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Does your agreement include a material adverse change clause?

Contracts in business can serve as the backbones of professional relationships. When valid, contracts establish the parties’ roles, responsibilities, and expectations in a legally binding document.

However, changes can occur between the time parties enter into an agreement and completion. Both parties to the contract should, therefore, understand what a material adverse change (MAC) clause is and how to utilize it.

What is a MAC clause?

A MAC clause, which is also called a material adverse event (MAE) clause, allows parties in a merger or acquisition to terminate the transaction in the case of a significant change in circumstances. It enables the buyer to back out of an agreement if a substantial change in a business’s valuation or viability occurs.

The bar for what constitutes a substantial change can be quite high, depending on the language used in the agreement. But generally, the change would have to be reasonably unforeseeable and would have a significant impact on the business. It would also be expected to last a long time. Under these circumstances, the transaction could fail.

Historically, situations in which the courts permit a party to cancel a merger or acquisition on the grounds of a MAC have been rare. However, Canadian businesses could see more cases come up that cite the COVID-19 pandemic as a MAC.

That said, now is a good time to review existing contracts for MAC clauses. And if you are anticipating an upcoming merger or acquisition, you might discuss with your lawyer whether an event like a pandemic would trigger this clause. 

Crafting the right agreement

The inclusion of a MAC clause can protect both buyers and sellers, depending on the language in the contract. If you are a buyer, broader terms and fewer restrictions can make it easier to meet the threshold for a qualifying event. 

If you are a seller, using specific language and detailed exceptions in a MAC clause can be beneficial for you. Doing so makes it more difficult for buyers to meet the requirements to back out of a transaction.

MAC clauses are standard, but they vary widely in the exact language and often benefit the party presenting them. Because of this, savvy negotiation skills and legal counsel will be critical for both buyers and sellers.

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