Material Adverse Change Clauses and COVID-19

I’m glad to be back here blogging especially when there have been so many newsworthy contracts items. At the forefront of every contracts profs mind is probably force majeure clauses. There was a spirited discussion about them on the list serve. But while force majeure clauses have been getting all the love from contracts profs, there’s another pandemic-relevant clause that has been mucking up corporate deals. That clause is the “material adverse change” or "material adverse effect" clause. Think of it as a force majeure clause but for M&A deals – essentially, it lets the buyer back out of a deal if there is a material adverse change. And as with FM clauses, lawyers are going to start paying a lot closer attention to MAC clauses given the havoc caused by the novel coronavirus. However, MAC clauses often exclude the same circumstances that excuse performance under a FM clause. In other words, “acts of God” and other circumstances beyond the reasonable control of the party will not excuse the buyer’s performance (although they typically excuse performance under FM clause). There is usually a significant caveat, however, and that is unless the circumstances that are excused have a disproportionate adverse effect on the company. In other words, X is not excused unless X has a disproportionate adverse effect on the company being acquired compared to other companies in the industry.

The MAC clause was in the news recently because of the deal Sycamore Partners signed with L Brands to purchase a majority interest in Victoria’s Secret for $525 million. As James Stewart reports in the New York Times, Sycamore Partners signed the contract on February 20 when the stock was trading at around $23/share. All Victoria Secret stores were closed in mid-March. On March 20, the stock was trading at $10/share. Understandably, Sycamore Partners wanted to adjust the purchase price. But L Brands didn’t want to give it a Covid-19 discount so Sycamore decided to call the whole thing off. Interestingly, according to the article, Sycamore Partners is not claiming the pandemic constituted a material adverse change; rather, it is claiming that Victoria’s Secret did not operate its business the way it had in the past. This strategy is likely because the MAC clause in their contract expressly excluded “pandemics.” In other words, a pandemic would not constitute a material adverse change under their contract. I don’t have a copy of the contract so I can’t see whether it also includes the caveat – no pandemics as reasons to exit unless pandemics have a disproportionate adverse effect on the company compared to other companies in the industry. Even if it did include that caveat, I don’t think Sycamore would be able to back out of the deal since Victoria’s Secret is arguably not more detrimentally affected than other similar companies.

The deal between Victoria’s Secret and Sycamore wasn’t the only high-profile deal that references COVID-19 or pandemics; Morgan Stanley’s acquisition of Etrade did as well. I was able to take a look at that MAC clause and it looks like the parties clearly considered and negotiated it – and it was likely reflected in the purchase price.  Morgan Stanley isn’t trying to wiggle out of the deal and it’s probably a good thing given all the business Etrade is likely doing these days.