The MAC Clause

MAC clauses first appeared in the merger and acquisition arena, where they gained institutional acceptance and upon which most of the case law opinions have centered. Because there are myriad devices to control and allocate risk using typical representations, warranties, covenants and conditions, leasing lawyers, much like their M&A counterparts, use MAC clauses to cover any change in those representations, warranties, covenants and conditions between the execution of the operative agreement and the culmination of the transaction at closing. Thus, MAC clauses are used in lease agreements in several contexts: 1) as a representation and warranty that there has been no material adverse change from the date of execution of the operative agreement until closing of the transaction; 2) as a closing condition requiring the disclosure of the existence of an adverse change prior to closing; 3) obligations of a party; 4) termination provisions; and 5) default provisions. See Kenneth A. Adams, A Legal-Usage Analysis of “Material Adverse Change” Provisions, 10 Fordham J. Corp. & Fin. L. 9 (2004).

MAC Clause Language

The consequences of an inartfully drafted MAC clause can present themselves on either the front end or back end of any deal by innocently dropping the following, or some variation thereof, in your lease document with the intent to provide a fail-safe remedy to completely avoid the transaction pre-closing or to declare a post-closing default:

Lessee suffers a material adverse change in its financial condition, business, operations or assets and, as a result, Lessor deems itself or any of its Equipment to be insecure.

In addition, the definition of the MAC clause you elect to insert in the lease could employ forward-looking representations when terms like “prospects” are included. The language employed in the MAC clause is terribly important and it varies. Definitional variations abound and may include the following:

Material Adverse Change means any set of circumstance or events which (a) has or could reasonably be expected to have any material adverse effect whatsoever upon the validity or enforceability of this Agreement or any Schedule; (b) is or could reasonably be expected to be material and adverse to the properties, assets, condition (financial or otherwise) or business operations, or the results of operations of the Lessee, any subsidiary of Lessee or any guarantor of this Lease taken as a whole; (c) impairs materially or could reasonably be expected to impair materially the ability of Lessee, any subsidiary or any guarantor to duly and punctually pay or perform its obligations; or (d) materially impairs or could reasonably be expected to materially impair the ability of the Lessor to enforce its legal remedies pursuant to this Agreement, or any Schedule or any other Transaction Document.

By using the phrase, “taken as a whole,” the drafter intends that materiality be measured by consideration of both the company and its subsidiaries on a consolidated basis. This highlights how seemingly innocuous language changes to the definition of material adverse change can have a rather significant effect on the outcome.

The Materiality Question

Whether the adverse change or the adverse effect is one that is material has been the subject of a many opinions of little precedential value due to the vastly distinguishable fact patterns. Consistent with the observation we made in the our article titled The
Irresistible Force Paradox in Play in the Middle Market, LJN's Equipment Leasing Newsletter, Vol. 32, Number 7, August 2013, (http://bit.ly/1cnnz93), the price for failing to agree moves in tandem with the increasing frustration and deal fatigue that sets in when there is difficulty in reaching an agreement. As the time spent on a large transaction increases, the pressure to successfully close the transaction increases proportionately. Given this dynamic, it is unlikely that a MAC clause would ever be an effective method to scuttle a deal. More likely, use of the clause might be employed to alter the terms of the transaction.

There are several reasons for this, but perhaps the most compelling is the fear of failure. It seems clear that' reliance on any MAC clause as a reason to cancel a transaction is more than likely to result in litigation unless the offended party lacks the financial ability to undertake litigation. At any rate, litigation is little more than a crap shoot even when the issue does not center on the usage and meaning of a MAC clause.

When the MAC clause is a central issue, the parties are inviting lengthy and costly litigation.

First, almost by definition and despite all reasonable attempts to quantify the clause and insert all manner of carve-outs, all MAC clauses are ambiguous. What qualifies as “material” varies from entity size to entity size and transaction to transaction. Any transactional attorney must possess a clear understanding of exactly what precedents exist regarding the interpretation of materiality before venturing down this path.

Second, the determination of materiality is most likely always going to be a factual determination and not a question of law. The presence or absence of an ambiguity is a matter of law, but the resolution of that ambiguity is a question of fact. Thus, submission of this issue to a fact-finder for determination is all but assured.

Third, because it will be determined by a fact-finder, the uncertainty of success is high and the prospect of a reversal on appeal is particularly unlikely given the scope of review. All of these considerations combine to make any litigation on the occurrence of a material adverse change a risky proposition at best and the price of failure too high. A better solution is to get to the heart of the unhappiness and to forge agreement on compromised transactional terms, usually on price.

A Defined Term

The MAC clause is typically a defined term. The definition will not infrequently include a quantitative measure by which to objectively analyze the threshold upon which a MAC is triggered, hopefully avoiding litigation. The seeming objectivity of the definition is illusory, however, since almost all litigation surrounding MAC clauses will include claims that the clause is ambiguous and providing for an objective standard by which to cover every event to avoid that ambiguity is impossible. Thus, it may prove disappointing if you are thinking that an effectively drafted MAC clause can be employed as a fail-safe to express “buyer's remorse” and escape the terms of the contract.

Moreover, even taking into account the inherent ambiguity in any MAC clause, existing case law has not been particularly helpful. In re IBP, Inc. Shareholders Litigation. IBP, Inc. v. Tyson Foods, Inc., 789 A.2d 14 (Del Chancery 2001) is instructive here. The Delaware Chancery Court concluded that Tyson Foods' assertion and reliance upon a material adverse change clause was an insufficient basis to cancel a merger. In what may have been, and may still be, a unique remedy at the time, this court granted specific performance and compelled two public companies to merge pursuant to the existing merger agreement. The parties eventually agreed to revised merger terms. The point is, however, that the predictive value of precedent to which we have all become accustomed does not apply to the enforcement and interpretation of MAC clauses. Courts seem to be particularly savvy about efforts to employ a MAC clause to cancel a transaction due to economic uncertainty over clear evidence of purposeful concealment of material facts, the prior knowledge of which would result in the parties not reaching agreement.

Recommendations

Leasing counsel for an assignor contemplating assignment naturally wants any material adverse change clause to be as broad as possible. Having said that, counsel must give consideration to all of the real contingencies that, if they occurred, would seriously cause your client to analyze the risk of proceeding further in favor of looking for an escape. Expecting that unanticipated downturns in business generally, or the cratering of business prospects of the opposing party in particular, will supply that excuse will not generally suffice.

The better practice might be to develop a rather complete list of the events, relegated to the schedules and not in the definition, that would cause your client to want to turn tail and run for the hills ' and use that list in both your representations and warranties and as a part of your closing conditions, the latter of which must be brought down and updated just prior to closing. By avoiding a list of adverse changes as part of the definition, you minimize a court's ability to avoid the clause because the event is not defined. You can then incorporate the nonoccurrence of anything in those schedules as a representation and warranty or a closing condition, the breach of which will increase your ability to terminate and avoid closing.

Save reliance on the termination remedy for those things, other than buyer's remorse, that would truly cause your client to avoid the transaction if known, i.e., the discovery of purposeful concealment, fraud or the truly unanticipated natural catastrophe. More realistically, the use of a MAC clause can be an effective tool to bargain for new or additional terms when it is clear that a material adverse change in some aspect of the business has occurred.

Conclusion

I have heard lawyers remark that a MAC clause can be the fail-safe panacea to avoid a transaction that has gone terribly wrong. Panacea, in Greek mythology, was the goddess of Universal remedy. If you believe, and have convinced your client, that reliance upon the MAC clause, without much more, is a panacea, you may just find yourself trying to explain to your client the thinking behind an appeal to an ancient Greek goddess to resolve a very real 21st-century distress call to scuttle a deal that has turned terribly bad.

Anthony L. Lamm and Stephen Levin are partners in the law firm of Lamm Rubenstone LLC with offices in Philadelphia, Trevose, PA, and Cherry Hill, NJ. Lamm, the firm's managing partner and a member of this newsletter's Board of Editors, is admitted in Pennsylvania. Levin is admitted in Pennsylvania and New York. They may be reached at [email protected] and [email protected], respectively.

Before the well-meaning concept of “bring your daughter to work day” was tortured beyond recognition to now include such ridiculous notions as “bring your pet to work day,” I recall one time when my six-year-old daughter, now an accomplished lawyer herself, was sitting and coloring at my office conference table. A colleague of mine who was working on a lease document walked in and asked if I knew, or could put my hands on, the standard language for a MAC. I suppose my daughter expected to come to my work and actually assist me in the practice of law (something I would enjoy today), and before I could caution my colleague to be careful with any indiscriminate use of a standard language MAC clause, my daughter immediately volunteered, “Two all-beef patties, special sauce, lettuce, cheese, pickles, onions ' on a sesame seed bun.” Imagine my surprise when she elected to go to law school and not venture into the field of advertising!

Any reasonable review of the law surrounding interpretation of Material Adverse Change (MAC) provisions would fill a book, the basis for my comment to my colleague to use caution. This is a luxury I do not have in this limited space, but the caution remains. What follows, then, is a discussion of the big issues to focus on from a 50,000-foot altitude in the belief that you will gain an understanding of just what is at stake.'

Background

MAC clauses first appeared in the merger and acquisition arena, where they gained institutional acceptance and upon which most of the case law opinions have centered. Because there are myriad devices to control and allocate risk using typical representations, warranties, covenants and conditions, leasing lawyers, much like their M&A counterparts, use MAC clauses to cover any change in those representations, warranties, covenants and conditions between the execution of the operative agreement and the culmination of the transaction at closing. Thus, MAC clauses are used in lease agreements in several contexts: 1) as a representation and warranty that there has been no material adverse change from the date of execution of the operative agreement until closing of the transaction; 2) as a closing condition requiring the disclosure of the existence of an adverse change prior to closing; 3) obligations of a party; 4) termination provisions; and 5) default provisions. See Kenneth A. Adams, A Legal-Usage Analysis of “Material Adverse Change” Provisions, 10 Fordham J. Corp. & Fin. L. 9 (2004).

MAC Clause Language

The consequences of an inartfully drafted MAC clause can present themselves on either the front end or back end of any deal by innocently dropping the following, or some variation thereof, in your lease document with the intent to provide a fail-safe remedy to completely avoid the transaction pre-closing or to declare a post-closing default:

Lessee suffers a material adverse change in its financial condition, business, operations or assets and, as a result, Lessor deems itself or any of its Equipment to be insecure.

In addition, the definition of the MAC clause you elect to insert in the lease could employ forward-looking representations when terms like “prospects” are included. The language employed in the MAC clause is terribly important and it varies. Definitional variations abound and may include the following:

Material Adverse Change means any set of circumstance or events which (a) has or could reasonably be expected to have any material adverse effect whatsoever upon the validity or enforceability of this Agreement or any Schedule; (b) is or could reasonably be expected to be material and adverse to the properties, assets, condition (financial or otherwise) or business operations, or the results of operations of the Lessee, any subsidiary of Lessee or any guarantor of this Lease taken as a whole; (c) impairs materially or could reasonably be expected to impair materially the ability of Lessee, any subsidiary or any guarantor to duly and punctually pay or perform its obligations; or (d) materially impairs or could reasonably be expected to materially impair the ability of the Lessor to enforce its legal remedies pursuant to this Agreement, or any Schedule or any other Transaction Document.

By using the phrase, “taken as a whole,” the drafter intends that materiality be measured by consideration of both the company and its subsidiaries on a consolidated basis. This highlights how seemingly innocuous language changes to the definition of material adverse change can have a rather significant effect on the outcome.

The Materiality Question

Whether the adverse change or the adverse effect is one that is material has been the subject of a many opinions of little precedential value due to the vastly distinguishable fact patterns. Consistent with the observation we made in the our article titled The
Irresistible Force Paradox in Play in the Middle Market, LJN's Equipment Leasing Newsletter, Vol. 32, Number 7, August 2013, (http://bit.ly/1cnnz93), the price for failing to agree moves in tandem with the increasing frustration and deal fatigue that sets in when there is difficulty in reaching an agreement. As the time spent on a large transaction increases, the pressure to successfully close the transaction increases proportionately. Given this dynamic, it is unlikely that a MAC clause would ever be an effective method to scuttle a deal. More likely, use of the clause might be employed to alter the terms of the transaction.

There are several reasons for this, but perhaps the most compelling is the fear of failure. It seems clear that' reliance on any MAC clause as a reason to cancel a transaction is more than likely to result in litigation unless the offended party lacks the financial ability to undertake litigation. At any rate, litigation is little more than a crap shoot even when the issue does not center on the usage and meaning of a MAC clause.

When the MAC clause is a central issue, the parties are inviting lengthy and costly litigation.

First, almost by definition and despite all reasonable attempts to quantify the clause and insert all manner of carve-outs, all MAC clauses are ambiguous. What qualifies as “material” varies from entity size to entity size and transaction to transaction. Any transactional attorney must possess a clear understanding of exactly what precedents exist regarding the interpretation of materiality before venturing down this path.

Second, the determination of materiality is most likely always going to be a factual determination and not a question of law. The presence or absence of an ambiguity is a matter of law, but the resolution of that ambiguity is a question of fact. Thus, submission of this issue to a fact-finder for determination is all but assured.

Third, because it will be determined by a fact-finder, the uncertainty of success is high and the prospect of a reversal on appeal is particularly unlikely given the scope of review. All of these considerations combine to make any litigation on the occurrence of a material adverse change a risky proposition at best and the price of failure too high. A better solution is to get to the heart of the unhappiness and to forge agreement on compromised transactional terms, usually on price.

A Defined Term

The MAC clause is typically a defined term. The definition will not infrequently include a quantitative measure by which to objectively analyze the threshold upon which a MAC is triggered, hopefully avoiding litigation. The seeming objectivity of the definition is illusory, however, since almost all litigation surrounding MAC clauses will include claims that the clause is ambiguous and providing for an objective standard by which to cover every event to avoid that ambiguity is impossible. Thus, it may prove disappointing if you are thinking that an effectively drafted MAC clause can be employed as a fail-safe to express “buyer's remorse” and escape the terms of the contract.

Moreover, even taking into account the inherent ambiguity in any MAC clause, existing case law has not been particularly helpful. I n re IBP, Inc. Shareholders Litigation. IBP, Inc. v. Tyson Foods, Inc. , 789 A.2d 14 (Del Chancery 2001) is instructive here. The Delaware Chancery Court concluded that Tyson Foods' assertion and reliance upon a material adverse change clause was an insufficient basis to cancel a merger. In what may have been, and may still be, a unique remedy at the time, this court granted specific performance and compelled two public companies to merge pursuant to the existing merger agreement. The parties eventually agreed to revised merger terms. The point is, however, that the predictive value of precedent to which we have all become accustomed does not apply to the enforcement and interpretation of MAC clauses. Courts seem to be particularly savvy about efforts to employ a MAC clause to cancel a transaction due to economic uncertainty over clear evidence of purposeful concealment of material facts, the prior knowledge of which would result in the parties not reaching agreement.

Recommendations

Leasing counsel for an assignor contemplating assignment naturally wants any material adverse change clause to be as broad as possible. Having said that, counsel must give consideration to all of the real contingencies that, if they occurred, would seriously cause your client to analyze the risk of proceeding further in favor of looking for an escape. Expecting that unanticipated downturns in business generally, or the cratering of business prospects of the opposing party in particular, will supply that excuse will not generally suffice.

The better practice might be to develop a rather complete list of the events, relegated to the schedules and not in the definition, that would cause your client to want to turn tail and run for the hills ' and use that list in both your representations and warranties and as a part of your closing conditions, the latter of which must be brought down and updated just prior to closing. By avoiding a list of adverse changes as part of the definition, you minimize a court's ability to avoid the clause because the event is not defined. You can then incorporate the nonoccurrence of anything in those schedules as a representation and warranty or a closing condition, the breach of which will increase your ability to terminate and avoid closing.

Save reliance on the termination remedy for those things, other than buyer's remorse, that would truly cause your client to avoid the transaction if known, i.e., the discovery of purposeful concealment, fraud or the truly unanticipated natural catastrophe. More realistically, the use of a MAC clause can be an effective tool to bargain for new or additional terms when it is clear that a material adverse change in some aspect of the business has occurred.

Conclusion

I have heard lawyers remark that a MAC clause can be the fail-safe panacea to avoid a transaction that has gone terribly wrong. Panacea, in Greek mythology, was the goddess of Universal remedy. If you believe, and have convinced your client, that reliance upon the MAC clause, without much more, is a panacea, you may just find yourself trying to explain to your client the thinking behind an appeal to an ancient Greek goddess to resolve a very real 21st-century distress call to scuttle a deal that has turned terribly bad.

Anthony L. Lamm and Stephen Levin are partners in the law firm of Lamm Rubenstone LLC with offices in Philadelphia, Trevose, PA, and Cherry Hill, NJ. Lamm, the firm's managing partner and a member of this newsletter's Board of Editors, is admitted in Pennsylvania. Levin is admitted in Pennsylvania and New York. They may be reached at [email protected] and [email protected], respectively.