A Material Adverse Change, or MAC clause is a section in the merger agreement listing various scenarios where either party can terminate the deal under a set of pre-specified circumstances. In fact, the merger agreement filed with the SEC often contains two sections where the MAC clause is divided. The “Company Material Adverse Effect” referring to the target firm, and the “Parent Material Adverse Effect” referring to the acquirer.
Negotiation of MAC Clauses are often indicative of the balance of power between the two negotiating firms. For instance, a broad definition of what constitutes a material adverse change can give the holder a number of avenues to explore should they wish to exit the deal. If they are successful in proving the existing of a material adverse change they will not have to pay the termination fee. Therefore, it is in either firm’s interest to try to negotiate as broader definition as possible for themselves. At the same time of course, trying to lock the counterparty into their obligations in completing the deal.
Traders need to be aware of the MAC clause and be able to fully appreciate its scope. For example, are “acts of god”, tsunamis, earthquakes for example, included in the definition? On the other hand, would a global pandemic that materially affects the profitability of the target be sufficient cause to walk away from the deal without penalty. Being able to read between the lines in these instances can enable the trader to judge the level of commitment from each side in completing the deal. Generally, broader definitions as opposed to specifics will lead to a wider merger arbitrage spread. Subsequently enabling the trader to trade the merger arbitrage spread more profitably.
MAC Clause in Practice
During the coronavirus pandemic, new deal announcements were unlikely to be able to use the pandemic as a reason to exit the deal. This is because the acquirer has bought in to the new economic environment. However, deals announced before the outbreak may feel there is a case to be heard as stock prices plummet and deals no longer make economic sense at the previously arranged higher cost levels. One test that has to be met is the disproportionate effect to the target firm within the wider economy. This demonstrates the height at which the bar is set to prove a MAC clause as almost all section of the economy have been broadly hit.
On May 18, 2020, Forescout Technologies (FSCT) informed the market that
Advent provided notice to Forescout that it would not be proceeding to consummate the acquisition of Forescout on May 18, 2020, as scheduled
Advent claimed a “material adverse effect” had occurred at Forescout. However, Theresia Gouw, Chair of the Forescout Board of directors responed to Advent in a press release dated May 20, 2020
We have satisfied all conditions to closing under our merger agreement, and a material adverse effect has not occurred … The only change since the merger agreement was jointly executed in February is the deepening of the COVID-19 pandemic, which has significantly impacted global macro-economic conditions. All companies have been challenged by this pandemic, and it is highly disappointing that Advent would attempt to exploit market volatility to renege on its contractual obligations, particularly when the merger agreement explicitly excludes the effects of a pandemic as a material adverse event. Advent is required to promptly complete the transaction. We are taking immediate action to enforce Forescout’s rights and ensure that Advent fulfills its obligations. We are confident that the steps that we are taking are in the best interests of Forescout and its shareholders.
The initial announcement caused the stock to fall significantly (as expected) and it continued to fall after the response from Forescout.
It can therefore be postulated that the MAE referred to by Advent is not related to the pandemic. This highlights the importance of reviewing ALL details in the agreement relating to the MAC clause so investors can fully understand the risks involved. Because of the various ambiguous nature of some of the language used, Forescout may genuinely believe there has been no breach whilst Advent may feel there is a possible exit strategy to exploit. The importance or fully researching the clause is highlighted further in times of market stress as acquirers look for avenues to escape the deal without paying the termination fee.
Conclusion
The possibility of legal action to resolve this issue creates deal extension risk which widens the spread further and pushes down the stock price. This is in addition to the already lowered DCP. Situations such as these involve significant risks to traders and are generally avoided by casual traders.
As always, we recommend traders and investors looking to make investment in the stock market, specifically trade merger arbitrage, and are concerned about the effect of MAC clauses, seek professional legal advice concerning legal matters of this type.
