Pandemic Risk and the Interpretation of Exceptions in MAE Clauses

Abstract

In business combination transactions, Material Adverse Effect (MAE) clauses allocate risks to the target’s business that arise between signing and closing. The COVID-19 pandemic adversely affected many businesses and so led to a series of broken deals in which acquirers claimed they were entitled to terminate a pending merger agreement because the pandemic had had a material adverse effect on the target. MAE clauses typically allocate to the acquirer many systematic risks to the target’s business by removing them from the definition of “Material Adverse Effect” in broadly worded exceptions. A key issue in the MAE disputes arising from the pandemic has thus been whether one or more of these exceptions shifted the relevant risk to the acquirer. In some cases, the issue has been the relatively straightforward one of whether the pandemic should count as a “natural disaster” or “calamity” in an exception related to force majeure events. In other cases, however, the issues have been considerably more complicated. In particular, when the causal chain from the pandemic to the material adverse effect on the company passes through multiple events (e.g., from pandemic to governmental lock-down orders to a drop in demand for the company’s products or services to the material adverse effect), and when, further, some of these events fall into exceptions in the MAE definition but others do not, the ultimate allocation of the risk depends on how we should understand the relation between the exceptions and the base part of the definition and the interrelations among the exceptions themselves. Working from the assumption that the sophisticated commercial parties that enter into business combination transactions are rational profit-maximizers who intend to allocate risks in a predictable way, this Article presents a general theory of how exceptions from MAE definitions should be interpreted in order to respect the intentions of the parties. It argues that the conclusions reached in dicta on the relevant issues in AB Stable and other cases are wrong, in large part because they confuse Material Adverse Effects with material adverse effects (i.e., events causing material adverse effects with the material adverse effects themselves).

Keywords: MAE, MAC, material adverse effect, material adverse change, pandemic, COVID-19, AB Stable, pandemic risk, force majeure

JEL Classification: K12, K22