Material Adverse Effects: Insights from the High Court of Justice

October 17, 2024

Written By Drew Broughton, Jesse Fontaine and Jordan Murray

Uncertainty caused by macroeconomic risks such as the COVID-19 pandemic, severe weather events and geopolitical tensions has given rise to increased judicial consideration of contractual terms apportioning risk in the negotiation and execution of commercial transactions. A common mechanism for apportioning such risks in the context of M&A transactions are "Material Adverse Event" Or "Material Adverse Change" (MAE) clauses. Once the subject of minimal judicial consideration, the evolving body of jurisprudence on MAE clauses gained another chapter in the recent decision of the English High Court of Justice in BM Brazil & Ors v Sibanye BM Brazil & Anor (Sibanye), which dealt with termination of an M&A transaction involving certain Brazilian mines.

Background

Generally speaking, an MAE is typically defined as any change, effect, fact, circumstance, occurrence or event that, individually or in the aggregate, is materially adverse to the business, operations, assets, properties or condition (financial or otherwise) of the target business, or that could delay or impair the ability of a party to consummate the transaction. Often, the definition of an MAE provides for certain exclusions or “carve-outs”, including changes to market or industry; changes in law or accounting principles; or natural disasters, acts of God, public health emergencies or other force majeure events.

An MAE condition is often included in private and public M&A acquisition agreements, which provides the purchaser with a contractual walk-away right if an MAE occurs during the interim period between signing of the definitive agreement and closing of the transaction. Commonly referred to as a "MAC Out" or "MAE Out", this condition has formed the subject of a growing number of cases in Canada, the United States and the United Kingdom since the 2018 decision of the Delaware Chancery Court in Akorn, Inc. v Fresenius Kabi (Akorn), which affirmed the ability of a purchaser to avoid closing a transaction where an MAE has occurred.

Canadian Cases

Canadian courts most recently interpreted MAE clauses in Fairstone Financial Holdings Inc v Duo Bank of Canada (Fairstone) and Cineplex v Cineworld (Cineplex). In both Fairstone and Cineplex, each being transactions entered into before the onset of the COVID-19 pandemic, the buyer tried to rely on an MAE clause to avoid completing the acquisition. In each case, the court found that the buyer was not entitled to rely on the MAE clause, primarily due to the applicable definition of MAE containing carve-outs which applied to the COVID-19 pandemic and its resulting effects. While these cases are instructive, there remains limited case law on the application and construction of MAE clauses in Canada outside of the COVID-19 context.

Fortunately, Canadian courts have shown a willingness to rely on international jurisprudence when interpreting MAE clauses. For example, the Court in Fairstone moved towards an objective assessment of MAE clauses by adopting the United States definition of MAE: "the occurrence of unknown events that substantially threaten the overall earnings potential of the target in a durationally-significant manner."

Given that Canada is home to a significant portion of the global mining industry, with more mining companies listed on the TSX and TSXV than any other global exchange, we expect that Sibanye will be considered by Canadian courts and should be considered in crafting appropriate MAE clauses.

Sibanye

The dispute in Sibanye arose between Appian Capital Advisory LLP (Appian), the plaintiff seller of two Brazilian mines through two natural resource investment funds, and Sibanye-Stillwater Limited, the defendant buyer of the mines through its Brazilian subsidiary, Sibanye BM Brazil (Pty) Ltd (SBSW). Pursuant to two Sale and Purchase Agreements, SBSW agreed to purchase the mines for an aggregate purchase price of USD $1 billion, with $525 million of the purchase price allocated to the Santa Rita Mine, a nickel mine located in Bahia State, Brazil. The dispute centred around the interpretation of the MAE clause in the purchase agreements.

The two purchase agreements were signed on October 26, 2021. Approximately two weeks later, a geotechnical event (Geotechnical Event) occurred at the Santa Rita Mine. This Geotechnical Event caused damage to the east wall of the mine, resulting in cracks approximately 84 meters in height. SBSW became aware of the Geotechnical Event during a site visit on or about November 16, 2021. On January 24, 2022, following review of several technical reports assessing the Geotechnical Event, SBSW delivered a letter to Appian purporting to terminate the SPA on the basis that the Geotechnical Event constituted an MAE. Importantly, it appears as though SBSW was provided with access to the site, and corporate and operational teams, and there was no attempt by the seller to conceal or understate the Geotechnical Event. Furthermore, SBSW noted in its internal analysis that “[t]his level of geotechnical risk is to be anticipated in mature mining operations”.

At trial, Justice Butcher considered whether: (1) the Geotechnical Event was an MAE; and (2) if the Geotechnical Event was an MAE on its face because it fell within the general words of the definition, whether any of the MAE exclusions applied.

The relevant portions of the MAE definition in the SPA are as follows:

"Material Adverse Effect" means any change, event or effect that individually or in the aggregate is or would reasonably be expected to be material and adverse to the business, financial condition, results of operations, the properties, assets, liabilities or operations of the Group Companies, taken as a whole, excluding any such change, event or effect arising out of, in connection with or resulting from

…

(i) any action, omission, change, effect, circumstance or condition attributable to or contemplated by the execution, delivery or performance of this Agreement or the announcement of the transactions contemplated in this Agreement (including any adverse effect proximately caused by threatened or actual loss of, or disruption in, any customer, supplier, vendor, lender, contractor, employee, landlord, community or government relationships or loss of any personnel, or by reason of the identity of the Purchaser or any communication by the Purchaser regarding its plans or intentions with respect to the Group Companies or the Project [viz the Santa Rita Mine])

Justice Butcher found that as of the date of termination, the Geotechnical Event “was not and would not reasonably have been expected to be material”, and that SBSW was not entitled to terminate the transaction.

Takeaways

The lengthy factual and legal analysis in Sibanye offers several key takeaways:

• “Revelatory” events, meaning changes, events or effects that expose broader problems or issues that existed as of the signing date, are not MAEs. Put differently, an MAE must be material in and of itself and cannot be considered material on the basis that it reveals some other existing problem or issue. This finding supports the notion that an MAE does not pre-exist the execution of the definitive agreement.
• Courts will undertake an objective assessment whether an event would reasonably be expected to be material and adverse. In assessing whether an MAE has occurred, parties should adopt the perspective of a reasonable, well-informed person in the position of the parties at the time when notice of termination on the basis of an alleged MAE occurs.
• Sibanye follows the US principle that, in assessing the materiality of a potential MAE, the effects must be considered over a commercially reasonable period of time measured in years rather than months. The size of the transaction, nature of the assets, length of sale process and the complexity of the definitive agreement are relevant factors courts will assess to determine materiality. As it turns out, the mine in question actually experienced increased production and financial growth in the year following the Geotechnical Event (although this subsequent fact was not specifically considered by the Court in its decision).
• Any analysis of an event or change should be done as objectively as possible, being mindful of anything that could undermine the integrity and reliability of such assessment. The evidence in Sibanye established that the purchaser appeared primarily concerned with establishing that the Geotechnical Event constituted an MAE, rather than ensuring that the analysis was conducted reliably.
• The threshold for establishing the occurrence of an MAE remains high, and there is a significant burden placed on the purchasers who seek to terminate transactions relying on an MAE condition. In most cases, the inclusion of an MAE closing condition will not materially increase closing risk for sellers.

For further reading on MAE clauses in the context of COVID-19, see Bennett Jones' previous insights:

• Delaware Judge Finds Elusive MAC—Does It Change Anything?
• The Impact of COVID-19 on M&A Dealflow 
• COVID-19: Material Adverse Change in a Canadian M&A Context
• Fairstone Financial v Duo Bank—Ontario Court Interprets MAC Clause

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