It's rare for a private equity buyer and its target to team
up and litigate on the same side. But in the US, radio company
Clear Channel and its private equity acquirers Bain Capital and
Thomas H Lee (THL) did just that. The New York suit centred on
the financing banks reneging on lending terms. As the company's
stock had been trading below the offer price due to the turmoil
in the credit markets, the private equity firms and Clear
Channel accused the banks of shying away from providing funding
now that market conditions have deteriorated. After agreeing to
provide credit that would mature in six to eight years, the
banks now insist on a three-year maturity.
The case came to represent the state of play in large
A new phrase is emanating from Wall Street, across the
Atlantic to Canary Wharf and reaching even as far as Hong Kong:
lender's remorse. Banks are regretting the terms of financing
they agreed on last year, and some are trying to back out.
And for deals negotiated now, there is a shift in the
conditionality that banks are prepared to accept in their
commitments to fund acquisition financing. This pushback is
shifting the risk of financing back to the buyers, who in turn
feel compelled to transfer some of the risk back to the
In short, if banks insist on making
borrowing more risky, those doing the borrowing will pass
whatever risk they can onto the sellers. This, coupled with the
volatility of the markets, has hastened the rise of the
material adverse change (Mac) clause. But the clause will not
simply become more important in the coming months. With the
threat of litigation, the clauses will start to look different
The Mac clause functions as a condition to the buyer's
obligation to close on a transaction – it's a get-out
clause. It applies from the date of the seller's most recent
financial statements to the closing of the deal. With the
fading of financing outs (in private equity-led deals) the
clauses are often the only way for a buyer to terminate a deal
without paying the hefty reverse breakup fee.
Until last summer, buyers generally had no desire to kill
deals. And with the availability of cheap financing and a glut
of suitors, Macs were mere boilerplate. Now things have
changed. With financing terms far harsher than a year ago (as
Bain and THL will testify), the Mac is expected to take on
increased prominence. But with companies underperforming and a
wave of litigation expected, these clauses are now being
negotiated with one eye on how they'll look in courts.
The benefits of Macs are clear and buyers have little to
lose in asking for it. For instance, most deals are structured
to limit the buyer's downside to the reverse breakup fee (the
charge leveled at an acquirer that backs out of a deal). If the
buyer claims a Mac has occurred but the court disagrees, it
will be treated just the same as a terminated deal without a
Mac, and have to pay the reverse breakup fee. This breakup fee
may be smaller than a multi-billion dollar acquisition, but
firms are aware of the damage to their reputation if they walk
away from a deal with supposedly acceptable terms. Macs cost no
more than a reverse breakup fee, but are priceless in terms of
salvaging reputation. So on the buyer side, there is no harm in
asking for one.
However, asking for a Mac and agreeing on one are entirely
The devil's in the drafting
This is because Mac clauses have no definition. What, for
instance, constitutes material? This ambiguity means that
buyers' and sellers' counsel face fierce negotiations over the
wording of a clause, especially in grim financing
Sellers have always wanted narrow, specific terms with
carve-outs (terms that limit what constitutes a Mac). Their
main priority now is to seek carve-outs that reflect market
conditions. "The seller will argue that its results may
deteriorate, but that so will its peers'," says Barbara Mok,
partner at Jones Day in Hong Kong.
This is where the major battles are being fought. Do a
target's poor results, when similar to those of its industry
peers, warrant a buyer terminating a deal? Tihir Sarkar, a
partner at Cleary Gottlieb in London thinks not, and predicts
sellers will be granted these carve-outs as a matter of routine
from now on. "This kind of volatility in the world markets will
be an area where sellers will want to limit termination risk by
narrowing Mac-out clauses," say Sarkar. "It's just not going to
be acceptable to the seller to be subject to those kinds of
uncertainties." he says.
It's understandable then, that sellers are focusing on
aligning their performances with those of their peers.
Genesco's Delaware victory of Finish Line (see box-out) set a
precedent for sellers successfully claiming these
It's not so simple for buyers and their counsel.
Historically, buyers fought for a broad Mac, because the vaguer
the definition, the more scope there is for claiming one. A
broadly drafted Mac is more of a mission statement to play on
ambiguity further down the line. "It gives the buyer some
wiggle room," says Lee Suet Fern, director of Stamford Law in
Singapore. No seller wants its financial records examined under
the cold light of a court. And once a deal is announced neither
party, especially the seller, wants it killed, for the sake of
Nevertheless, the definition of a Mac hasn't changed since
the market crashed last summer. A study by Kenneth Wolff and
Cason Moore of Skadden Arps Slate Meagher & Flom compared
the terms of Mac clauses in recent public deals to those before
the crash. It looked at the 3Com/Bain & Huawei, Radiation
Therapy/Vestar and Goodman Global/Hellman & Friedman deals
(all made from October 2007 onwards) alongside five
transactions announced in July 2007. The definition of a Mac
was broadly the same.
A Mac, according to these deals, is "facts, circumstances,
events or changes that are, or are reasonably expected to
become, materially adverse to the business, financial condition
or results of operations of the company and its subsidiaries,
taken as a whole".
Buyers: be specific
But things are likely to change soon. If a case is remotely
likely to end up in court, case law shows that the clause will
be read against the party that tries to cite it. This means
buyers should also be willing to narrowly define what
constitutes a Mac. The terms may be demanding of the target,
but they should at least be specific.
A buyer requesting a clearly defined Mac seems disingenuous,
but it is not. "Importantly, a court will always try to
anticipate what was in the buyer's mind when the clause was
negotiated." says Robert Ashworth, head of Freshfields'
corporate practice in Asia.
So demands on the performance of the target can be high, but
they need to be transparent to hold up in court. Common court
laws don't favour the seller by default necessarily, but if a
party is trying to invoke an exclusion provision, the burden of
proof will fall upon that party. A woolly Mac will reflect
badly on both parties but is likely to damage the buyer's claim
These theories, until now largely hypothetical, will be put
into practice as litigation over failed deals increases. Only a
handful of disputes have so far reached the Delaware Chancery
Court in the US, and fewer still have come to court in Asia.
But this will change now that the credit squeeze has set in.
Europe is also likely to see more cases.
Macs in Asia
That Mac clauses are burgeoning in Asia is surprising, given
that it's the only region where potential targets have remained
largely unscathed by the financial crisis. A study carried out
by Lee Suet Fern, director at Stamford Law in Singapore,
examined the frequency of Macs in takeovers of publicly listed
companies in Singapore, Malaysia, Hong Kong and Australia (see
box-outs). The survey found that although Mac clauses aren't
common in Singaporean, Malaysian and Hong Kong M&A they are
on the rise, especially in Hong Kong – where three out
of five public M&A deals included such a clause in
"I didn't see any on term sheets in Hong Kong deals three
years ago but we've been recommending them to private equity
buyers for most of 2007 onwards," says Ashworth.
Chinese sellers are also getting used to the concept of
Macs, and understandably so. "If you're investing large amounts
of money into a relatively young Chinese company, you'll want a
Mac," says Ashworth. On the face of it, this seems
counter-intuitive, considering the number of private equity
buyers and the scarcity of good targets in China. But when it
comes to actual deal making the Chinese may be willing to
concede a Mac in exchange for similar sell-side protection,
such as a break-fee.
Asian companies may be one step removed from the turmoil of
the west, but the rise of the Mac in the region underscores a
general trend: Macs now matter.
Narrow is the new wide
In seminars and forums everywhere, Macs are being discussed
with the same ferociousness as they are negotiated. Counsel
know that the clauses are more important now than ever.
But to talk of the pendulum swinging back to buyers (as many
are) misses the point. Anaemic markets don't justify a vague,
catch-all Mac being stamped on the seller.
They do, however, make a failed bid and exercising of a Mac
more likely. And because courts have traditionally put the
burden of proof on buyers, their counsel will need to keep Macs
specific. The expected wave of litigation will see more failed
M&A deals going to court. Cerberus/United Rentals (see box
out) and Clear Channel's saga are prime examples. Here,
vagueness would have suited only the seller, by showing up the
acquirer and its counsel as cynical during the drafting.
Mac clauses will almost certainly change. No one argues that
that is not the case. But, most importantly, buyers' counsel
will now have one eye on the courts when they negotiate. The
days of woolly, catch-all drafting are over; a new tighter,
narrow clause will emerge.
Tom Young Asia editor with additional reporting from
Lynann Butkiewicz and Nicholas Pettifer
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