Transaction Cost Economics & MAEs: The Dealmaker's Crystal Ball

Abstract

Material adverse effect (MAE) provisions have taken center stage in mergers and acquisitions (M&A) in the midst of the COVID-19 pandemic. Like with other crises, as the pandemic unfolds, two questions inevitably arise for dealmakers. First, in the short term, what grounds may parties use to exit pending transactions? And, second, in the long term, what impact will the crisis have on negotiating current and future deals and drafting related contractual provisions? In many M&A transactions, especially those involving publicly traded companies, the answers to both questions almost always involve MAEs. These provisions allow parties, typically the acquirer, to exit a transaction without penalty if the other party has suffered a MAE, as that term is defined in the agreement.

This Essay examines MAEs through the lens of transaction cost economics, a theory utilized to determine how to best structure transactions especially amidst uncertainty. Uncertainties are inherent in purchasing a highly specific asset, like a company, which are further compounded by external socioeconomic conditions. This, in turn, gives rise to higher transaction costs, such as due diligence, increased negotiations, and ex post enforcement. MAE provisions are one of the ways in which dealmakers attempt to control the transaction costs of ex post enforcement. As life in a pandemic becomes the new reality, dealmakers are adjusting to ensure that pandemic-related effects do not trigger MAEs. Consequently, this raises transaction costs and has an impact on whether a deal is signed and ultimately consummated, and on what terms.

This Essay discusses how dealmakers have dealt with the pandemic in terms of MAEs and argues that while revised MAEs may complicate dealmaking, they will not hinder it. This Essay attempts to look into the dealmaker’s crystal ball to foresee changes both in deal process and deal terms. It argues that in place of the traditional role of a MAE, dealmakers instead will take other steps to compensate for uncertainty, including expanded due diligence, adjusted valuations, provisions to renegotiate terms, or reverse termination fees. If anything is clear as dealmakers look into their crystal ball, it is that hope creates opportunity but so does chaos.

Keywords: MAE, MAC, material adverse effect, merger agreement, pandemic, COVID-19, transaction cost economics, TCE, risk, reverse termination fees, Akorn, Hexion v. Huntsman, IBP, Tyson

JEL Classification: K22, K12, K2, G34