Seventh Annual MAC Survey A Nixon Peabody study of current negotiation trends of Material Adverse Change clauses in M&A transactions Nixon Peabody’s Seventh Annual MAC Survey provides an analysis of publicly disclosed M&A transactions, and finds a significant shift in the landscape as the previously held sellers’ advantage shifts, making MAC terms more buyer-friendly. As in years before, we are pleased to announce the comple- definitional elements and include as many exceptions as tion of our annual MAC study of agreements with transac- possible, and buyers doing the reverse. This year we have tion values of $100 million or greater based on agreements again compared our sampling of 528 deals with the top dated between June 1 of the prior year and May 31 of the 100 deals during the period examined. The top 100 agree- current year. We initiated this annual survey because of ments were derived from the list of top 100 deals for 2007 the dramatic stock market decline in 2000 and the events and the top 25 deals for Q1 2008 announced in Mergers of September 11—to track their effects on the negotia- & Acquisitions: The Dealmakers Journal, excluding those tion of MAC provisions in M&A deals. Since that time, deals that occurred during the first six months of 2007 and this annual exercise has undergone significant expansions would have been reported on the previous year’s survey. In of scope and analysis to help identify current negotiation comparison to the sampling as a whole, we have seen that trends and the advantages and disadvantages provided these top 100 deals generally followed the same percent- to transacting parties in mergers and acquisitions. Now, age trends of the MAC definitional elements and had a seven years later the credit crisis has created arguably more slightly higher percentage trend in the MAC exceptions. dire financial circumstances than those under which the Our findings indicate that, in a deviation from the prior MAC survey was created. year’s trend, buyers have successfully limited the number of exceptions to the MAC definition. By way of explanation, a material adverse change (“MAC”) or material adverse effect (“MAE”) provision in an agree- ment generally comprises two elements of an acquisition Impact of Credit Crisis agreement. In the first, the MAC or MAE definition de- This year’s survey reflects deals that took place from June 1, scribes the circumstances that would constitute a material 2007, right before the initial onset of the credit crisis that adverse change or effect on the target. This definition is began in July 2007, and includes deals only through May used in the representations and warranties of the target or 31, 2008. Accordingly, the deals surveyed do not include sellers, i.e., “The company’s contracts are in full force and the effect of recent events. We anticipate the current un- effect, except as would have a Material Adverse Effect.” The certainty in the market to exist for some time to come, and definition is also used to delineate the circumstances that, upon their occurrence, permit a buyer to withdraw from the transaction without penalty. This latter use is known in common parlance as the “MAC out” and appears in the buyer’s conditions precedent to close, i.e., “there shall not have occurred a Material Adverse Change in the company.” The flip side of the coin is the listing of specific events, the “MAC exceptions”, that would prohibit a buyer from backing out of a deal. The elements of MAC clauses generally are negoti- ated heavily, with sellers attempting to narrow the MAC 2 we anticipate that MAC clauses in acquisition agreements in the merger agreement. The buyers argued, among will be affected by this uncertainty. other things, that the recent collapse in the credit markets constituted a change in the general economic, business Survey results confirm that, during the relevant period, or market conditions and changes affecting the financial the previously overheated pro-seller market cooled off services industry generally, and accordingly, a MAC had significantly as a result of less leverage being available to occurred. The buyers further noted that the collapse of the both strategic and financial buyers. MACs serve as a risk- securitization market and disruption of the asset-backed allocation tool, and as access to credit decreases, MACs commercial paper market had disproportionately affected become more highly-negotiated. Sellers wishing to en- Sallie Mae, and therefore were not excluded from the sure certainty of closing will have to balance that desire merger agreement’s MAC definition. After a bitter legal with the real-world lack of available credit. In light of battle over whether an actual MAC had occurred, the the credit crisis, we are seeing MAC terms become more case finally settled. The potential for litigation in these buyer-friendly, and we anticipate the market to stay this uncertain times adds to the high level of negotiation with way through most of 2009. respect to the MAC provisions and the need for a delicate Some immediate effects of the credit crisis are being seen balance between specificity in the exceptions and breadth more readily in the increased attempts by buyers to walk to capture those items that are not readily apparent. away from signed M&A deals by stating that a MAC had occurred with respect to the target. There have been Methodology several deals that have been litigated over the last year as In completing this year’s survey, we examined 528 asset the markets began to cool in which buyers have attempted purchase, stock purchase and merger agreements. The to use the MAC provision to terminate an existing agree- surveyed transactions represent many significant industries ment. In addition to the Huntsman decision described and range in value from $100 million to $27.3 billion. elsewhere in this survey, SLM Corporation v. J.C. Flowers II, C.A. 3279-VCS is an example. In this case, the buy- In selecting our 528 agreement sample, we generated a ers (J.C. Flowers, JPMorgan Chase and Bank of America) list of deals executed between June 1, 2007 and May 31, refused to consummate the proposed acquisition of SLM 2008 from publicly available information submitted to the (better known as Sallie Mae) on the terms set forth in the Securities and Exchange Commission and selected agree- merger agreement because they alleged that a MAC had ments from that list. Although this analysis is not techni- occurred. Accordingly, the buyers sought to reduce the cally scientific, we believe that the results are statistically purchase price. Sallie Mae brought the action, alleging representative of the climate of M&A transactions during it was entitled to collect a $900 million termination fee that period. because the buyers refused to close on the terms set forth “In light of the credit crisis, we are seeing MAC terms become more buyer-friendly, and we anticipate the market to stay this way through most of 2009” Seventh Annual MAC Survey – 3 Results In the agreements surveyed, while the MAC definitional credit available to finance transactions, and sellers’ under- elements were slightly narrower than in the prior year, standing that they must decrease their expectations to get we noted a decrease in the number of MAC exceptions a deal done. Sellers are finding that in order to sell their included in the agreements surveyed, indicating the ad- businesses, they need to agree to additional concessions vancement of buyers’ bargaining power during this period. including the inclusion of fewer MAC exceptions. The current shift towards more buyer-friendly terms noted Set forth below is a table detailing the prevalence of the during the period is likely due at least in part to a lack of MAC elements in our survey: MAC Elements 2 MAC on validity or enforceability of agreement 0 MAC on the securities or purchased assets 23 36 MAC on prospects of the Company/Target 3 0 Ability of Target to continue to operate business immediately after 1 closing in substantially same manner as immediately before closing 0 Ability of Purchaser to continue to operate business immediately after 1 closing in substantially same manner as immediately before closing 1 MAC on the benefits contemplated by the agreement 1 1 Losses over a specified threshold deemed to be a MAC 3 3 MAC on Purchaser's ability to close the deal 23 19 MAC on Seller's ability to close the deal 44 41 MAC on the business, operations, financial condition, etc. 88 95 % 0 20 40 60 80 100 % of deals having element/exception % of Top 100 deals having element/exception 4 In conducting our review, in addition to examining the In addition, when we reviewed certain exclusions from elements of, and exclusions from, MAC definitions, we MAC definitions, such as changes in markets or the also sought to evaluate certain uses of MAC provisions target’s industry, we found that 51% of the time, such in acquisition agreements. One example is the language exclusions were qualified such that they only applied to that a given event “would reasonably be expected to have a the extent that such events disproportionately affected the Material Adverse Effect” on the target, as opposed to sim- target, as opposed to such qualifications appearing in 69% ply stating that such event has in fact had such an effect. of transactions surveyed for the prior year. Interestingly, This nuance is important because the “would reasonably in these buyer-favorable times, the foregoing examples be expected to” formulation puts the onus on the seller trended toward sellers’ favor. An example of such a carve- to think thoroughly through the effects of certain events. out from the MAC definition would be “changes resulting For example, if there were a threatened litigation, no event from general economic, financial, regulatory, or market actually affecting the target’s balance sheet would have oc- conditions, provided that such changes shall not have af- curred. However, if the case were a strong one, it could fected the target in a materially disproportionate manner reasonably be expected to have an MAE. Although we saw as compared to other companies operating in the target’s the pendulum swing back to the buyer, interestingly, the line of business.” The “disproportionate effects” language “would reasonably be expected to” formulation showed up is a sophisticated tool for the buyer to push back on what in only 15% of the agreements as compared to 52% in would typically be a seller’s negotiation victory. This may the prior year. One possible reason for this result is sell- be directly related to the credit crisis, as we’ve unfortu- ers’ desire for increased deal certainty by eliminating this nately come to realize, changes in the market are not an forward-looking language. unlikely occurrence and sellers appear largely unwilling to assume the risk. “Sellers are finding that in order to sell their business, they need to agree to additional concessions including the inclusion of fewer MAC exceptions” Seventh Annual MAC Survey – 5 Results A recent Delaware Chancery Court decision addressed the the chemical industry taken as a whole. Hexion had analysis to be undertaken with respect to the “dispropor- argued that Huntsman had suffered an MAE principally tionate effects” language. On September 29, 2008, the as compared to other chemical companies. However, the Delaware Chancery Court rendered its decision in Hexion Court found that, as compared to prior years, Huntsman’s Specialty Chemicals, Inc. et al v. Huntsman Corp., C.A. financial condition, business and results of operations, No. 3841-VCL (Sept. 29, 2008). In general, Hexion, a while decreasing, had not suffered an MAE. Accordingly, portfolio company of Apollo Global Management, agreed its position as compared to other chemical companies was to acquire Huntsman, a chemical company, pursuant to irrelevant. Notably, the Court reaffirmed that absent clear a merger agreement executed in July 2007. The merger language, the burden of proof with respect to an MAE agreement included a “no MAE” condition to closing. The rests on the party seeking to excuse its performance, and merger agreement defined “Material Adverse Effect” to that Delaware courts have never found a material adverse exclude events resulting from changes in general economic effect to have occurred in the context of a merger agree- or financial market conditions, except to the extent such ment. event has had a disproportionate effect on Huntsman and Lastly, we observed that leaving the term “material adverse its subsidiaries, taken as a whole, as compared to others change” undefined is still pretty rare, although not as rare in the chemical industry. In holding that no MAE had as on our previous survey where 1% of the deals did not occurred, the Court found that the exception to the MAE define what constituted a MAC, as opposed to 7% on this definition had to first be tested before testing the excep- year’s survey. tion to the exception. The Court found that Huntsman had not suffered an MAE, and accordingly, determined Set forth below is a table detailing the findings in our that the Court need not reach the question of whether survey in respect of the miscellaneous definitional matters its performance had been disproportionately worse than described above: 4 No MAC out 4 51 Disproportionate Effects Language 80 7 MAC out with no definition of "MAE" or "MAC" 1 Reasonable expectation of event to have a 15 material adverse effect/change 9 % 0 20 40 60 80 100 % of deals having element/exception % of Top 100 deals having element/exception 6 Decrease in exceptions relating to change in markets This year marked a decrease in MAC exceptions for all previous year’s survey. The inclusion of other exceptions types of change in markets categories surveyed, other than (“changes in the economy or business in general” and “changes in exchange rates” which saw a slight increase “changes in trading price or trading volume of the compa- that could be attributable to the concerns surrounding ny’s stock”) also experienced declines in M&A transactions the weakening U.S. dollar. To cite a few examples, of the for the period surveyed. Again, these decreases, while not total deals examined, 70% included a MAC exception for substantial, are further evidence of the trend towards more “changes in general conditions of the specific industry”, as buyer-favorable terms. opposed to 75% in the prior year, 16% included a MAC Set forth below is a table detailing the prevalence of MAC exception for “changes in interest rates”, as opposed 17% exceptions found in our survey which relate to “Changes in the prior year, and 45% included “changes in the securi- in Markets”: ties markets” as an exception, as opposed to 51% on our MAC Exceptions: Change in Markets Change in exchange rates 12 17 Change in interest rates 16 22 33 Change in trading price or trading volume of Company's stock 54 Change in securities markets 45 64 Change in general conditions of the specific industry 70 84 75 Change in the economy or business in general 89 % 0 20 40 60 80 100 % of deals having element/exception % of Top 100 deals having element/exception Seventh Annual MAC Survey – 7 Results Exceptions relating to changes in legal developments For the period surveyed, the results relating to the excep- years, occurring in 63% of the agreements surveyed this tions concerning changes in legal developments were year (as compared to 59% in 2007 and 42% in 2006) mixed. The MAC exceptions for “changes in applicable and the “changes resulting from bankruptcy or actions of taxes/tax law” and “changes in interpretation of laws by a bankruptcy court” appeared in 3% of the agreements courts or government entities” decreased. Only 27% of surveyed this year, up from 0 in the previous year. Despite the agreements surveyed contained the MAC exception the buyer-favorable climate, it appears that sellers remain “changes in interpretation of laws by courts or govern- unwilling to take the risks with respect to changes in law or ment entities”, marking a 5% decrease from the prior year, regulations; therefore it is up to the buyers to get comfort- a contrast to the 11% increase between 2006 and 2007. able with the legal landscape in which the target company However, the MAC exceptions for “changes in laws or operates. regulations” has continued to increase over the past several Set forth below is a table detailing the prevalence of MAC exceptions found in our survey which relate to “Changes in Legal Developments”: MAC Exceptions: Legal Developments 3 Change in applicable taxes/tax law 2 3 Changes resulting from bankruptcy or actions of a bankruptcy court 0 27 Change in interpretation of laws by courts or govt entities 47 63 Change in Laws or Regulations 78 % 0 20 40 60 80 100 % of deals having element/exception % of Top 100 deals having element/exception 8 Exceptions for changes resulting from terrorism, acts of war, changes in political conditions and national and international calamites remain unchanged MAC exceptions for changes resulting from terrorism, acts In contrast, this year’s survey showed a continued increase in of war, changes in political conditions, and international the exceptions for changes caused by acts of God (as before, calamities generally remained unchanged or, in the cases we have tabulated events of weather and natural disasters in where there was a change, slightly decreased, in the period the “acts of God” category). Over the prior two years we saw surveyed in contrast to 2006 and 2007, when there was a sharp increase in this category, rising from 9.5% in 2006 an across-the-board increase of these types of MAC excep- to 23% in 2007, and we saw another increase, to 25%, this tions. For example, the frequency of MAC exceptions for year. This increase may be explained by the natural disasters changes due to acts of terrorism in the United States or that have occurred over the last few years, nationally and abroad fell only 1% from 61% of surveyed agreements in internationally, including the Southeast Asian tsunami and 2007 to 60% in 2008; whereas between 2006 and 2007, Hurricane Katrina. With the occurrence of other events such the frequency of this exception increased by 26%. Simi- as the rash of hurricanes affecting the southern U.S. and the larly, the number of agreements that contained exceptions Chinese earthquake occurring earlier this year, this category for changes due to “acts of war or major hostilities” and may be one that we continue to see develop. “natural calamities” remained constant in this year’s sur- A table detailing the prevalence of MAC exceptions found in veyed agreements, 60% and 12%, respectively. This may our survey which relates to “Changes arising from Hostilities, be due in part to the longevity of the wars in Iraq and Calamites and Acts of God” follows: Afghanistan and acceptance by buyers and sellers of this being the new reality. 7 International calamity directly or indirectly involving U.S. 2 12 National Calamity 12 38 Change in political conditions 47 25 Acts of God 36 59 Acts of Terrorism 75 60 Acts of war or major hostilities 74 % 0 20 40 60 80 100 % of deals having element/exception % of Top 100 deals having element/exception Seventh Annual MAC Survey – 9 Conclusions Conclusions and notable comparisons with the top 100 Generally, MAC exceptions appeared with slightly greater about 14-20% more often in the top 100 deals in compari- frequency within the top 100 deals in comparison to total son to the total deals surveyed. The outcome of the current deals surveyed, indicating that sellers have slightly greater crisis in the financial markets will influence whether sellers negotiating power in larger transactions. However, given will retain greater bargaining power in larger deals. the fact that exceptions to MAC within the top 100 deals As we are witnessing every day, the financial markets in the experienced a significant decline from the prior year, this U.S. and abroad remain in constant flux. We expect the observation should not be taken as a continuation of the number of transactions to be down during the next year. prior year’s trend but as an indication that even though It remains to be seen whether the buyer-friendly trend will buyers’ bargaining power has increased, sellers can argu- continue or whether the lack of available credit will cause ably ask for the inclusion of more MAC exceptions on sellers to demand more MAC exceptions in an effort to those deals that command higher purchase prices. No- obtain more certainty of closure. We will be monitoring table examples of this are MAC exceptions relating to the the trends over the next year. general categories “changes in markets” and “national and international hostilities, calamities and acts of God”. The The following chart shows the remaining results of our exceptions making up these categories generally appeared survey: MAC Exceptions: Employee Matters Changes in the Target's relationship with any 1 labor organization/unions 0 Lay-offs 1 0 Employee attrition 13 20 % 0 20 40 60 80 100 % of deals having element/exception % of Top 100 deals having element/exception 10 MAC Exceptions: Changes in Ordinary Course of Business 3 Delay or cancellation of orders for services or products 1 2 Adverse effect resulting in seasonal reduction in revenues 3 Commencement of a proceeding in bankruptcy 0 with respect to a material customer 0 11 Reduction of customers or decline In business 21 % 0 20 40 60 80 100 % of deals having element/exception % of Top 100 deals having element/exception MAC Exceptions: Miscellaneous Litigation resulting from any law relating to the agreement or 15 the transactions contemplated 27 Any action required to be taken under any law or 7 any existing contract by which the Target is bound 1 35 Failure by the Target to meet revenue or earnings projections 52 60 Changes in GAAP 76 Changes caused by the taking of any action required or permitted or in 56 any way resulting from or arising in connection with the agreement 70 5 Expenses incurred in connection with transaction 2 64 Effect of announcement of transaction 78 Developments arising from any facts that were expressly disclosed 5 to the Parent/public 2 % 0 20 40 60 80 100 % of deals having element/exception % of Top 100 deals having element/exception Seventh Annual MAC Survey – 11 Nixon Peabody LLP is a full service, international law firm with more For additional information about our than 700 attorneys collaborating across 25 major practice areas in 18 Seventh Annual MAC Survey, please office locations, including Boston, Chicago, London, Los Angeles, New contact: York, San Francisco, Silicon Valley, Shanghai, and Washington, D.C. Dominick P. DeChiara, Partner Chair, Private Equity Practice (212) 940-3772 firstname.lastname@example.org Philip B. Taub, Partner Private Equity Chair, Private Company Nixon Peabody is recognized as leader in private equity in both deals Transactions Practice closed and funds negotiated or structured. Our practice includes more (617) 345-1165 than 65 attorneys who provide strategic advice and legal counsel to email@example.com private equity, distressed and venture capital funds, hedge funds, port- folio companies, and institutional investors. We advise clients on a broad scope of transactions including, leveraged buyouts, control and non-control investments, business combinations, divestitures, growth financings, joint ventures and other strategic investments. Our knowledge of business issues, industry opportunities, and market conditions, combined with our extensive experience, enables us to deliver efficient, cost-effective and value-added solutions at all stages of a transaction. 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"Buyer Friendly Asset Purchase Agreement"