Terminating M&A deals for material adverse change

Important lessons from the English courts 5 min read

In October 2024, the English Commercial Court delivered an important decision in BM Brazil¹ concerning the ability of a buyer to rely on a material adverse change (MAC) condition to terminate an M&A deal. The decision, which may impact the approach taken by Australian courts, reminds parties of the importance of well-drafted MAC provisions and the need to exercise caution when relying on a MAC to terminate a deal.

What is a material adverse change clause?

MAC clauses (sometimes referred to as material adverse effect clauses) are a common feature of public M&A deals in Australia and, to a lesser extent, private M&A deals. In a scheme implementation deed (SID) or sale and purchase agreement (SPA), a MAC clause will generally entitle a party to terminate the contract if a sufficiently materially adverse event occurs between signing and completion. This provides the buyer with a degree of protection against unforeseen events prior to completion.

In Australia, MAC clauses are almost universal in lending arrangements with banks (such as commercial mortgages),² and have been the subject of case law in this area. However, whilst commonly featured in SIDs (and, to a lesser extent, SPAs), there is relatively limited case law concerning the use of MAC clauses in M&A transactions. The lack of judicial authority and perceived uncertainty in their operation and interpretation have caused ASIC to scrutinise their use in public M&A deals (see our Insight). In this context, the approach of the English Commercial Court in BM Brazil may prove influential on Australian courts and ASIC, despite not being formally authoritative in the jurisdiction.

The facts

The decision in BM Brazil concerned the termination of a $1.2 billion acquisition of two mines in Brazil. The buyer, Sibanye Stillwater Ltd, entered into two SPAs with the seller, BM Brazil, each of which contained a US-style MAC clause. The MAC clause in dispute defined a 'Material Adverse Effect' as:

'…any change, event or effect that individually or in the aggregate is or would reasonably be expected to be material and adverse to the business, financial condition, results of operations, the properties, assets, liabilities or operations of the Group Companies, taken as a whole, excluding…'

It did not prescribe quantitative triggers for its operation. Between signing and closing, a geotechnical event occurred at one of the mines (the Event). The sellers treated the Event as being relatively routine and developed a remediation plan, with minimal additional costs to be incurred.

However, the buyer purported to terminate the SPAs on the basis that the Event constituted a MAC. The seller commenced proceedings seeking damages for wrongful repudiation of the SPAs.

The Commercial Court found in favour of the sellers and held that the Event did not constitute a MAC. Consequently, the buyer had breached the SPAs in failing to close the agreement. The claimants were entitled to terminate and seek damages.

The English Commercial Court's decision

In English law, there is no standard meaning of 'material adverse effect' or 'material adverse change'. As is the case in Australia,³ a MAC provision must therefore be construed in the context of the relevant contract.

Whilst the US case law is neither binding nor formally persuasive upon English courts, a number of US authorities were referenced by the English Commercial Court in interpreting the MAC clause in BM Brazil. As part of this interpretive exercise, the Court set out a number of general principles relevant to interpreting MAC provisions:

• Objective assessment of 'material' and 'adverse'. The Court assessed what would reasonably be expected to be 'material' and 'adverse' from the perspective of a reasonable person in the position of the parties, at the point time when the MAC is relied upon (ie when the contract was purported to be terminated on the basis of the MAC). The Court assumed that the reasonable person would have the information available to the parties and indicated it would not ignore the parties' good faith contemporaneous assessment of the position, as this may shed light on what it was reasonable to expect in the circumstances.
• A high threshold for materiality. The Court held that 'material' is intended to mean 'significant or substantial' (and not simply more than de minimis). The Court referred to, and agreed with, Delaware case law that there is no bright line test as to what constitutes materiality, which reflects the position adopted in Australian case law.⁴
  
  However, the Court referenced a number of factors that may be relevant to an assessment of materiality:
  • the size of the transaction
  • the nature of the assets concerned
  • the length of the process of sale
  • the complexity of the contractual arrangements
  • any reduction in the equity value of the target.

Importantly, the Court commented that a reduction of 15-20% of equity value might be material, and a reduction of 20% or more of equity value would be material.

• Not applicable to revelatory events. The Court considered that a 'revelatory event' (being an event that reveals broader issues with the asset) would not amount to a MAC. This is because the MAC clause applied only to the change, event or effect itself, and not to anything that might be revealed by such an event.
  
  Applying the above to the facts in BM Brazil, the Court found that the Event did not constitute a MAC. This was on the basis that the Event was relatively small, the cost of remediation was low (below 5% of the purchase price of the mine) and various features of the transaction—including its size, the nature of the assets concerned (including their susceptibility to geotechnical events) and the length of the sale process—meant that a higher threshold for materiality should apply.

Key takeaways

The decision in BM Brazil is a useful reminder to buyers that there is a degree of risk in relying on qualitative thresholds in a MAC condition to terminate an M&A transaction. This is because:

• the requirement to establish that a MAC has occurred, within the meaning of the contract, can be a challenging task and is highly sensitive to the facts relevant to the transaction; and
• if a buyer purports to terminate on the basis of a MAC clause, it risks incurring liability to the seller for wrongful termination and/or repudiatory breach of contract.

Clients should bear in mind that:

• counterparties may disagree over what constitutes a MAC in a given situation;
• a MAC clause should not be a substitute for careful and considered due diligence; and
• a purported termination on the basis of a MAC clause may give rise to significant litigation risk.

While utilising quantitative thresholds may provide greater certainty for parties, it may not provide either party with a better outcome. In uncertain cases, ambiguity may be helpful for the vendor or target in seeking to enforce the agreement. Equally, a buyer or bidder may seek to use the uncertainty as leverage in a renegotiation on price rather than as a means of terminating the agreement.

Should you wish to discuss further, please do not hesitate to contact us below.