Material adverse effect là gì

Material Adverse Effect in the time of COVID

The High Court has recently considered the interpretation of a Material Adverse Effect clause, in the context of the COVID-19 pandemic. It is the first COVID-related Material Adverse Effect dispute to come before the English courts and has determined a number of preliminary issues for the purposes of assessing whether the pandemic had a disproportionate effect on the targets of an M&A transaction as compared to other industry participants.

Background

In Travelport & Ors v WEX Inc; Olding & Ors v WEX Inc [2020] EWHC 2670 (Comm), the Court was asked to consider certain preliminary issues as to the proper construction of, and burden of proof in relation to, the definition of Material Adverse Effect contained in a Share Purchase Agreement (SPA). The SPA was between the defendant buyer, WEX Inc, a financial technology services provider (Buyer), and the claimant sellers of the target companies, which belonged to the Optal and eNett group of companies respectively (Sellers).

One of the conditions precedent to the Buyers obligation to close the deal, entitled No Material Adverse Effect, was a clause that read as follows:

Since the date of this Agreement there shall not have been any Material Adverse Effect and no event, change, development, state of facts or effect shall have occurred that would reasonably be expected to have a Material Adverse Effect.

The definition of Material Adverse Effect (MAE) was detailed and included a list of nine matters that would not be construed to be a MAE (Carve-Outs). This included conditions resulting from any pandemics. However, the definition of MAE also provided that such conditions could be taken into account to determine whether there had been a MAE, if the event in question has had a disproportionate effect on [the target companies], taken as a whole, as compared to other participants in the industries in which [they] operate (Carve-Out Exception).

On 4 May 2020, the Buyer notified the Sellers that, as there had been a MAE due to conditions resulting from the SARS-CoV-2 pandemic, it was not obliged to close the transaction. On 11 May 2020, the Sellers issued claims for a declaration that no MAE has occurred or is reasonably expected to occur; and for specific performance by the Buyer of its obligations under the SPA. Given that the Buyers funding would lapse on 27 October 2020 had the transaction not been completed by then, the Court expedited the trial of various preliminary issues.

The trial of preliminary issues

The trial was held as a hybrid hearing, with opening and closing submissions heard in a physical court room with core teams from each side present, and the remaining legal and client teams linked to that courtroom virtually. The evidence was heard entirely virtually, with sitting hours adjusted to allow for witnesses to participate from various time zones.

Eight issues were identified as preliminary issues to be determined by the Judge, relating to the proper construction of the Carve-Outs and the Carve-Out Exception contained in the SPA. These broadly related to the burden of proof and the identification of the relevant industries for the purposes of the MAE definition, as such industries had not been defined in the SPA.

The Courts conclusions

On the question of burden of proof, the Court held that the Buyer had the burden of proving whether and to what extent any effect within the Carve-Outs fell within the scope of the Carve-Out Exception. Practically speaking, this meant that the Buyer had to show that the conditions resulting from the COVID-19 pandemic had a disproportionate effect on the target companies, as compared to other participants in the industries in which they operate.

The question of which industry or industries were relevant to the Carve-Out Exception, i.e. when considering the relative effect of the pandemic on the target companies compared with other companies, proved to be more complicated. The Sellers case was that such comparison is to be carried out by reference to the travel payments industry. The Buyer claimed it should be done by reference to the broader B2B payments industry, or even just the payments industry in general.

In considering this question, the Court took several factors into account, including the construction of the MAE clause and the commercial purpose of the MAE clause and the transaction.

On construction, the Judge found that no special principles of interpretation applied to MAE clauses in English law. There was also no authority to suggest that MAE clauses are required to be construed contra proferentem, i.e. against the party seeking to rely on such clause. The starting point of the Judge was to note that the parties had chosen the word industries and not markets, sectors or competitors, all of which are narrower than industries. The SPA also made use of the term businesses in other places, indicating that the parties had sought to distinguish between the two terms.

The commercial purpose of the transaction was held to be admissible as factual matrix evidence, i.e. relevant background of a sufficiently material nature bearing on the parties objective understanding of the terms to which they had agreed. While the Judge accepted that evidence of the parties intentions was not admissible as factual matrix evidence, it was permissible to consider the parties intentions solely with a view to evaluating the objective purpose of the deal (emphasis added).

Bearing the above in mind, the Court found that the Sellers case that the transaction was considered to be just a purchase of a travel payments business was an oversimplification. Although the Buyer was particularly interested in the travel-specific perspective of the target companies, there was evidence to show that the Buyer was cognisant of the possibility of expanding their offering to other verticals (i.e. business areas). In other words, the transaction carried with it future value in other markets.

The Judge also concluded that there was no such industry as the travel payments industry, whether as defined by the Sellers or more broadly. The Sellers definition of the term was one that materialised in the litigation and, in any event, there was a paucity of the use of the term even generally which indicated that it is not in everyday use. However, the payments industry and B2B payments industry clearly existed.

Owing to a dearth of English case law on MAE clauses, the Judge drew heavily on the Delaware case of Akorn Inc. v Fresenius Kabi AG, given the similar structure of the MAE clause that was in dispute. In that case, the Court found that, consistent with standard practice in the M&A industry, the risk of endogenous, business-specific events, i.e. those events with an internal cause or origin, was allocated to the seller and that of exogenous, systematic risks, i.e. those events with an external cause or origin was allocated to the buyer.

It was the Sellers case that the MAE clause operated as a backstop to the allocation of business risk, with the warranties, representations and covenants in the SPA serving as the primary safeguards against such risk. The Buyer argued that the MAE clause ought to be seen as a separate protection directed to a different risk, namely a commercial allocation of how much systemic (as opposed to specific) risk each party was to bear in the period prior to the closing of the transaction. The Judge could find no clear authority or rationale in favour of the Sellers arguments and concluded that the Buyers construction was the preferred one. It followed that the comparison exercise for the purposes of the Carve-Out Exception was to be carried out with reference to the participants in the B2B payments industry or the payments industry.

Comment

In delivering its judgment on these preliminary issues, the Court has provided a valuable insight into the interpretation of MAE clauses. Although the Judge accepted that the burden is on the buyer to prove that a particular carve-out to an MAE clause falls within an exception to that carve-out, the judgment gives an indication of factors that the Court is likely to take into consideration in arriving at its own interpretation of the clause. The judgment also highlights the importance of considering the words used when drafting agreements so as to ensure that the allocation of risk is clear. In citing the Akorn case, the Judge acknowledged that parties often prefer to leave certain terms undefined because the resulting uncertainty generates productive opportunities for renegotiation. However, this brings with it the risk that a failure to renegotiate will result in the Court having to fashion an objective intent which was never subjectively shared by the parties.

In the meantime, permission to appeal the judgment has been granted and so the Court of Appeal may have the opportunity to remedy the dearth of English case law on MAE clauses and provide insight into an area of law that will likely have far reaching implications on parties with similar contractual provisions.

The judgment can be found here.