Material Adverse Change (MAC)

What is a material adverse change?

Material adverse change (MAC, in German: wesentliche nachteilige Veränderung) describes a significant, generally not merely temporary deterioration of a company that occurs after a contractually specified point in time. It can affect the business operations or the financial position and results of operations, that is, what the company owns, how it is financed and what it earns. A MAC clause attaches legal consequences to this, usually the buyer's right to refuse closing or to withdraw from the contract. With closing, the shares pass to the buyer against payment of the purchase price.

A comparable case is a holiday apartment booked months in advance. If it is uninhabitable on arrival after water damage, the guest should not have to pay; a dripping tap, by contrast, does not entitle the guest to cancel. The MAC clause sets where this line between significant and insignificant runs.

The clause belongs to company purchase agreements (share purchase agreement, SPA) in which signing and closing fall apart. It appears there as a closing condition (MAC condition), as a separate right of withdrawal or as a warranty that no material adverse change has occurred since the last balance sheet date. It is also found in investment agreements with staged payment and in loan agreements. In the US market, the term material adverse effect (MAE) is used with the same meaning. In German transactions, such clauses are used more cautiously than there.

Structure of a MAC clause

Definition

A MAC definition has four building blocks: an event or several circumstances, an adverse effect on the business, assets, financial position or results of operations of the target company, a materiality threshold and a time reference. It is often sufficient that such an effect can reasonably be expected. A distinction is made between a company-specific clause, which covers only deteriorations of the target company, and a market-based clause, which also includes general developments in capital or sales markets. Market-based clauses are rare in German purchase agreements.

Qualitative and quantitative wording

A purely qualitative clause speaks of a "material" deterioration without quantifying it. It leaves room for interpretation and thus for dispute. A quantitative clause sets objective thresholds. This can be a fall in revenue or earnings by a certain percentage against a comparison period, the loss of specifically named customers or damage above a certain amount. In German contracts, quantified triggers are a widespread means of making the clause predictable.

Exceptions and counter-exceptions

Sellers demand a list of circumstances that do not constitute a MAC. Common are general economic developments, industry-wide changes, changes in laws or accounting standards, political events, armed conflicts, natural events and pandemics. In addition come the consequences of the announcement of the transaction, such as reactions of customers or employees, as well as measures that the buyer has requested. Merely missing a plan is usually excluded, but the causes behind it may be covered. Buyers push through a counter-exception: if a general circumstance hits the target company significantly harder than comparable companies in its industry, it counts to that extent after all.

MAC clauses in German law

For company acquisitions, German law has no statutory MAC provision. What counts as a material adverse change results solely from the contract and its interpretation by wording, purpose and circumstances (Sections 133 and 157 of the German Civil Code, BGB). Under general principles, the party relying on the clause bears the burden of presentation and proof, which as a rule means the buyer. It must present the facts and, in a dispute, prove them. Published case law of German courts on MAC clauses in company purchase agreements is sparse, also because disputes are often settled before arbitral tribunals, whose decisions are mostly not published. Precise wording is all the more important.

If there is no MAC clause, the buyer is left only with the disruption of the basis of the transaction under Section 313 BGB. It permits an adjustment of the contract and, where that is not possible or not reasonable, withdrawal. The hurdles are high: the development of the acquired company is in principle part of the buyer's risk, and where the contract itself regulates the allocation of risk, there is hardly any room for Section 313 BGB. In the US market, MAC clauses are more widespread, and the courts there have only rarely found a material adverse change. This case law cannot simply be transferred to contracts under German law.

MAC clauses in transactions and funding rounds

In auction processes, sellers often reject MAC clauses or restrict them to narrowly defined triggers. In bilateral negotiations and where there is a long time until closing, buyers are more likely to push them through. The purchase price mechanism also has an effect. With the locked box mechanism (a fixed purchase price based on a balance sheet before signing), opportunities and risks pass to the buyer already from the reference date. This is hard to reconcile with a broad right of withdrawal. With completion accounts, the purchase price adjustment absorbs part of the changes anyway. Milder instruments are a warranty without a right of withdrawal and the confirmation of the warranties on the closing date.

In practice, an alleged material deterioration often serves as the starting point for renegotiating the purchase price. In funding rounds with payment in tranches, investors often tie later tranches in the participation agreement to milestones and to the absence of a MAC. For the company, an open-ended wording is particularly risky there, because it plans with the tranche.

Worked example: testing a MAC threshold against a fall in EBITDA

A purchase agreement defines the MAC by adjusted EBITDA (earnings before interest, taxes, depreciation and amortisation, excluding one-off effects). A MAC exists if, in the twelve months before closing, it is more than 25% below the value of the twelve months before signing. General market developments are disregarded unless they hit the company harder than comparable companies.

• Adjusted EBITDA before signing: EUR 4.0 million, before closing: EUR 2.9 million.
• Decline: 4.0 minus 2.9 = EUR 1.1 million, so 1.1 / 4.0 = 27.5%, above the threshold.
• Of this attributable to an industry-wide weakness in demand: EUR 0.4 million, which is 10% of the starting value.
• Comparable companies also lost around 10% in the same period: the exception applies in full.
• Relevant decline: 1.1 minus 0.4 = EUR 0.7 million, so 17.5%, no MAC.
• Variant: comparable companies lost only 4%. The disproportionate part of 6 percentage points, 4.0 × 6% = EUR 0.24 million, counts as well. The decline is then 0.7 + 0.24 = EUR 0.94 million, so 23.5%, still no MAC.

Without the exception for market developments, the decline of 27.5% would be above the threshold, and the buyer could withdraw. Exceptions and counter-exceptions therefore determine the outcome more than the threshold itself. Both sides should therefore agree in advance how the market effect is determined and which comparable companies are relevant.

Distinctions: MAC clause, disruption of the basis of the transaction and warranty

• Disruption of the basis of the transaction: a statutory fallback provision with high hurdles. The MAC clause, by contrast, expressly regulates the allocation of risk in the contract.
• Warranty on business development: leads to damages or a purchase price reduction, but leaves closing unaffected.
• MAC in loan agreements: a right of termination for the lender alongside the covenants (financial ratios that the borrower must meet), independent of a company acquisition. The law additionally gives the lender an extraordinary right of termination if the borrower's financial circumstances deteriorate materially and repayment is at risk (Section 490(1) BGB).

Common mistakes

• Indefinite definition. A clause that speaks only of "material" shifts the dispute to the period after signing, when negotiating positions are unequally distributed.
• Missing exceptions. Without exceptions for general developments, the seller in effect bears the market risk until closing.
• Plan as yardstick. If the clause is tied to missing the budget, every deviation from plan becomes a possible ground for withdrawal.
• Conflict with the purchase price mechanism. With a locked box, the buyer bears the result economically from the reference date. A broad right of withdrawal for MAC at the same time gives it this risk back.
• Open legal consequence. The contract should regulate whether the MAC entitles to withdrawal, within what period the right is to be exercised and whether damages are excluded alongside it.

Frequently asked questions

Are MAC clauses common in German company purchase agreements?

Less than in the US market. In auction processes, sellers often push through a contract without a MAC clause. Where one is agreed, it is usually narrowly drawn and often tied to financial metrics.

Does a pandemic count as a material adverse change?

That depends on the clause. If it expressly excludes pandemics, such a development counts only to the extent a counter-exception applies because the target company is hit significantly harder than comparable companies. If the clause is silent, interpretation must determine whether general events were meant to be covered at all. There is then no certain answer.

Who has to prove that a MAC exists?

In principle the buyer, who relies on the clause. If the seller relies on a contractual exception, there is much to suggest under general principles that the seller must present its conditions. An express burden of proof rule in the contract avoids this dispute.

What applies if the contract contains no MAC clause?

Then the buyer in principle bears the risk of business development until closing itself. Withdrawal comes into consideration only through the disruption of the basis of the transaction, the conditions of which are rarely met.

What is the difference between MAC and force majeure?

Force majeure concerns the parties' ability to perform, the MAC the condition of the object of the purchase. A force majeure clause releases a party from obligations it cannot fulfil because of external events. The MAC clause, by contrast, allows the buyer to step back from the purchase even though both sides could perform. Many MAC clauses even expressly exclude typical cases of force majeure such as natural events.

Are there MAC clauses in funding rounds too?

Yes, above all with staged payment. Investors reserve the right not to provide later tranches if the company's position has deteriorated materially.

The Roemer Capital view

If a bidder demands a MAC clause, we assess it as a restriction on transaction certainty and set it against the purchase price when comparing offers. If it cannot be avoided, we push for a quantified version tied to metrics from the client's ongoing reporting, and for exceptions that cover general market developments. The wording is the responsibility of the law firm.

For funding rounds with tranches, we recommend objective milestones instead of a general MAC condition. Only in this way can the later payment be reliably reflected in the financial model and in liquidity planning.