Panellists at IFLR’s Asia M&A Forum on Tuesday agreed that material adverse changes (Macs) are rarely triggered, despite their popularity. The speakers favoured protection mechanisms involving payment, such as deposits.
Deal protection is a focus in Asia, due to many factors including warranty and indemnity concerns, domestic regulatory regimes and general counterparty risk.
Questions remain about the enforceability of Macs both in the region and globally. As such, panellists recommended parties protect themselves with more specific – and enforceable – measures, such as deposits and break fees.
KEY TAKEAWAYS
An increasing number of parties to Asian M&A are looking to deposits and break fees versus more contractual deal protections such as Macs;
Buyer-paid deposits are becoming more popular, which highlights Asia’s seller-driven market;
Break fees may also incentivise a party to get a deal done;
Macs are difficult to enforce, and are often weakened through carve-outs.
Deposits
They agreed that deposits are an important incentive for buyers to complete deals. “We see deposits ranging between five to ten percent,” said Neil Hyman of Slaughter and May.
Break fees are much lower than that, he added, but it depends on the size of the deal, as well as whether the company is listed or not.
Either the buyer or seller can put down a deposit. Michael DeSombre of Sullivan & Cromwell said that it’s a function of who has leverage, although putting the deposit down at signing does sharpen the buyer’s mind and makes sure that they are paying attention.
“Having some money on the table between signing and closing has value in that regard,” he said.
In Asia, where a large number of buyers are seeking a comparatively small number of good assets, sellers have the advantage.
“We’re seeing deposits by buyers particularly in control deals or in those in which significant stakes are being acquired,” said DeSombre. “There’s more money chasing fewer deals, so sellers have more leverage in that regard.”
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There’s a lot of strategy in terms of shaking things up so that the real issues come out |
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Break fees
Eric Solberg, CEO and founder of independent investment firm EXS Capital, favours break fees.
“We require specific dollar amount termination fees on almost every deal we do,” he said. “A typical clause is that if our counterparty misrepresents or attempts to materially renegotiate the agreement by the time we’ve closed, we have the ability to terminate and they’re personally liable for a meaningful sum, say $1 million.”
Aside from being a helpful deal protection mechanism, it is also an important tool in terms of due diligence.
Solberg described it as a mechanism to poke and prod, figure out what people are hiding, what their pressure points are, what they’re not confident about. “Papering things over in terms of reps and warranties is an important part of the process, but there’s a lot of strategy in terms of shaking things up so that the real issues come out,” he said.
Macs
These payment-focussed mechanisms may be more compelling than a Mac.
The Mac usually gets watered down during negotiations, said Hyman. “While it may start as a pure clause, it usually ends up with some carve-outs and with materiality being defined.”
And even so it may not be enforceable. For a Mac to be enforced, the evidence and facts, the legal analysis and the documentation must be in your favour, he added. “All those stars don’t align very often.”
The party must show that the event destroyed the long-term value of the business. For example, one panellist said that if a company owned two factories, and one burned down, that may not constitute a material adverse change because that factory could be rebuilt.
“People view Macs as a general protection, but what a lot of clients don’t focus on in the negotiations is that if there’s a specific risk that they really care about, it needs to be in a separate representation or separate closing condition,” said Sullivan & Cromwell’s DeSombre.
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