A current US case concerning a Material Adverse Change (MAC) clause illustrates how important it is for M&A transactions to provide just the right contractual regulations for the period between the signing and the closing of an agreement for the sale and purchase of a business.

On 23 July 2016, US telecommunications company Verizon Communications Inc. (“Verizon”) and Yahoo! Inc. (“Yahoo”) signed a share purchase agreement (SPA). Verizon intends to acquire the core business of Yahoo (online advertising, search engine) by purchasing 100% of the shares of Yahoo Holdings, Inc., a newly established subsidiary of Yahoo that is going to own Yahoo’s operative core business at the closing date; the purchase price amounts to USD 4.825 billion. The billion-dollar share of the Chinese online platform Alibaba held by Yahoo, Yahoo Japan Corporation and Excalibur IP, LLC, do not form part of the transaction.

Before the closing, which is scheduled to take place in spring 2017, it has now been disclosed that hackers had gained access to personal data of up to 500 million Yahoo customers; Yahoo published a corresponding press release on 22 September 2016. This illegal access to data took place two years ago, but was not discovered until after the signing. Immediately after this was disclosed, the value of Yahoo‘s shares fell by 3%. Quite understandably, Verizon is alarmed about the incident referred to as ‘breach of cyber security’; for Verizon the question now is whether, in the light of these unforeseen developments, the purchase price in the amount of USD 4.825 billion is still justified for the business unit to be acquired and/or whether there is any chance to withdraw from the agreement.

From a buyer’s perspective, it is important to take precautions for possible adverse developments occurring in the period between the signing and the closing. It is advisable to have contractual provisions in place that will safeguard the buyer from having to go through with closing if, at the closing date, the purchase price agreed at the signing date must be regarded as excessive due to adverse developments of the business. Such contractual safeguards are usually implemented in the form of an MAC clause. The term MAC, which originated in Anglo-American jurisdictions, means the occurrence of material adverse changes affecting primarily the target company; in particular, it refers to substantial impairments of a company‘s assets and income. MAC clauses are an effort to account for, and share, economic risks faced by the buyer on account of a change in circumstances between the signing and the closing. Typically, the buyer is to have a right to withdraw from the agreement or to pay a lower purchase price in the event of an MAC. Sellers usually try to prevent, if possible, the potential withdrawal right of the buyers and to restrict it by introducing numerous exceptions (carve-out).

MAC clauses can take various forms; careful and accurate drafting of the relevant contractual provisions will have a major impact on whether, and to what extent, buyers will actually be able to rely on these clauses in cases of dispute. Business MAC? Market MAC? Or confirmation by the sellers, as a condition precedent, that the representations and warranties will be correct ‘in all material respects’ also at the closing date?

The shareholders of Yahoo were successful negotiators insofar as only the third variant mentioned in the preceding paragraph (confirmation of representations and warranties ‘in all material respects’) was agreed in the SPA. Therefore Verizon must, in order to successfully assert claims under the MAC clause, be able to connect the negative development that has occurred with a specific violation of a representation and warranty. And what exactly does ‘material’ mean, after all? How significant must an impairment be to qualify as an MAC?

It is therefore highly recommendable for the parties to a share purchase agreement to dedicate increased attention to the phrasing of MAC clauses and to state as precisely as possible in which cases and to what extent MAC clauses should apply. But the ‘Yahoo case’ shows not only the relevance of proper and precise drafting but also the importance of conducting a ‘cyber-security due diligence’ examination in certain areas to identify whether such violations exist. Buyers of a business could demand an adequate representation and warranty in this respect.