A Legal-Usage Analysis of "Material Adverse Change" Provisions

INTRODUCTION In recent years, many articles have discussed that prominent feature of contract topography-provisions making use of the phrase material adverse change (referred to here as "MAC"). This attention is a function of uncertainties that have prompted deal parties, and the business and legal communities as a whole, to consider anew on what basis a MAC provision could allow a party to get out of a deal. These uncertainties include those arising from the downturn in the economy that began in 2001,1 the terrorist attacks of September 11, 2001,2 and even the prospect of war with Iraq in 2003.3 Many of these articles have focused on the decision of the Delaware Chancery Court in IBP, Inc. v. Tyson Foods, Inc.4 Many also discuss particularly contentious aspects of MAC provisions, such as carve-outs. What has been lacking, however, is a methodical parsing, from the perspective of the contract drafter, of the full range of issues raised by MAC provisions. That is what this article attempts; to suggest its scope, this article refers to this analysis as a "legal usage" analysis.5 Note that this article approaches this topic from a U.S.-law perspective. Issues raised by MAC provisions fall into two categories: those relating to using MAC provisions and-since MAC is generally used as a defined term-those relating to how MAC is defined. In discussing any given issue, this article considers the preferred approach and the more commonly used alternatives. USING MAC Where MAC Provisions Are Used MAC provisions are used in different parts of a contract. They occur most commonly in representations, where they can be used in two different ways. First, a party can make a representation regarding nonoccurrence of a MAC since a given date. A simple form of this kind of representation would be as follows: Since December 31, 2003, no MAC has occurred. (This article refers to as an "absolute" MAC provision any provision that in this manner addresses directly nonoccurrence of a MAC.) A buyer might want to rephrase as follows that absolute MAC representation so as to be sure that it encompasses adverse changes that are only material when considered in the aggregate: Since December 31, 2003, no events or circumstances have occurred that constitute, individually or in the aggregate [or collectively], a MAC.6 But in this context a court should be willing to aggregate adverse changes even without explicit contract language to that effect-there would seem no reason why an instance of change could not be multifaceted. The absolute Material Adverse Effect (referred to here as "MAE") representation and definition of MAE at issue in the IBP case did not explicitly provide for aggregation of adverse changes, yet the court did not dispute the defendant's assertion that a combination of factors can amount to an MAE.7 Second, a MAC provision can serve to modify a representation as to some aspect of a party's operations so as to indicate the absence of anything leading to a MAC. The modification is in the negative when the noun or noun phrase-in the following example, inaccuraciesbeing modified is in the negative: Acme 's books and records contain no inaccuracies except for inaccuracies that would not reasonably be expected to result in a MAC. The modification is in the affirmative when the negative is expressed elsewhere in the representation: Acme is not [or TVo Seller is] party to any litigation that would reasonably be expected to result in a MAC. (This article refers to as a "modifying" MAC provision any MAC provision that modifies a noun or noun phrase in this manner.) Adding individually or in the aggregate would serve to aggregate, for purposes of determining materiality, instances of the thing in question, although using a plural noun (inaccuracies') or noncount noun (litigation) in the modifying MAC provision should be sufficient to accomplish that.8 MACs also occur in closing conditions. …