Material Adverse Effect Clauses and the COVID-19 Pandemic: How Sophisticated Parties Allocate Risk by Contract

Abstract

Currently pending in the Delaware Court of Chancery and other courts around the country are numerous cases in which the parties to a public-company merger agreement are disputing whether the target (the company being sold) has suffered a "material adverse effect" (an MAE) because of the COVID-19 pandemic. Tremendous amounts of money are at stake in such cases. In the LVHM-Tiffany transaction, for example, if Tiffany has suffered an MAE, LVHM may terminate the agreement and walk away from the deal; otherwise, it will likely have to close and pay the full $16.6 billion purchase price for a company that, it says, is no longer worth anywhere near that amount. Sophisticated commercial parties allocate between them risks that may materialize during the pendency of the merger through MAE clauses, extremely elaborate contractual provisions that have given rise to more litigation than any other standard provision in public-company merger agreements. This short essay considers how courts will construe MAE clauses in connection with the COVID-19 pandemic and, in so doing, explains more generally how sophisticated parties allocate risks efficiently in order to create value in business combination transactions.

Keywords: MAE, MAC, material adverse effect, material adverse change

JEL Classification: K12, K22