‘Material Adverse Change’ during acquisitions: “mind the shop” or “push to the moon”?

“The deal is going through, with velocity, and lots of it... Lots of [Waystar] I really like. But lots of it I also really hate.” – Lukas

Charles Russell Speechlys Succession Watch: Episode 6

This week’s episode of Succession continues to build up to the sale of Waystar Royco to Lukas Matsson’s GoJo. The exact nature of the contractual intricacies of the Waystar/GoJo deal have not been revealed in Succession to date, but we do know that certain shareholders and the majority of the management are still fighting to complete the deal (or for some of the Roy siblings, abort it). Special mention is also owed to Kendall’s flight jacket, Shiv’s “Bitey” game and the inaugural appearance of Greg the “pitch robot”.

The focus this week was on the launch of Waystar Royco’s new product “Living+”: a dystopian-esque real estate venture with all-access content, features and services reminiscent of Charlie Brooker’s show ‘Black Mirror’. The purpose of this article is to consider the same, the impact this may have on the target entity, and the consequences which Living+ and other actions taken by the Roy siblings could have on a pending transaction.

From a legal perspective, transactions such as this are often subject to certain regulatory consents. A period of time will arise between exchange of the purchase agreement (the point at which one becomes legally bound by the contract) and completion of the same (the point at which the ownership actually changes hands), during which these certain consents are obtained. This is known as a ‘split exchange and completion’ transaction. Whilst it is not clear whether the transaction in question meets this bill, we have assumed so for the purposes of this article.

Ordinarily, from the point of exchange, buyers assume a certain level of risk, as they have become bound by the terms of the purchase agreement. To rebalance such risk, buyers often insist on “material adverse change” clauses (“MAC Clause”) in purchase agreements which may allow them to walk away from a transaction where, during the period between exchange and completion, there is a material change to the target entity – i.e. they are no longer buying what they thought they were. 

Whilst the Roy siblings’ frivolous actions do not indicate any thought having been given to the above, sellers can learn from their actions, and instead, exercise caution if entering into an agreement with a MAC Clause.

‘Material Adverse Change’

MAC Clauses often cast the net widely in order to capture as many potentially materially adverse events as possible. Depending on the exact wording, it covers any fact, matter, event, circumstance, condition or change which materially and adversely affects the business, financial or trading position, performance, operations, assets, liabilities, or condition of a target. It is a clause often heavily negotiated between the parties, which given its possibly nuclear outcome, is understandable.

The English courts rarely interpret MAC Clauses, offering little guidance as to how they may be interpreted in the context of litigation. The English courts did, however, offer some useful insight during the case of Grupo Hotelero Urvasco v Carey Value Added SL and Another [2013] EWHC (Comm) 1039. Blair J considered that for an adverse change to be ‘material’, it must not be temporary in nature, must have a lasting impact and must significantly affect a party's ability to perform its obligations. It is also well established that the event must also be somewhat unexpected or unanticipated, such that a party cannot rely on a MAC Clause for circumstances that it knew about at the time of contract of sale (unless those circumstances themselves materially change).

Would Kendall’s inflated financial forecasts, or Roman’s ‘firing’ of Gerri and Joy meet this standard? The waters are murky, and it’s likely to be up for debate.

Pending litigation against the Company

“Now we are open to litigation.” – Gerri

Roman’s firing spree in this episode of both Gerri as General Counsel and Joy as head of Waystar Studios seems to be a precarious move considering the ongoing acquisition (“Be serious, you're minding shop” warns Gerri; “Matsson will be very angry”). The formalities of the firings were questionable, being that they were done without speaking to any in-house counsel or HR and without someone else present at the time, likely opening the door to legal proceedings in the future.

Whilst Kendall assures Roman that this won’t be significant ("Put on the Dad goggles. Right? It's nothing. Dynamic Waystar duo shake up their senior leadership team. Grumble quote, grumble quote, caveat”), a contract of sale will usually contain a suite of warranties in which the sellers will warrant that there is no litigation (which includes claims, actions, suits, proceedings, arbitrations, complaints, charges or investigations) that is pending or currently threatened against the target. If this warranty transpired to be untrue, the sellers would likely be subject to a breach of warranty claim, or worse, if a ‘no litigation’ warranty was included in any such MAC Clause, the buyer may have a right to walk away from the deal. Additionally, any such MAC Clause may also include a ‘key personnel’ requirement for the retention of key employees. With Gerri being absent from Matsson’s “kill list” and residing in a position of significant responsibility, if included in any such MAC Clause, it is likely that her termination would breach such a clause.

Financial condition of the Company

“We can push this to the moon.” – Kendall

We see Kendall instruct an analyst named Peter to “go explosive” on the numbers and use “the biggest headline number that's credible” for the revenue forecasting and projected growth ahead of the launch of Living+. He goes as far as playing a doctored video of Logan Roy endorsing the expected doubled growth of their parks division. These exaggerated numbers are intended to convince investors to “go to the moon” with Waystar as if inspired by the Gamestop saga of 2021, and to hike up its share price with the goal of squeezing Matsson out from acquiring the company.

Subject to its drafting, a MAC Clause may be triggered by any change, which is not in the ordinary course of business, in the financial condition or financial results of the Company against those reflected in financial statements provided to the buyers. During the period between exchange and completion, Sellers are often required to conduct the business in the ordinary course. If any such requirement is tied to a MAC Clause, any deviation from the ordinary course may entitle the buyer to walk away from the deal. Depending on its terms, the action of directing time, money and resource to Living+ may well amount to a detraction from the ordinary course and entitle the buyer to walk.

Concealing lower financial figures and overstating future income during the acquisition process was considered in the recent case of Decision Inc Holdings Proprietary Ltd v Garbett [2023] EWHC 588 (Ch). The sellers provided the buyers with engrossed turnover forecasts for the three months leading up to the signing of the sale and purchase agreement. They also embellished a workstream of assignments that they expected to win, in particular with four large contracts being sought at the time. The court held that whilst the shortfall of three months of turnover did not constitute a ‘material adverse change’, there was deemed to be a materially adverse effect on the company’s prospects where the future contracts in reality would generate much less than promised. Whilst the agreement may not be terminable, in the context of Decision Inc Holdings Proprietary Ltd v Garbett damages were ordered to be paid by the sellers, calculated based on the difference between the company's value had the prospects been as expected and its value with its prospects impaired.

In summary

MAC Clauses are most pertinent in contracts containing a split exchange and completion. They are heavily negotiated, and transaction specific. Advice should be taken as to the drafting of the same, and care must be taken by sellers when operating during this time period. Whilst the actions taken by the Roy siblings may have forced Matsson to make an even higher offer in the next upcoming episode, he could equally have walked away with a damages claim under his belt.