In light of the “permacrisis” the UK has faced in recent times, all forms of commercial enterprises from banks, investors and corporates are operating in a seemingly constant state of flux, requiring them to adapt to an ever-changing political, economic, societal and physical environment to remain viable.
With this myriad of external factors at play, it is increasingly important for transaction parties to ensure their legal documents protect their interests, in case the commercial viability of their transactions are adversely affected by any number of existential events.
Case Summary
In the recent case of BM Brazil 1 Fundo De Investimento Em Participacoes Multistrategia v Sibanye BM Brazil (Pty) Ltd [2024] EWHC 2566 (Comm) (10 October 2024) (the BM Brazil case), the High Court considered whether a purchaser of a mining company was discharged from its obligation to complete a corporate acquisition by relying on a material adverse change clause in a sale and purchase agreement (SPA).
Ultimately, the court held that the purchaser was wrong to rely on a material adverse change clause contained in the SPA to terminate its obligation to purchase the target company due to a geotechnical event that occurred between exchange and completion, affecting a mine owned by the target company.
How and why are materiality-linked terms used?
LENDING CONTEXT
In corporate lending transactions, provisions adopting the concepts of material adverse effect (MAE) and material adverse change (MAC) are used.
MAE definition
MAE is often defined in the loan agreement and is used to qualify certain representations, undertakings and events of default. The MAE definition often provides that a MAE will be deemed to occur where there is a material adverse effect on:
- the business, operations or financial condition of the obligors/their group companies;
- the obligors’ ability to perform its obligations under the finance documents; and/or
- the legal validity/enforceability of security granted by the obligors under the loan agreement.
MAC representations
With a MAC representation, the obligors are typically required to represent that there has been no material adverse change in their group’s business, assets, or financial condition since the date of the most recently prepared financial statements of the target business. These representations are tested on the date of the loan agreement and, where drawdowns are permitted during the term of the facility (for example, with revolving credit facilities), the date that the drawdown request is made, the date of drawdown itself and interest payment dates.
If there is a breach of the MAC representation, a lender will not usually be obliged to lend if monies are available to be drawn and it will trigger an event of default, subject to any grace periods negotiated.
Representations and undertakings – diluted by negotiation?
Borrowers often introduce the concept of materiality when negotiating representations and general undertakings clauses, so that a breach only occurs where non-compliance with the representation/general undertaking would have a MAE. A lender is more likely to accept a MAE qualification for fact-based representations and general undertakings.
In contrast, a lender is unlikely to agree that any fundamental provisions that would restrict the lender’s ability to rely on the terms of the finance documents can be qualified by MAE – for example the borrower’s power and authority to enter into and perform its obligations under the finance documents, or that entry into the finance documents does not conflict with the borrower’s constitutional documents. These are so fundamental to the lender that it will not agree that they should be qualified by MAE.
MAC event of default
A MAC event of default caters for unforeseen circumstances which might not otherwise be caught by an event of default, but which nonetheless could have a detrimental impact on the obligors’ risk profile for the lender.
The implications of a breach of a MAC event of default are more fundamental than a breach of a MAC representation; an event of default affords the lender the right to stop further drawdowns (as would a breach of the MAC representation), but also allows the lender to cancel the loan facility commitment, demand early repayment and enforce any security held.
Acquisition Context
In a corporate transaction, where there is a gap between exchange and completion, MAC clauses are used to address risk allocation by giving the purchaser a right to terminate the acquisition agreement if an event occurs during that time, which has a significant, detrimental effect on the target business/assets.
If a MAC clause is required by the purchaser, well-advised sellers will seek to ensure that its scope is framed as narrowly as practicable. Conversely, a purchaser’s ability to rely on a MAC clause might be improved if objective tests are included to determine whether a MAC has taken place, such as financial metrics relating to the target business. Sellers may also seek to carve out any matters dealt with during the disclosure process.
Recent Case – Why Is It Relevant?
Returning to the BM Brazil case, the purchaser argued that a “geotechnical event” that occurred in one of the target company’s mines after exchange of the SPA but before completion, would constitute a MAC. The purchaser sought to rely on the MAC provision in the SPA to release it from its obligation to complete.
The court noted that when interpreting MAC clauses, you must consider the contents of the SPA in its entirety (in particular, other clauses dealing with risk allocation between the parties) to determine the intentions of the parties. In the present case, a MAC was defined as “any change, event or effect that… is or would reasonably be expected to be material and adverse to the business, financial condition, results of operations, the properties, assets, liabilities or operations” of the target group companies.
The judge noted there was a particular lack of English cases where MAC clauses have been considered in the context of share purchases, as opposed to finance transactions. The court used the lack of judicial authority to fully consider the specific drafting of the MAC terms in question, and resisted the purchaser’s claim that adverse issues relating to the mine, that were only revealed by the geotechnical event, should allow the purchaser to renege on its contractual obligation to complete the purchase.
The court also held that what might constitute “material and adverse” change must be determined objectively, with the degree of probability assessed as to whether the change was more likely than not to have had a material and adverse effect.
Consideration was also given by the court to the meaning of “material”, with the judge recognising that there is no universal definition to test the materiality of an event, but instead acknowledging that there will be a number of factors to consider. In this case, the judge cited:
- The size of the transaction – here, the purchase price was $1 billion;
- The nature of the assets involved – in particular, their susceptibility to external events such as geotechnical events, as was the case in the present case; and
- The complexity of both the SPA and the extent to which it was negotiated.
In the BM Brazil case, the court concluded that these factors were not material enough to the ultimate viability of the transaction for the purchaser to rely on the MAC clause. The court also considered whether a specific level of reduction in the value of the target business/assets from a given event can be deemed to have a material adverse effect – 20% was seen as being material, 15% potentially sufficient but 10% likely too low.
The decision in the BM Brazil case illustrates that English courts do not wish to impose hard and fast rules when interpreting MAC clauses, particularly where the parties have taken legal advice and where the implications of the repudiating party walking away from the transaction would be significant. This further reinforces the importance of all parties taking advice on these technical and detailed provisions used in their finance and acquisition transactions to ensure that the risks associated with the transaction at the outset are effectively managed for the duration of the parties’ commercial relationship.
If you have any questions as a result of this article, please contact Dan Barnhouse at [email protected]
