The Covid-19 pandemic impact on SPAs

By James Arnold

The Covid-19 pandemic impact on SPAs: enforcement of Material and Adverse Change (MAC) clauses in M&A transactions

The Covid-19 pandemic has created unprecedented disruption to the global economy. With M&A activity rapidly tailing off, buyers at the pre-completion stage of existing deals are also becoming increasingly risk-averse, and those with cold feet are starting to look at MAC clauses within SPAs to extricate themselves. Private Equity group Sycamore has recently attempted to pull out of buying Victoria’s Secret from L-Brands, citing Victoria’s Secret’s closure of most of its 1,600 stores in response to the Covid-19 pandemic as a breach of its obligation to “continue business operations consistently with past practices”.

As always, whether an event has had material adverse effect will depend on the drafting of the MAC clause in a given SPA. Although MAC disputes can and have historically turned on the meaning of “material”, given the widespread impact of Covid-19 on all industries the real battleground here is likely to be over seller carve-out clauses. These will be bespoke and vary widely between SPAs, but they can exclude changes in general economic conditions, regulations or laws which do not have a materially disproportionate effect on that company compared to other companies in the same industry. In other words, if everyone is impacted by the relevant effect, there is no escape for the buyer.

There is no “one size fits all” answer as to whether Covid-19 will allow buyers to invoke a MAC clause to escape their contractual obligations. The unprecedented nature of Covid-19 (at least, unprecedented since the invention of MAC clauses) means that we are in uncharted territory.  However, buyers should consider the following before trying to trigger a MAC clause:

  1. Whether the parties were aware of the existence of the adverse event (in this case Covid-19) when the SPA was signed. The World Health Organisation declared a public health emergency on 30 January: the closer execution was to that point, the likelier it will be that Covid-19 disruptions were not a materially adverse change to circumstances that existed at execution.
  2. Buyers may be looking to pull out due to cash drying up from their own performance. Some businesses (such as supermarkets) have however done very well as a result of disruption to normal life, and many services businesses have ploughed on remotely. The material adverse change must affect the target – not the buyer’s bottom line.
  3. At the time of writing, there is no set timeframe on when lockdown measures will cease. Case law indicates that a material and adverse change cannot be temporary or transitory. Whilst it is clear some business sectors will be severely impacted over the course of the next few years (such as, for example, passenger air transportation), over the medium term it is difficult to predict which businesses will suffer more permanent adverse impact, as opposed to a temporary dip in performance.
  4. There may also be interplay between an SPA’s Force Majeure clause and its MAC. Depending on the drafting of both clauses, if a Covid-19 related disruption gives rise to a force majeure event and a material adverse change, it may be necessary to determine which clause takes precedence: a force majeure event will usually suspend parties’ rights and obligations automatically which may include the seller’s obligation to ensure there has been no material adverse change and also a buyer’s right to invoke the MAC clause.

Quite where each deal ends up is impossible to predict, and these issues will likely be hard-fought over the coming months and years. Legal advice on a MAC clause in a given SPA is essential.