By: Adrian Lopez Casab
The Material Adverse Effect clause (also referred to as MAE or MAC, for Material Adverse Effect or Material Adverse Change, respectively) has become one of the most relevant and thoroughly negotiated provisions in transactions involving a deferred signing and closing, particularly in mergers and acquisitions (M&A) transactions, although its inclusion has also become increasingly frequent in other type of transactions.
The Material Adverse Effect clause is a contractual provision that grants one party (typically the buyer) the right to terminate the agreement or transaction, or to trigger a renegotiation of its terms, in the event an occurrence materially alters the financial condition, operations, and/or the industry in which the target operates. In other words, the main purpose of this clause is to foresee and allocate between the parties the risks that may arise during the period running between signing of the agreement and the closing. This provision is commonly included in the form of a closing condition in the relevant agreements, although it is also frequently used as a qualifier to representations and warranties, limiting their scope in those matters that would result in “materially adverse effects.”
From the buyers’ perspective, they logically will seek to draft the MAE clause scope as broadly as possible, given the inherent difficulty in anticipating all circumstances that could negatively impact the condition (legal, economic, operating, etc.) of the target. Sellers, on the other hand, typically aim to include as many nuances and exceptions (carve-outs) as possible in order to limit the circumstances under which the buyer may exercise its right to withdraw from, or renegotiate the terms of, the transaction. Common carve-outs include changes affecting the target’s industry, amendment in applicable legislative framework, changes in financial or capital markets, acts of god and force majeure events, actions implemented by or attributable to the counterparty, among others. In recent years, there has been a trend toward greater specificity in these exceptions, to expressly include events such as pandemics and cyberattacks within exclusions to the buyer’s ability to terminate a transaction based on an MAE. These carve-outs are often among the most heavily negotiated aspects of this clause.
In certain transactions, particularly those involving private equity firms, it is also fairly common to find “reverse MAE” clauses, pursuant to which sellers negotiate provisions allowing them to terminate the transaction if a material adverse effect with respect to the buyer or to its sources of financing occurs.
Given that the MAE clause has its origins in common law, and considering the characteristics of the Mexican legal system, it is generally advisable, in agreements governed by Mexican law, to include quantitative (generally monetary) parameters in order to establish objective criteria for determining materiality, rather than leaving such determination to the discretion of the judicial system, which in certain cases and due to the particularities of the Mexican market, may not be familiar with disputes arising from this type of contractual arrangement.
The Material Adverse Effect clause represents a key mechanism for risk balancing and allocation in transactions with deferred signing and closing. Its drafting requires careful legal advice to ensure the proper negotiation of its critical elements, particularly carve-outs and materiality parameters.
