Tag: Adverse effects

Top 5 Delaware Case Developments in 2013 for M&A Practitioners

Kerry E. Berchem is partner and co-head of corporate practice at Akin Gump Strauss Hauer & Feld LLP. The following post is based on an Akin Gump Client Alert by Elisabeth Cappuyns, Trey Muldrow, and Carlos Bermudez. This post is part of the Delaware law series, cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

During 2013, in addition to the important changes to the Delaware General Corporation Law (“DGCL”) and the Limited Liability Company Act, described here, the Delaware courts issued a number of decisions that have a direct impact on the M&A practice. Below are our Top 5 case law picks for M&A practitioners:

1. A new look at the standard of review in going-private mergers (the Business Judgment Rule)

In its In re MFW Shareholders Litigation (May 29, 2013) decision, the Court of Chancery held that in going-private mergers with a controlling stockholder on both sides the deferential business judgment standard of review applies, instead of the entire fairness standard, if certain procedural safeguards are included from the beginning. Specifically, the controlling stockholder has to agree at the outset to proceed with the merger only if the transaction is both (1) negotiated and approved by an attentive special committee comprised of directors who are independent of the controlling stockholder and fully empowered to decline the transaction and to retain its own financial and legal advisors and (2) conditioned on the un-coerced, fully informed and non-waivable approval of a majority of the unaffiliated minority stockholders.


Delaware Court: Missed Sales Forecasts Could be “Material Adverse Effect”

The following post comes to us from Robert B. Schumer, chair of the Corporate Department at Paul, Weiss, Rifkind, Wharton & Garrison LLP, and is based on a Paul Weiss client memorandum. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

In Osram Sylvania Inc. v. Townsend Ventures, LLC, the Delaware Court of Chancery (VC Parsons) declined to dismiss claims by Osram Sylvania Inc. that, in connection with OSI’s purchase of stock of Encelium Holdings, Inc. from the company’s other stockholders (the “Sellers”), Encelium’s failure to meet sales forecasts and manipulation of financial results by the Sellers amounted to a material adverse effect (“MAE”). The decision was issued in the context of post-closing indemnity claims asserted by OSI against the Sellers and not a disputed closing condition.

OSI, a stockholder of Encelium, agreed to purchase the remaining capital stock of Encelium not held by OSI pursuant to a stock purchase agreement executed on the last day of the third quarter of 2011. The $47 million purchase price was agreed based on Encelium’s forecasted sales of $4 million for the third quarter of 2011, as well as Sellers’ representations concerning Encelium’s financial condition, operating results, income, revenue and expenses. Following the closing of the transaction in October 2011, OSI learned that Encelium’s third quarter results were approximately half of its forecast and alleged that Encelium and the Sellers knew about these sales results, but failed to disclose them at closing in violation of a provision in the agreement requiring them to disclose facts that amount to an MAE. OSI also alleged other misconduct by Encelium and the Sellers, including, among other things, that they had manipulated Encelium’s second quarter results to make its business appear more profitable.

In considering the Sellers’ motion to dismiss OSI’s contract and tort-based claims, the court held that:


Runaway MAC Carve-outs

The following post comes to us from Neil Whoriskey, partner focusing on mergers and acquisitions at Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary Gottlieb memorandum by Mr. Whoriskey.

The definition of “material adverse change” plays a critical role in public company merger agreements, effectively defining the situations in which a buyer may walk away from the transaction. There is significant case law defining what is (or, much more commonly, what is not) a material adverse change, but the case law only serves to interpret the agreed definitions. The agreed definitions, in turn, are typically very vague in defining what is a material adverse change (leaving lots of scope for judges), but explicit in listing the types of changes that may not be considered in evaluating whether a material adverse change has occurred. The use of these carve-outs to limit what may be considered a material adverse change has expanded significantly in recent years — arguably to a point where it may make sense for the pendulum to start to swing back.

It has been traditional for adverse effects attributable to changes in general economic conditions to be excluded in considering whether a material adverse effect has occurred, such that e.g., a loss of sales attributable to the great recession, no matter how severe, would not give buyer the right to terminate a merger agreement. This carve-out from the material adverse change definition can be grouped with others, such as carve-outs for downturns in the target industry, changes in law or accounting policies, acts of war, etc. — all of which shift to buyer the risks associated with the environment in which the target operates. What is notable is that over the last several years, not only has the percentage of deals that shift these “environmental” risks to buyer increased significantly, but MAC carve-outs that shift to buyer the risk of the deal, and (anecdotally at least) even the risk of running the business, have also increased markedly.


Custom-Made Material Adverse Effect Provisions

Daniel Wolf is a partner at Kirkland & Ellis LLP focusing on mergers and acquisitions. This post is based on a Kirkland & Ellis M&A Update by Mr. Wolf, David B. Feirstein, and Joshua M. Zachariah.

Regardless of the state of the deal market, Material Adverse Effect, or MAE/MAC, provisions remain among the most hotly contested negotiating points for dealmakers. Contemporary purchase and merger agreements almost invariably contain some form of an MAE, defined generally as events or changes that have (or, in some cases, would or could reasonably be expected to have) a material adverse effect on the target company, subject to negotiated exceptions. MAE clauses typically serve two main purposes — they are used to qualify representations and warranties (and in some cases, covenants), and act as a condition to closing for the benefit of the buyer (i.e., the buyer is not required to close if the target has suffered an MAE between signing and closing).


Delaware Court Provides Further Guidance on Material Adverse Effect Clauses

This post is from Scott J. Davis of Mayer Brown LLP. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

The Delaware Chancery Court’s decision in Hexion Specialty Chemicals, Inc. v. Huntsman Corp. represents a strong statement by the Delaware courts that they will not tolerate efforts by buyers who have changed their minds about deals, or have been pressured by their lenders to change their minds, to avoid their contractual obligations on the basis of contrived arguments. Following previous Delaware cases, the Court rejected the buyer’s claim that a material adverse effect excused its obligation to close, holding that the buyer had not met its burden of showing “the occurrence of unknown events that substantially threaten the overall earnings potential of the target in a durationally-significant manner.”

My partner William Kucera has written a memorandum discussing the court’s reasoning and offering detailed suggestions and observations for drafting MAE clauses in future deals. In particular, it discusses provisions — other than MAE clauses — on which buyers could rely as a means to avoid closing a transaction. Against the backdrop of the decision, the memo also explains the continued relevance of MAE clauses in deals and describes how threats by the buyer to invoke such a clause have played out in a number of recent transactions.

The memorandum is available here.