“Material adverse effect” and “material adverse change” are two terms that are often used interchangeably, but there are differences. Material adverse effect refers to a condition whereby certain adverse events are regarded as non-actionable under a transaction agreement. It gives the buyer the right to withdraw from a deal following a change in anticipated value. Material adverse change, on the other hand, refers to a contingency clause that is commonly found in venture finance contracts and merger and acquisition agreements. It enables the funding or acquiring party to walk away from an agreement.

What Is Material Adverse Effect?

Material adverse effect (MAE) serves two main purposes in a transaction agreement. Firstly, it functions to qualify and therefore limit seller representations, covenants, and warranties, setting a higher threshold for compliance and disclosure with regard to risks related to changes that occur to the target's company. For instance, a representation may provide that all the target's liabilities have been disclosed, besides those that will not have an MAE.

As a result of MAE qualification, certain adverse events will become irrelevant and non-actionable according to the terms of the agreement. In the given context, the seller will benefit from the application of the MAE concept because he or she will have fewer disclosure obligations and a lower tendency to breach the agreement.

Secondly, MAE is in effect in the conditions that must be fulfilled or waived before the buyer consummates the deal. It must not have taken place during a gap period or else the buyer may cancel the acquisition agreement. In contrast to its application in seller representations, covenants, and warranties, the MAE concept benefits the buyer by allowing him or her to back out from a deal after its expected value has changed.

However, in both contexts, the seller will want to reduce the chances of an MAE occurring by narrowing which circumstances and events will fit the definition, while the buyer will try to achieve the opposite. A condition to closing is typically included in an acquisition agreement to enable a party to not complete the deal if the other party has suffered an MAE between the date of signing and the closing date.

What Is a Material Adverse Change?

A material adverse change (MAC) refers to a contingency clause that is specifically included in merger and acquisition agreements, venture finance contracts, and lending agreements to enable the buyers or sellers, or funding or acquiring parties, to withdraw from the agreement. It also gives these parties the option of seeking a change of conditions if there is a significant adverse change in the business or its prospects or business conditions that have an impact on the parties of the agreement. Material changes may include changes in any aspect of the company and its subsidiaries, including:

  • Assets and liabilities
  • Process operations
  • Properties, such as patents and other kinds of intellectual property
  • Licenses and leases, such as spectrum licenses, mining licenses, and land leases
  • Market access, including access to foreign markets

In many cases, when a party seeks to nullify an agreement based on MAC clauses, the matter will be brought to the court and the final outcome will depend on how the court interprets what constitutes an MAC.

An MAC provision can also be used to mitigate risk in commercial agreements where adverse events happening around the world can have an impact on any of the participating parties. Such agreements include long-term purchase or sale agreements for power, oil, natural gas, and other such products. The aggrieved parties have the right to request changes in the quantities, prices, or other conditions of the purchase or sale based on MAC clauses in the agreements.

In an agreement, an MAC provision may be a condition, representation, or both. If it is a closing condition, an MAC provision enables the buyer to choose not to complete the transaction if the target business experiences an MAC between a baseline date and the date of closing.

If it is a seller representation, an MAC provision states that the target company has not experienced an MAC between the baseline date and the date of closing, and includes a closing condition that enables the buyer to back out if such a representation is proven false on the closing date. If an MAC has indeed not occurred, the MAC provision will not be regarded as a closing condition.

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