Part II of this Note defines a MAC clause, identifies some common features, and discusses the standard for materiality. Part III briefly summarizes the two leading Delaware cases on the interpretation of MAC clauses. Part IV examines the role of MAC clauses in the 2001 recession and draws comparisons with today’s conditions. Part V analyzes two recent cases that adhere to a strict standard for determining whether a MAC exists. Part VI considers whether courts should continue to maintain this steep hurdle for buyers seeking to prove a MAC. Finally, Part VII concludes.