15 Mar 2012
The MAC is back?
Despite their popularity, it is widely accepted that it is notoriously difficult to establish that a material adverse change (MAC) condition has been triggered.
2011 saw increasing reliance by bidders on conditions in their deals to protect themselves from the volatile markets and uncertain economic environment and there is no reason to think 2012 will be any different. Among the many conditions bidders relied on, 78% of public M&A deals announced in 2011 included a condition that a material adverse change (MAC) did not occur in respect of the target or its business. [i]
Despite their popularity, it is widely accepted that it is notoriously difficult to establish that a MAC condition has been triggered. Various authorities both here, in the UK and the US have established that it is only significant events which have a material and sustained effect on the target that can give rise to a MAC. While those circumstances are rare, they do happen and there has been a recent example in the US.
Procter & Gamble had agreed to sell its Pringles brand to Diamond Foods, in return for Diamond Foods' scrip. Given it was a scrip deal, there was a MAC in respect of Diamond Foods. Before the deal closed, Diamond Foods was forced to restate its earnings for the past two years, leading to more than a 50% decrease in earnings in those years as well as the current year. Diamond Foods also puts its CEO and CFO on "administrative" leave. The parties announced a week later that they had mutually agreed to terminate the deal. While there was no express reference to reliance on the MAC, the parties did state that no break fees or other fees would be paid in connection with the termination.
There were no similar examples in Australia in 2011. In fact, although the overwhelming majority of Australian public M&A deals included a target MAC, less than a third of deals which offered scrip consideration to target shareholders included a bidder MAC. This means that in most of these deals, the target would have had no right to terminate if the bidder found itself in the same position as Diamond Foods.
In light of Diamond Foods, and given the uncertain economic environment, our view is that targets will become more insistent on a bidder MAC for recommended scrip bids, particularly where the target allows the bidder a reciprocal target MAC.
Target MACs are increasingly being drafted in broad terms, with the majority of target MAC triggers in 2011 including forward looking effects, past events that become known to the bidder and events affecting the prospects of a target. Bidders will also seek to include material adverse change triggers with reference to specific financial tests such as EBITDA or net assets, as most bidders did throughout 2011 to create greater certainty around the circumstances that will trigger a MAC.
We also expect that target Boards will seek to continue to limit the scope of target MAC conditions even though MACs are notoriously difficult to trigger: in 2011, almost a third of target MACs had an exception (ie. would not be triggered) for events arising from general changes in economic or market conditions.
The increasing focus of target boards on bid certainty in an uncertain economic environment is resulting in a trend towards more objective conditions. This is also being felt at a regulatory level, with the Takeovers Panel adopting a narrower interpretation of objective conditions in takeovers and schemes in relation to the range of circumstances that can trigger the condition.
The UK Takeovers Panel has adopted an even harsher approach, only permitting objective conditions which do not inappropriately transfer risk of unknown events from the bidder to target shareholders. Australia is still a long way from that position but it is evident that this is becoming an issue of interest for the Australian regulators.
Coming back to Diamond Foods, regardless of how broadly or otherwise a MAC was drafted, it seems pretty clear that a person seeking to rely on a MAC in those circumstances would always succeed. The tricky question is how much less adverse circumstances could be while still giving rise to a right to terminate.
[i] Clayton Utz will today release THE REAL DEAL (2012 edition), a new Clayton Utz publication providing an unparalleled depth of insight and analysis into public M&A deal structures, tactics adopted by targets and acquirers, and developments shaping the future of the Australian M&A market. The statistics in this article are taken from THE REAL DEAL and Clayton Utz's survey of all Australian public M&A deals announced in 2011 with deal value over A$50 million.
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