UK: Share purchase agreements - guidance on the interpretation of material adverse effect provisions

There are limited UK authorities in this area, so the case will be of interest to parties involved in M&A transactions that are governed by English law. The decision highlights a number of general principles which will be relevant in drafting and analysing MAE and MAC clauses, which can give rise to a termination right for the buyer prior to completion of an M&A transaction.

For a discussion of MAE and MAC clauses generally, see our recent M&A report.

What happened?

The case involved the acquisition of two mines in Brazil and a geotechnical event (GE) at one of the mines which occurred between signing and closing. The SPA (one of two connected SPAs for the acquisition) contained a number of conditions to completion, including no MAE having occurred since the date of exchange. The buyer gave notice to terminate the SPAs, stating that the GE constituted a MAE. The seller disputed this and proceeded to give notice to terminate and claimed declaratory relief and damages in respect of the buyer’s wrongful repudiation.

Subject to certain carve-outs, a MAE was defined as a: “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 companies]…".

The court concluded that the GE did not amount to a MAE permitting the buyer to terminate the SPAs prior to completion (so the buyer had wrongfully repudiated the SPAs).

Guidance

In reaching a conclusion, the court applied the ordinary principles of construction of contracts governed by English law. The Judge (Butcher J) reviewed the limited English case law on MAE clauses, as well as some key decisions and academic commentary from the US.

The judgement therefore provides useful guidance for parties negotiating M&A transactions on how MAE and MAC clauses in share purchase agreements governed by English law will be interpreted. This includes whether a change can be material not because of its effects but because it reveals something negative about the wider business (a revelatory event).

In reaching his conclusion, Butcher J noted:

• The buyer argued that whether a matter was “material” and “adverse” had both quantitative and qualitative aspects (ie matters which can be measured in financial terms and matters which cannot). However, Butcher J noted that if there is no significant financial (or quantitative) impact on the target companies or their business, then it is difficult to see that qualitative matters on their own could mean that a change, event or effect was “material and adverse”.
• Whether a change, event or effect was or would reasonably be expected to be material and adverse was to be assessed at the point at which a notice of termination was served.
• What would reasonably expected to be material and adverse was an objective test and did not depend on what the parties thought subjectively at the time.
• There is no special rule in English law as to the construction or application of MAE clauses or as to the burden on the party invoking such a clause.

On the three main issues of construction on the facts:

• Revelatory events: The materiality and adversity had to be features of the “change, event or effect” itself for there to be a MAE for the purposes of the definition. MAE clauses are not applicable to revelatory events – they only apply to the change, event or effect itself and not to anything that might be revealed by such change, event or effect.
• Assessing what would reasonably be expected to be material and adverse: this is to be determined by what a reasonable person would have regarded as the position at the time the MAC was relied on to terminate the contract, looking forward from that date. This is an objective evaluative judgment (by a court in the event of a dispute), rather than considering a range of possible views.
• Materiality: Butcher J agreed with US decisions holding that, for a buyer who seeks to purchase a target company as part of a long-term strategy, the question was whether the company had suffered a MAE that was consequential to the company's earnings power over a commercially reasonable period, measured in years rather than months. Material means “significant or substantial”. There is no universal bright line test for materiality applicable to all MAC clauses. A number of considerations will be relevant as to what is material in a particular case. Here, Butcher J considered that a reduction in equity value of between 15% and 20% might be material and a reduction of 20% or more would be material.

Key takeaways

The correct construction of a MAE (or MAC) provision is fact specific. The court will look at the provision objectively in the context of the agreement as a whole. In practice, it can be difficult to rely on a MAE provision. This is particularly the case in public M&A deals due to the high materiality threshold that the Takeover Panel will invoke. In private M&A transactions, buyers will generally find it helpful to be as specific as possible in the context of the target business when drafting a MAE provision, including defining materiality thresholds by reference to a monetary amount or percentage of a specified financial metric. Wherever possible, buyers should look to identify specific events that will trigger their termination rights, rather than relying on general MAE provisions.

Read the judgement: BM Brazil I Fundo De Investimento Em Participacoes Multistrategia v Sibanye BM Brazil (Pty) Ltd [2024] EWHC 2566 (Comm)