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The economic efficiency of material adverse change clauses in private M&A agreements subject to English law
Master Thesis
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1. Introduction
Contracts related to mergers and acquisitions of companies (“M&A”) often, where the contract requires a period of delay between the date of the contract and the performance thereof, contain a clause with which the buyer seeks to protect herself from any unforeseen deterioration of the business of the target company during such period. These material adverse change clauses (“MAC clauses”) allow the buyer to terminate the contract where the target company is subject to a material adverse event (“MAE”) prior to completion.
Due to the dramatic impact which MAC clauses can have on M&A agreements, they have been described as “the most important contract term of our time”.1
Often, MAC clauses are drafted in a very general way2 and do not make reference to specific circumstances which trigger their application. This paper focuses on this type of MAC clause (as opposed to clauses which relate to a small number of clearly defined MAEs) and limits itself to the use of these clauses in private M&A (i.e. in contracts for the purchase of shares in a closely held company which is not listed on a stock market).
The following example scenario will be used throughout the paper: a seller and a buyer have contracted for the sale of the entire issued share capital of a target business. The sale price is €100 million but the sale can only be completed several months after the date of the contract as the transfer of the shares is subject to consent from the relevant competition law authority. Before the merger clearance from the competition authority can be granted (it ultimately is granted), an accident occurs in the target business which destroys one of its manufacturing plants and significantly affects the perception of the target business by its customers. The buyer estimates that the value of the target business has been reduced to €60 million. This figure is mainly based on the damage to the target’s reputation and projected loss of future business. The buyer would therefore pay €100 million in return for an asset with a value of €60 million.
The buyer could proceed with the acquisition and accept that she is overpaying by €40 million or she could breach the contract and face a claim from the seller which, if her estimates are correct, is likely to result in an award of damages in the sum of €40 million
1 Schwartz, Standard Clause Analysis, UCLA L. Rev. 2009-2010/57, p. 789
2 52% of all MAC clauses in English law acquisition agreements according to Middelkoop & Steer, Themes in
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(ignoring any element of legal and/or wasted transaction costs). Damages in this amount would reflect that, following specific performance of the contract, the seller would no longer own the company (now worth €60 million) but would have received €100 million from the buyer. Neither of these options is attractive to the buyer.
Being aware that events may happen between exchange and completion of the contract which reduce the value of the target company, a rational buyer would seek to address such risks before entering into the contract.
This paper analyses whether the introduction of a general MAC clause would improve the position of the buyer in a manner which preserves the economic efficiency of the contract. The focus of this paper is therefore to understand whether English courts in practice follow the intentions of the parties when interpreting such clauses and arrive at a more buyer friendly outcome than they would have if the contract did not contain such a clause. This is the minimum threshold which a MAC clause must pass to render it an effective ex ante choice of (self-help) remedy by the parties. Schwartz has argued that this is case under English law in the case of public M&A transactions3 but no such analysis has been conducted for private M&A.
The analysis is conducted in the context of English law as private acquisition agreements subject to English law only contain a MAC clause in a significant minority of cases.4 Their inclusion therefore appears to be a conscious choice (rather than for example in agreements subject to US law where they are seen as boilerplate clauses which are included as standard5). This may indicate a degree of ambivalence as to their effectiveness among practitioners which would render research into this topic particularly relevant.
The main question posed by this paper is:
Do English judges interpret widely drafted MAC clauses in a way which reflects the risk allocation negotiated by the parties and therefore preserves the economic efficiency of the contract?
To arrive at an answer, a number of sub-questions are put forward.
(i) How are MAC clauses linked to economic efficiency?
3 Ibid., p. 829
4 Middelkoop & Steer, Themes in Private M&A, Allen & Overy 2016, p. 12 [online] 5 Ashton (et al), Much Ado about nothing?, D&P 2013/13(4), para 2
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This sub-question conducts a brief descriptive literature review of the classic theory of efficient breach followed by the introduction of a revised version of this theory which will be used throughout this paper. The aim is to identify a definition of economic efficiency which can be used as an evaluation criterion to answer the main question posed by this paper.
(ii) How are MAC clauses used in the context of private M&A subject to English law?
This chapter conducts a literature review of academic writing on MAC clauses to identify the key theoretical approaches to this type of clause. It then eliminates the theories which are not relevant to private M&A under English law. The purpose of this exercise is to establish whether a MAC clause in principle is capable of fulfilling the criterion of economic efficiency set out in the answer to sub-question (i). Finally, the chapter provides a sample MAC clause to illustrate the key issues relevant to the drafting and functions of such a clause. (iii) How would English law interpret the sample scenario if the contract did not
include a MAC clause?
The doctrine of frustration is introduced to demonstrate how an English court would treat the sample scenario in the absence of a specific clause dealing with the sample scenario. The aim of this chapter is to provide a baseline outcome for the parties. It is put forward that the MAC clause only has an economic effect if it changes the outcomes obtained by the parties following an MAE from this baseline position.
(iv) Which rules of interpretation would be relevant for the construction of a MAC clause under English law and how would English law treat a buyer who relies on a MAC clause in error?
This sub-question provides a descriptive overview of the English law rules of contractual interpretation. The purpose is to demonstrate the limits to a court’s scope for interpretation of a MAC clause under English law and to understand whether a court should be able, in the abstract, to interpret a MAC clause in line with the intention of the parties.
This sub-question also investigates whether the invocation of a MAC clause creates a risk for the buyer in case a court subsequently holds that no MAE had occurred when the clause was triggered.
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(v) How have English courts construed MAC clauses in the past?
This chapter reviews the case law in which English courts had to interpret MAC clauses. As only a very limited number of MAC clauses connected with M&A transactions have been brought before the English courts, this chapter will not only review decisions taken in an M&A context but will also review cases related to other areas. The aim is to identify the arguments and approaches used by judges in construing MAC clauses.
These findings are then used to evaluate whether the decisions reached leave the parties in a position which differs from the default outcome introduced by sub-question (iii). It is also examined how closely the court follows the parameters prescribed by the MAC clause in the individual cases.
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2. Efficient breach theory
The theory of efficient breach been traced back to ideas first expressed by Birmingham6 in 1970.7 In that time, academics have continued to develop the theory and its current form differs significantly from its first iteration.8 This chapter provides a brief outline of the
original theory before identifying one specific evolution of the theory which will be used throughout this paper.
The classic theory of efficient breach
At its heart, the classical theory of efficient breach holds that the law should not in all circumstances enforce a contract by giving the non-breaching party the ability to sue for the performance of the contract. Instead, the theory argues that the default remedy should be a payment of damages by the breaching party. Performance of the contract should only be available as a remedy where such performance will lead to the creation of economic value.9 The classic theory argues that using the expectation interest10 as starting point for the award of contract law damages will provide an incentive only to perform a contract where such performance leads to the creation of economic value. This is commonly illustrated by an example along the following lines (see for example Posner11).12
Assume that a potential customer (C) approaches a trader (T) to purchase a widget. T establishes that she can instruct a manufacturer (M) to produce the widget and have it ready for delivery to C in one month’s time. M has calculated that it will cost €600 to produce the widget and has quoted a price of €800 to T. On this basis, T has contracted with C to deliver the widget in one month’s time for a price of €1,000. In this scenario, economic value in the amount of €400 is being created of which M and T each retain €200. It is therefore reasonable for both of them to enter into the relevant contracts and the transaction is also sensible from a macroeconomic perspective.
6 Birmingham, Breach of Contract, Rutgers L. Rev. 1970/24, p. 273
7 Liao, Efficient Breach in the Common European Sales Law, Syracuse J. Int’l L. & Com. 2013-2014/41, p. 336 8 Klass, Efficient Breach, in Philosophical Foundations of Contract Law, 2014, p. 363
9 Ibid, p. 363
10 I.e. allowing the non-breaching party not only to recover its wasted costs (the reliance interest) but also the
profit which it would have subsequently gained had the contract not been breached – see ibid p. 364
11 Posner, Economic Analysis of the Law, Little, Brown and Co. 1992, p. 118 - 121 12 Ibid, p. 364
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While the transaction is reasonable at the outset, events may occur prior to the production of the widget which affect M’s willingness to perform its obligations under the contract. These events can take a positive or a negative form. A positive event would be another customer approaching M with an offer to pay an amount in excess of €800 for the widget. An increase in the production costs of the widget above €600 would be a negative event. The literature on efficient breach more commonly discusses scenarios of a positive nature13 but this paper will limit itself to discussing the negative version as this leads to a more appropriate analogy to the sample scenario.
An increase in production costs of no more than €200 will reduce M’s profit margin but will not impose further costs on M. Even in a hypothetical world where M does not have to fear legal sanctions from T, the incentive for M to breach the contract would be low as breaching the contract would mean that M is likely to incur reputational damage. This changes once the costs of producing the widget increase above €800. M now has to incur costs to avoid breaching the contract. Allowing T to recover expectation damages from M, means that it is still reasonable for M to perform the contract as long as the increase in production costs is lower than the combination of its own profit margin of €200 and T’s profit margin of €200 (i.e. €400 in total). A production cost increase of €350 to €950 would lead to M suffering a loss of €150 but performance of the contract would still be reasonable both for M who would avoid a claim in the sum of €200 from T and from a macroeconomic perspective as €50 of economic value is being created by the overall transaction. A production cost increase to €1,050 on the other hand renders performance inefficient for M who would rather pay T’s expectation loss of €200 than incur the loss of €250 that would arise if the contract were performed. Performance of the contract is also no longer efficient from a macroeconomic perspective as now an aggregate of €1,050 is invested by M to create €1,000 in value.
This demonstrates the key argument of the classic efficient breach theory. Allowing parties always to claim for the specific performance of contracts can lead to the performance of contracts which reduce the wealth of society as a whole. Expectation damages on the other hand avoid this while still adequately compensating the innocent party.14
13 Ibid, p. 365
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Criticisms of the classic theory
The classic theory of efficient breach has been the subject of much criticism from contract law theorists. They feel, among other criticisms, that encouraging breach of a contract is a moral wrong.15 These critics argue that rights, including contractual rights, should not be
subjected to an instrumentalist view which only gives effect to them where they serve an ulterior motive such as the maximisation of wealth.16 This paper will not discuss this or other
criticisms of the classical theory in any further detail as they do not take into account how the classical theory has been developed by Klass.17 This is demonstrated by him in his review of “criticisms from outside the model” in one of his recent papers18 and is also borne out by a
review of current articles engaging with the theory of efficient breach.
Academics such as Harrison19, Isaacs20, Liao21 and Vilaça22 have continued to write about
moral and ethical objections to the theory.
Olson23 has restated a pragmatic criticism of the theory by focussing on the burdens which
courts would have to face when reviewing large quantities of economic evidence.
Epstein24 and Al-Tawil25 both review whether the theory could be applied in a specific
context (intellectual property law and English law respectively).
The most comprehensive review of the theory was produced by Harrison26 who summarised
three main lines of criticism, these being the question of which default remedy is truly most efficient, the moral component to contractual promises and an argument based in behavioural economics which questions whether efficient breach increases overall happiness.
Finally, Niblett27 and Foulds28 both look at the theory in the context of public company takeovers. Niblett focuses on the relationship between target company staff and management
15 Ibid, p. 363
16 Ameer, Between Scylla and Charybdis, UCL Juris. Rev. 1995/2, p. 204
17 Klass, Efficient Breach, in Philosophical Foundations of Contract Law, 2014, p. 363 18 Ibid, p. 366 – 370
19 Harrison, Influence of Law and Economics Scholarship, N.Y.U. Ann. Surv. Am. L. 2012-2013/68, p. 11 – 12 20 Isaacs, Hypothetical Efficiency, Va. L. Rev. 2013/116, p. 364
21 Liao, Efficient Breach in the Common European Sales Law, Syracuse J. Int’l L. & Com. 2013-2014/41, p. 337 22 Vilaça, Why teach legal theory today?, German L.J. 2015/16, p. 793
23 Olson, Who mourns for specific performance?, Advocate Vancouver 2013/71, p. 859 24 Epstein, Intellectual Property Law and the Law of Contract, E.R.C.L. 2013/9(4), p. 349 25 Al-Tawil, English Contract Law and the Efficient Breach Theory, M.J. 2015/22(3), p. 397 26 Harrison, A nihilistic view of the efficient breach, Mich. St. L. Rev. 2013, p. 168 – 171 27 Niblett, Hostile Takeovers and Overreliance, Seattle U. L. Rev. 2014-2015/38, p. 605
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while Foulds reviews a specific decision of the Delaware courts which considers whether target company management should be permitted to lock the target into an offer without the option to walk away in a manner akin to an efficient breach.
All the articles mentioned in the preceding paragraphs engage only with the classic theory.
Klass’ revised theory
The revised theory of efficient breach as presented by Klass is less prescriptive than the classic theory which seeks to improve default remedies (including self-help remedies) which are to prevent the performance of economically inefficient contracts. Instead, it merely demands that contract law respects the wishes of the parties not only in respect of the obligations under the contract but also in respect of the remedies (including self-help remedies) which are available.29
The rationale for this demand is that the parties themselves are in a much stronger position to quantify the relative importance of any individual right than a court would be and are therefore much better placed to identify the appropriate remedy or self-help remedy which should apply to a specific breach.30 The aim of the restated theory is thus not to enable an efficient breach of all contracts but to give the parties the option to allow for an efficient breach of their specific contract. As the buyer is likely to pay a “price” (presumably in the form of a concession elsewhere in the agreement31) for the inclusion of such a clause in the contract,32 the standard ethical criticism that efficient breach rewards immoral behaviour would also not apply.
This can be seen as a variation of the “standard clause analysis” put forward by Schwartz which argues that the law creates default terms which are implied into contracts that do not contain provisions specifically dealing with the subject matter of the relevant default term. The parties to any given contract can then choose to retain the implied default term or to include an alternative solution which is more appropriate to their situation.33 Chapter 4 will
discuss the relevant default term which would apply under English law.
28 Foulds, For whom should the corporation be sold?, J. Corp. L. 2012-2013/38, p. 748
29 Klass, Efficient Breach, in Philosophical Foundations of Contract Law, 2014, p. 381 – 384 30 Ibid, p. 385
31 Supreme Court 02-11-2011, Rainy Sky SA v Kookmin Bank, [2011] UKSC 50, para. 19 32 Klass, Efficient Breach, in Philosophical Foundations of Contract Law, 2014, p. 381 33 Schwartz, Standard Clause Analysis, UCLA L. Rev. 2009-2010/57, p. 792
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From the perspective of Klass’ theory, a MAC clause therefore would be economically efficient if it provided the buyer with enhanced protection following an MAE.
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3. MAC clauses
Having established why a buyer may want to seek protection against a deterioration of the target’s business between exchange and completion, this chapter sets out how such protection can be provided by a MAC clause and reviews the surrounding academic discussion.34
A large part of the literature on MAC clauses focuses on acquisitions of companies which are publicly traded and/or located in the United States (including all of the articles cited in the preceding paragraph) and it is important to understand how this literature has to be interpreted in the context of a private acquisition agreement subject to English law.
MAC clauses in English law contracts
Practitioners in England expect MAC clauses to be used in public M&A transactions but state that they are far less frequently used in private M&A.35 One explanation is that English legal culture leads to sellers expecting that a buyer will assume the full risk regarding the target from the date of the contract.36
This argument for the relative scarcity of MAC clauses in English law agreements (which is also noted by other practitioners37) sits well with the general theme of this paper that parties will bargain for legal entitlements just like they bargain over the purchase price.38 A cultural predisposition to assign risk to the buyer39 would increase the “price” which a buyer would need to pay for the inclusion of a MAC clause.
While MAC clauses are less prevalent in English private M&A agreements than they are in their US counterparts, practitioners still report that they were included in 33% of agreements.40 This constitutes a significant minority of all transactions.
34 See for example: Gilson & Schwartz, Understanding MACs, J.L.E.O 2005/21(2), p. 330 – 358; Garrett,
certainty in uncertain times, J.L.S.P. 2010/43(3), p. 333 – 362; Monson, The modern MAC, S.Cal. L. Rev. 2015/88(3), p. 769 – 804; and Elken, Rethinking the Material Adverse Change Clause, S. Cal. L. Rev. 2008-2009/82, p. 295
35 Ashton (et al), Much Ado about nothing?, D&P 2013/13(4), para 5 36 Ibid, para 4
37 Baker & McKenzie, Global M&A Handbook, 2015, p. 663
38 Klass, Efficient Breach, in Philosophical Foundations of Contract Law, 2014, p. 382 39 see for example Peel, The Law of Contract, 2007, para 9 – 123
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Public and private acquisitions
Very different rules apply to MAC clauses for public and private M&A transactions under English law. Private acquisitions are governed by the rules of English contract law. Public acquisitions on the other hand are subject to the rules set down by the City Panel on Takeovers and Mergers in The Takeover Code which mainly seeks to create certainty for the shareholders of the target company and therefore sit outside the scope of this paper.41
MAC clauses in academic theory
A number of, non-mutually exclusive, theories regarding the purpose of a MAC clause have been provided over time. Elken42 has provided a succinct summary of these theories.
The first function which has been identified is to shift risk from the buyer to the seller by allowing the buyer to unilaterally terminate the agreement if pre-determined circumstances occur.43 This is the purpose of a MAC clause on which this paper focuses.
The second purpose is described by the so called “symmetry theory” which is particular to the circumstances of a US law merger agreement. Under US law, the shareholders of the target will need to ratify the merger agreement after it has become binding on the buyer. This allows the shareholders of the target to reject the contract if this seems advisable in light of events occurring after the date of the agreement. The buyer has no corresponding safeguard and will therefore want a MAC clause to level the playing field.44 This theory has been challenged on the basis of US law considerations45 but is also not relevant to a private M&A transaction in which no ratification (or acceptance of the offer as in a bid for a target which is listed on the stock market) from the target’s shareholders is required as they are a party to the sale agreement. It is therefore not relevant to this paper.
The third function is set out in the “investment theory”.46 Here, one purpose of a MAC clause
is to ensure that, especially in fast moving and research intense industries, the target business does not invest further funds into product lines which will be discontinued following
41 Cline & Trobman, Comparing the value of US and UK MAC clauses, Int’l Fin. L. Rev. 2002/21, p. 20 42 Elken, Rethinking the Material Adverse Change Clause, S. Cal. L. Rev. 2008-2009/82, p. 295 43 Ibid, p. 29
44 Ibid, p. 296 45 Ibid, p. 297 46 Ibid, p. 298
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completion of the acquisition.47 This function of a MAC clause does not relate to the impact of an unforeseen external event on the target and will therefore not be discussed further. Finally, the fourth theory sees the function of a MAC clause as creating “renegotiation leverage”. Having a credible threat of successfully invoking a MAC clause may focus the parties’ minds and result in a renegotiation which leaves both parties satisfied after the occurrence of an MAE.48 It has also been pointed out in the literature that both parties face
considerable risk if the clause is actually litigated. If the buyer is unsuccessful, she will acquire a business which she has publicly described as no longer feasible. An unsuccessful seller will be left with a company which a court has just described as the object of a catastrophic event.49
There is anecdotal evidence of such negotiations happening in practice.50 The question of whether these bargains reach a result which is economically efficient or merely more favourable to the buyer than performance of the original contract would have been is beyond the scope of this paper. The fact that such bargains are struck does imply though that they reduce the buyer’s loss as they would otherwise not occur.
For the purpose of this paper, this function sets out a second way in which a buyer may end up with a better result than she could hope for if purely relying on the doctrine of frustration. Chapter 6 will review English cases dealing with MAC clauses to understand the degree to which MAC clauses transfer risk from the buyer to the seller (as per the first function of a MAC clause discussed in this chapter). This is an important test to establish whether MAC clauses in fact provide additional renegotiation leverage. Unless risk is transferred back to the seller, her willingness to renegotiate the sale terms following the occurrence of a pre-completion MAE should not be influenced by the inclusion of a MAC clause in the contract. It is now time to turn to the practical form of MAC clauses.
Specific and general MAC clauses
A MAC clause can either deal with specific and pre-defined MAEs51 or with a general and
much more widely defined MAE. This can be illustrated using the sample scenario. Two
47 Monson, The modern MAC, S.Cal. L. Rev. 2015/88(3), p. 337
48 Elken, Rethinking the Material Adverse Change Clause, S. Cal. L. Rev. 2008-2009/82, p. 300 49 Schwartz, Standard Clause Analysis, UCLA L. Rev. 2009-2010/57, p. 824
50 Elken, Rethinking the Material Adverse Change Clause, S. Cal. L. Rev. 2008-2009/82, p. 300 51 Woolrich, MAC clauses, J.I.B.L.R. 2014/29(6), p. 377
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parties have contracted for the sale of a company. Between exchange and completion, a crucial manufacturing plant of the target burns down and the resulting delay in performing existing orders and damage to the company’s market reputation lead to a significant deterioration of its prospects.
In this situation, a MAC clause could allow the buyer to escape from the transaction in one of two ways. A specific MAC clause would function akin to a condition to completion52 and
would identify the factory (either specifically or as part of a class of factories of strategic importance) and prescribe that the factory must continue to exist undamaged and functioning at completion. Subject to it being drafted in a competent manner, such a MAC clause leaves very little room to the seller to argue that the relevant MAE has not occurred.
A general MAC clause on the other hand would not refer to the factory at all. Instead it would aim to cover off much wider range of risks by using less specific language (e.g. identifying damage to the target’s prospects as the trigger).
It will be easier for the buyer to demonstrate that a specific MAC clause has been triggered as the triggering event will be more clearly defined therein. A general MAC clause might afford the seller more scope to argue that the relevant event was not an MAE but theoretically protects the buyer against a wider range of events.
The two types of clause are therefore appropriate for buyers with different appetites for risk. Typology of risks
Miller has provided a typology of the four main types of risk which are capable of being
covered by a MAC clause which can be summarised as follows: firstly, there is “systematic risk” which is macroeconomic risk outside the control of either party.53 Secondly, there is
“indicator risk” which refers to the potential failure by the target to meet key financial goals. In itself this may not constitute an MAE but it may indicate an impending MAE.54 Thirdly,
there is what Miller calls “agreement risk”. This is risk created by the deal itself becoming public knowledge. Employees may decide to leave and customers may decide to switch to a
52 I.e. an obligation which one of the parties, often the seller, has to fulfil before completion can occur.
Examples of such an obligation are obtaining a competition law clearance for the acquisition, performing a re-organisation of the target or obtaining third-party consent to the assignment or novation of key contracts – see Denicolo, Acquisitions, CLP 2016, p. 110
53 Miller, The Economics of Deal Risk, Wm. & Mary L. Rev. 2008-2009, p. 2071 54 Ibid, p. 2071 – 2072
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competitor if they feel the impact of the deal will be negative for them.55 This is naturally far less of a problem in private M&A than in public M&A as there is no requirement to announce the deal publicly upon its signing.56 Fourthly, there is all other risk which is described as “business risk” and is defined as “arising from the ordinary operations of the [target’s] business”.57
Sample MAC clause
A MAC clause addressing these risks could take the following general form:
The buyer is entitled to terminate this agreement without any further obligation to the seller where any event occurs between the date of this agreement and the date of completion which has or is reasonably expected to have a material adverse effect on the target, its assets, its business and/or its financial condition save where such event has a comparable effect on all competitors of the target.
The above clause is a loosely drafted example but contains the four elements which are to be expected in any general MAC clause. These are (1) a definition of the time frame during which the MAE has to have occurred; (2) the required likelihood that the trigger event will amount to an MAE; (3) a definition of which aspects of the target business need to be affected by the MAE; and (4) a list of exceptions noting events which would constitute MAEs but are expressly for the risk of the buyer.58
Each of these four elements can take a number of forms (and in general the seller will aim to limit the scope of the clause while the buyer will aim to widen it59).
The time period in which the MAE has to occur to trigger the MAC clause normally runs from the contract date to completion but could also start earlier.60
Regarding the nature of the relevant event, a buyer would ideally want the ability to trigger the MAC clause as soon as an event has occurred which has the mere potential of turning into an MAE while a seller would ideally allow this only where the event has actually amounted
55 Ibid, p. 2072
56 contrast Rule 2.7, The Takeover Code [online]
57 Miller, The Economics of Deal Risk, Wm. & Mary L. Rev. 2008-2009, p. 2073
58 Quintin, M&A contracts in the American financial maelstrom, I.B.L.J. 2008/3, p. 280 – 281 59 Hall, How big is the MAC?, U. Cin. L. Rev. 2002-2003/71, p. 1064
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to an MAE. In practice, the parties are likely to agree on some form of “reasonable foreseeability” as a compromise.61
Defining the way in which the target needs to be affected is also likely to be contentious. While the inclusion of the target itself, its assets and its financial position is uncontroversial, a buyer will also want to include the prospects of the target in this list while a seller will resist this as too subjective.62
Returning to the example, the seller would argue that the destruction of the factory will only lead to a temporary reduction in customer orders while the buyer would, for the purposes of being able to trigger the MAC clause, treat these customers as irretrievably lost.
Finally, each clause will include exclusions which assign some or all of the risk for external MAEs to the buyer.63 These exceptions tend to be more detailed in US transactions than in acquisitions which are subject to English law64 which may be owed to the fact that claims related to MAC clauses have been prominent in the US in recent times65 while the English courts have seen fewer cases involving MAC clauses66 resulting in fewer opportunities to understand the manner in which such clauses will be interpreted by the courts and a more limited need to refine the drafting of existing standard clauses.
MAC clauses and economic efficiency
The theories developed to describe the functions of a MAC clause are consistent with finding of the last chapter that MAC clauses may be an economically efficient tool to allocate risk between the parties. While much will depend on the drafting of the individual clause, the case law review in Chapter 6 analyses whether this is also borne out by court decisions in practice.
61 Ibid, p. 280 – 281
62 Ibid, p. 281
63 Gilson & Schwartz, Understanding MACs, J.L.E.O 2005/21(2), p. 339 64 Ashton (et al), Much Ado about nothing?, D&P 2013/13(4), para 8 65 Gilson & Schwartz, Understanding MACs, J.L.E.O 2005/21(2), p. 331 66 Woolrich, MAC clauses, J.I.B.L.R. 2014/29(6), p. 373
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4. Change of circumstance
Having explained how MAC clauses are meant to improve the buyer’s position in the previous chapter, this chapter analyses how English law would deal with the sample scenario in the absence of a MAC clause. Would English law treat the destruction of a factory owned by the target as a change of circumstance which would allow the buyer to claim relief under common law?
Historically, the answer would have been no as English law views contractual obligations as absolute67 and initially only deviated from this view where the contract was for the
performance of personal services and the individual who was to provide such services had died68.
Over time, this absolute contract theory has been tempered by the doctrine of frustration. Bingham LJ, as he then was, set out five general propositions regarding this doctrine in the case of The Super Servant Two.69 These state that (1) its purpose is to “mitigate the rigour … of absolute promise”; (2) it discharges the contract in full and therefore cannot be “lightly invoked”; (3) it results in the contract being brought to an end “forthwith, without more and automatically”; (4) it has to be triggered by an “outside event or extraneous change of situation”; and (5) such event must occur “without blame or fault on the side of the party seeking to rely on it”.70
The doctrine of frustration only can be applied in specific scenarios, three of which are relevant to the question investigated by this paper. These are impossibility of performance, frustration of the contract’s purpose and subsequent illegality of the contract. Each of these scenarios will be investigated in turn but first three general points regarding the doctrine need to be discussed.
General observations
Firstly, frustration is different from the doctrine of mistake in that it can only be triggered by an event or circumstance which had not yet occurred at the time the contract was signed.71
The doctrine of mistake could only provide relief if both parties had entered into the
67 Peel, The Law of Contract, 2007, para. 19-002 68 Ibid, para. 19-003
69 Court of Appeal 12-10-1989, The Super Servant Two, [1990] 1 Lloyd’s Rep 1, Question 2 70 Beale, Chitty on Contracts, 2015, para. 23-007
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agreement under the same mistaken assumption with regard to a fact which was fundamental to the agreement.72 As the example scenario supposes that the factory is destroyed after the contract is entered into and not that the factory had already been destroyed on the contract date without either party being aware of this fact, it is therefore frustration which may offer relief and not mistake.
Secondly, the event referred to in Bingham LJ’s fourth proposition needs to constitute a liability which has crystallised and may not merely be contingent on a future event.73 The
MAE in the example scenario of this paper does constitute an event which has caused actual damage and therefore fulfils this requirement.
Thirdly, English law has in the past deemed contracts to be frustrated where conditions had changed. These cases though do not focus on the change in condition itself but instead infer that conditions must have changed on account of an external event which prevented the parties from performing the contract for a long period of time. This is illustrated, for example, by Acetylene Co of GB v Canada Carbide Co74 where a contract for carriage was suspended for three years as the intended vessel had been requisitioned for wartime service.75
This form of frustration will not be discussed in further detail as an M&A acquisition agreement is very likely to contain a long-stop date by which completion must have occurred.76 If completion has not occurred by this date the parties are free to walk away from the contract without further obligations.77 A delay of several years before completion of the contract is therefore prevented by contractual means. As a result, the parties would not have to rely on the doctrine of frustration to avoid the contract in a comparable scenario rendering any further discussion of the issue moot.
Impossibility
Here the contract is discharged because an intervening event has rendered its performance impossible. This is often illustrated by the case of Taylor v Caldwell78 in which the lease of a
music hall was discharged after the venue burned to the ground before the start of the lease
72 Beale, Chitty on Contracts, 2015, para. 6-002
73 Thomas, Frustration and force majeure, C.L.Int. 2001/6(2), p. 22
74 Court of Appeal 18-07-1921, Acetylene Co of GB v Canada Carbide Co, [1921] 8 Ll.L.Rep, p. 456 75 Peel, The Law of Contract, 2007, para. 19-019
76 Modrall, Antitrust-approval risks, NRF November 2013, p. 10 [online] 77 Denicolo, Acquisitions, CLP 2016, p. 110
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term.79 It has been argued that this case in fact demonstrates a situation of severe impracticability rather than impossibility as the venue could, at great expense, have conceivably been rebuilt in time.80 This discussion is moot as it has since been determined, for example in the case of Davis v Fareham,81 that physical impossibility is required and that “it is not hardship or inconvenience or material loss itself which calls the principle of frustration into play”.82
This application of the principle of frustration would therefore not provide relief in the case of the destroyed factory as the seller’s obligation is to transfer the shares in the company which owns the defunct factory. This remains perfectly possible. Further, this application of frustration is much more relevant to the position of a seller than that of a buyer. The buyer would therefore need to consider her other options.
Frustration of purpose
One of these other options takes its origin from maritime law and deals with situations in which performance remains possible but where the commercial objective of the contract can no longer be achieved.83
Two cases linked to the coronation of Edward VII in 1902 help to understand this form of frustration. Krell v Henry84 demonstrates how the concept is applied while Herne Bay v Hutton85 shows its limitations.86
The dispute in Krell concerned a lease of a room overlooking the route of the coronation procession for the intended day of the procession. When the king fell ill and the procession had to be postponed, the tenant argued that the contract had been frustrated as its purpose had not been to rent the room but to see the procession. The court found in favour of the tenant and discharged the contract.87
Hutton concerned the hire of boat for the day of the coronation with the intention to sell
tickets to spectators who wanted to see the review of the fleet which was to be held later that
79 Peel, The Law of Contract, 2007, para. 19-009 80 Ibid, para. 19-032
81 House of Lords 19-04-1956, Davis Contractors Ltd v Fareham UDC, [1956] A.C., p. 696 82 Parker & Chapman, Escaping from a bad bargain, I.E.L.R. 2010/7, p. 244
83 Kotzur, Frustrated parties, J.I.B.L. 1998/13(11), p. 345
84 Court of Appeal 11-08-1902, Paul Krell v CS Henry, [1903] 2 K.B., p. 740
85 Court of Appeal 06-08-1903, Herne Bay Steamboat Co v Hutton, [1903] 2 K.B., p. 683 86 Peel, The Law of Contract, 2007, para. 19-042
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day. Here, the court refused to discharge the contract and argued that it was still possible to take visitors out on a boat ride even if at a lower ticket price than if the review had been held that day.88
The two judgements contradict each other but in practice Hutton has been followed while
Krell has been described as “the exceptional case” which “has been subject of much
criticism”.89
For the purpose of the example scenario, it appears that a buyer would be unable to claim relief under this heading as long as the target business is still able to engage in some form of its business at all. Arguably, even the destruction of all factories operated by the target would still leave its intellectual property, know-how and customer relationships intact and allow it to continue its business after its manufacturing capabilities have been restored.
While arguing that the doctrine of frustration would not provide relief in even such an extreme scenario involves some speculation, the case of Denny, Mott & Dickson v James B
Fraser90 shows how high the hurdle for a successful claim for frustration of purpose is. In this case, the court had to decide whether the lease of a timber yard had been frustrated when wartime regulations rendered a separate contract under which the tenant was to provide a third party with wooden beams illegal. Both parties to the dispute were in agreement that the tenant had leased the timber yard solely for the purpose of fulfilling this contract and the contract was discharged by the court.91
The tenant in this case was in a very specific situation for two reasons. Firstly, the linked contract to supply wooden beams and secondly the wartime context. The buyer in the example scenario on the other hand seeks to acquire the target for its ability to generate future income. The reason for this construction of the example is that a buyer with a very specific reason for acquiring the target knows where the main risks from its perspective lie and is likely to seek protections in the contract which are tailored towards these specific risks instead of the inclusion of a general MAC clause.
Commentators have also warned against putting too much reliance on cases in which the courts had to deal with wartime measures as the policy considerations around such measures
88 Ibid, para. 19-042
89 Beale, Chitty on Contracts, 2015, para. 23-034
90 House of Lords 19-05-1944, Denny, Mott & Dickson Ltd v James B Fraser & Co Ltd, [1944] A.C., p. 265 91 Peel, The Law of Contract, 2007, para. 19-043
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tend to be particularly strong and can lead to judgments which would not have been given had only commercial considerations been at stake.92
The buyer from the example case is therefore still unlikely to obtain relief while relying on the doctrine of frustration.
Illegality
The previously introduced notion of wartime restrictions is the most obvious example for a contract which is subsequently rendered illegal. This can be illustrated by the Fibrosa93 case
in which a contract under which an English company was to ship machinery to Poland was frustrated by the German invasion of that country in September of 1939. Again, this is a very specific example in which the policy considerations are extremely strong.94
In other cases, it has been held that the prohibition needs to address the subject matter of the contract very specifically, e.g. a prohibition on export will affect only contracts for the sale of goods which have been designated for export and not contracts where the buyer merely intends to use them for export even if the seller is aware of this intention.95
While of no use to the buyer in the example scenario, it is at least conceivable that this iteration of the frustration doctrine might be of use to other buyers who are unable to rely on a MAC clause. For example, a buyer who has contracted to purchase a company which manufactures so called “legal highs” might be able to rely on the doctrine of frustration if the manufacturing of such products is outlawed prior to completion of the sale. The buyer would still need to be able to demonstrate though that this legislative change was neither foreseen nor foreseeable.96
In summary, the doctrine of frustration does not provide relief for the buyer in the example scenario. There is also only a very limited range of situations in which the purchaser of a company would be able to rely on the doctrine of frustration in general. It remains to be seen whether a general MAC clause improves on this position in practice.
92 Ibid, para. 19-072
93 House of Lords 15-06-1942, Fibrosa v Fairbairn, [1943] A.C., p. 32 94 Peel, The Law of Contract, 2007, para. 19-045
95 Ibid, para. 19-046 96 Ibid, para. 19-047
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5. The interpretative context and the risk of repudiation
Having established how an MAE would affect a contract without a MAC clause in the previous chapter, this chapter briefly examines the rules of construction which an English court will have to apply when interpreting a MAC clause. This is followed by a brief discussion of whether a general MAC clause risks being too wide to be enforceable. Finally, this chapter will look at the consequences faced by a buyer who refuses performance of a contract in reliance on a MAC clause which is subsequently found not to have been triggered at the relevant time.
The rules of interpretation under English law
The starting point for the construction of a contract under English law is that the court has to take an objective approach.97 This means that the contract is to be interpreted from the perspective of “a reasonable person […] who has all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract”.98
To this end, the courts have developed various rules of construction. Today, these are no longer applied in a strict way but serve as guidelines instead.99 This chapter outlines the following areas which it sees as most relevant in the context of this paper: (1) words and their ordinary meaning; (2) commercial common sense; (3) evidence taken from pre-contractual negotiations and (4) contract terms which appear one-sided.
Firstly, words should be interpreted according to their ordinary meaning. This rule is seen as a mere starting point in contemporary jurisprudence though. It mainly prevents a court from interpreting a provision in a manner which runs contrary to its natural meaning in the absence of strong evidence in favour of such interpretation.100 Legal commentators continue to stress that “literal meaning isn’t decisive of legally correct outcomes”.101 This view has also been
endorsed by the Supreme Court with Lord Clarke stating “it is not in my judgment necessary
97 Beale, Chitty on Contracts, 2015, para. 13-043
98 Supreme Court 02-11-2011, Rainy Sky SA v Kookmin Bank, [2011] UKSC 50, para. 14 99 Beale, Chitty on Contracts, 2015, para. 13-045
100 Ibid, para 13-051
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to conclude that, unless the most natural meaning of the words produces a result so extreme as to suggest that it was unintended, the court must give effect to that meaning”.102
Reverting to the sample MAC clause introduced in Chapter 3,103 a court would therefore have discretion to interpret, for instance, the term “competitor” in a narrower or wider manner depending on how it expects that a reasonable person would construe the term.
Secondly, a court may not alter the terminology used in the contract to arrive at an outcome which it considers to make more commercial sense than the outcome under the contract.104
Nevertheless, the Supreme Court has clarified that “where a term of a contract is open to more than one interpretation, it is generally appropriate to adopt the interpretation which is most consistent with business common sense”.105
Applying this to the proviso in the sample MAC clause that an event is no MAE “where such
event has a comparable effect on all competitors of the target”, a court will therefore be able
to take into account business common sense when construing “comparable effect” and “competitor” but may not use this as a justification for removing the “all”.
Thirdly, English law knows a rule, often referred to as the “parol evidence rule”, which prevents court from relying on pre-contractual negotiations when interpreting the contract.106 Judges and academic commentators have called for this rule to be relaxed where the sole reason for relying on extrinsic evidence is to identify a consensus reached by the parties prior to entry into the contract but not documented therein.107
This approach was subsequently endorsed by the House of Lords in the case of Chartbrook v
Persimmon Homes. Lord Hoffmann also noted that in this context “there are no conceptual
limits to what can properly regarded as background” and is therefore admissible.108
102 Supreme Court 02-11-2011, Rainy Sky SA v Kookmin Bank, [2011] UKSC 50, para. 20
103 The sample MAC clause allows the buyer to terminate the purchase agreement where any event occurs
between the date of the contract and the date of completion which “has or is reasonably expected to have a material adverse effect on the target, its assets, its business and/or its financial condition save where such event has a comparable effect on all competitors of the target”.
104 Beale, Chitty on Contracts, 2015, para. 13-074
105 Supreme Court 02-11-2011, Rainy Sky SA v Kookmin Bank, [2011] UKSC 50, para. 30 106 Beale, Chitty on Contracts, 2015, para. 13-099
107 McMeel, Prior negotiations, L.Q.R. 2003/119(Apr), p. 296
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For the purpose of construing the example MAC clause, if the court were aware of a consensus between the parties on who is to be counted as a “competitor” and this consensus is not in dispute, it could rely on this information when interpreting the clause.
Fourthly, the case of Chartbrook v Persimmon Homes also notes that a court must not disregard a provision simply because it seems “to be unduly favourable to one of the parties”. The reason for this is that the court cannot know whether the inclusion of this clause “was not in exchange for some concession elsewhere or simply a bad bargain”.109
This means that a court might find that the reference to “all competitors” in the proviso of the sample MAC clause does constitute a very high hurdle but that this view must not sway the court to construe the clause differently than the parties appear to have intended.
Is a general MAC clause too wide for enforcement?
One way to question the usefulness of a general MAC clause is to argue that the more general its nature the greater its ambiguity will be, ultimately jeopardising its enforceability. There are two arguments why this is not a substantive risk.
Firstly, an ambiguous contract will still need to be interpreted through the objective bystander test.110 Arguably, the vaguer the terms of the MAC clause are the greater is the range of events which could conceivable constitute an adverse change.
Secondly, the court might argue that the clause is so vague that its vagueness actually constitutes bad drafting. In this case, the courts are generally expected to be less likely to depart from business common sense than had the drafting been clear.111 It seems unlikely that a court which is looking at the clause from such a perspective would decide that the parties chose to include the clause without the intention of it having some effect.
Repudiatory breach
Imagine that all conditions precedent to the contract’s completion have been fulfilled and that the completion date has arrived. Now, the buyer alleges that the MAC clause has been
109 Ibid, para. 20
110 Beale, Chitty on Contracts, 2015, para. 13-057 111 Ibid, para. 13-058
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triggered112 and refuses to proceed to completion. The seller argues that no MAE has occurred and that the buyer will be in default if she refuses to complete the contract.
If on the facts no MAE has occurred, English law would hold that the buyer has renounced the contract113 as the breach affects a fundamental term114. English law then requires that the
seller formally “accepts” the breach. Acceptance here means an acknowledgement that the buyer is now in breach and must not be confused with a waiver of the buyer’s breach by the seller.115 The seller is immediately relived of its obligations under the contract116 and, much
more importantly in this situation, is entitled to bring a claim against the buyer117.
So while English law employs rules of construction which ensure that a court remains as close as possible to the agreement reached by the parties, much will depend on the terms of the individual MAC clause and the decision to invoke it is not without risk for the buyer.
112 This paper assumes that the buyer has notified the alleged MAE to the seller in a way which complies with
all procedural requirements under the contract.
113 Beale, Chitty on Contracts, 2015, para. 24-018
114 Thomson, The effect of a repudiatory breach, Mod.L.Rev. 1978/41, p. 138 115 Beale, Chitty on Contracts, 2015, para. 24-023
116 Ibid, para. 24-024
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6. Judicial interpretations
There has been only very limited litigation of MAC clauses in English courts. Judges have speculated that this is because “the interpretation of such provisions may be uncertain, proof of breach difficult and the consequences of wrongful invocation […] severe, both in terms of reputation and legal liability”.118
There are only five decisions of English courts regarding MAC clauses: (1) Grupo Hotelero
Urvasco v Carey Value Added119; (2) BNP Paribas v Yukos Oil Company120; (3) Attrill v
Dresdner Kleinwort121; (4) Thomas Witter v TBP Industries122; and (5) Levison v Farin123. All
of these are decisions of the High Court and therefore do not constitute binding precedents. The first two cases deal with MAC clauses in a financing context, Attrill concerns the use of a MAC clause in an employment dispute and the last two cases look at the concept of material adverse change in agreements for the acquisition of companies.
These cases may therefore seem most relevant but are also the oldest, provide only limited input on the interpretation of MAC clauses and deal with warranties regarding the absence of MAEs, not MAC clauses outright. These cases will be reviewed first.
The financing cases will be reviewed next. Grupo Hotelero is the most recent case and discusses MAC clauses in great detail while Yukos is a very short case regarding an interim application and relies on facts which are rather extraordinary.
Finally, Attrill has some lessons to offer on construction but uses a form of MAC clause which differs to quite some extent from what is to be expected in an M&A transaction.
As previously noted, decisions of the Takeover Panel, including WPP Group/Tempus
Group124 and the related Practice Statement No. 5125, sit outside the scope of this paper as
they primarily apply the rules of the Takeover Code and not those of English contract law.126
118 Queen’s Bench Division 26-04-2013, Grupo Hotelero Urvasco SA v Carey Value Added SL, [2013] EWHC
1039 (Comm), para. 334
119 Ibid
120 Chancery Division 24-06-2005, BNP Paribas SA v Yukos Oil Company, [2005] EWHC 1321 (Ch) 121 Queen’s Bench Division 09-05-2012, Attrill v Dresdner Kleinwort Limited, [2012] EWHC 1189 (QB) 122 Chancery Division 15-06-1994, Thomas Witter Ltd v TBP Industries Ltd, [1996] 2 All ER, p. 573 – 608 123 Queen’s Bench Division 04-11-1977, Levison v Farin, [1978] All ER, p. 1149
124 Takeover Panel, WPP/Tempus, 2001/15 [online] 125 Takeover Panel, Practice Statement No. 5, 2004 [online]
Page 27 of 46 Thomas Witter v TBP Industries
The underlying transaction in this case was the sale of a carpet manufacturing business.127 The main dispute before the court related to the alleged misrepresentation of a one-off item of expenditure for the production of pattern books in the management accounts of the target. This item was included with an amount of £120,000 when in reality it should have been only £50,000 (i.e. £70,000 of recurring expenditure were disguised as one-off expenditure).128
Aside from this misrepresentation claim, the case also dealt with breaches of warranties including a warranty stating that there had been no material adverse change in respect of the target.129
This warranty was worded as follows: “Since the 31st December 1988 (but disregarding the sale hereby agreed) … there has been no materially adverse change in the financial or trading position of the Business”.130
This aspect of the case turned on whether “financial and trading position” was wide enough to include the current profitability of the business or whether it was limited to the balance sheet position of the business. The court held that “material” must be interpreted from the purchaser’s perspective and, opting for the wider interpretation, held that there had been a material adverse change as “what is “material” to [the buyer] is what matters”.131
Unfortunately, the court does not discuss what level of breach would be required to satisfy the materiality requirement. The court merely holds that the discrepancy constituted “a substantial amount” but does elaborate on this.132
It has to be noted that the breach of this warranty had little importance within the wider context of the case as the claim and the award of damages were in respect of misrepresentation133 and related to the preparation of the accounts under a separate provision
of the sale contract134.
127 Chancery Division 15-06-1994, Thomas Witter Ltd v TBP Industries Ltd, [1996] 2 All ER, p. 573 (d-g) 128 Ibid, p. 598 (g-h) 129 Ibid, p. 586 (c) 130 Ibid, p. 585 (g) 131 Ibid, p. 605 (c) 132 Ibid, p. 605 (d) 133 Ibid, p. 606 (a) 134 Ibid, p. 602 (a-b)
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This case therefore is not one in which the occurrence of an MAE could have afforded the buyer a more advantageous right of termination than the doctrine of frustration. Regardless of this, it finds that a MAC clause has to be interpreted from the perspective of the buyer even though it fails to provide further guidance by simply stating that a “substantial” change will be “material”.
Levison v Farin
The second claim in an M&A context regarded a warranty which stated that “there will have been no material adverse change in the overall net assets of the company”.135 The target
business was a fashion company which was already loss making prior to the sale contract being signed. It had also lost its chief designer to a long term illness and had therefore been unable to design a new collection for the spring/summer season.
Both of these facts had been disclosed against the relevant warranty but the court held that this disclosure was insufficient as it merely identified circumstances which were likely to cause an MAE as defined by the warranty but did not quantify the expected impact.136
The issue of the buyer’s awareness of the circumstances causing the MAE will be discussed in greater detail in the section on the Grupo Hotelero case. As far as Levison is concerned, it suffices to note that the parties had identified a very specific criterion (a deterioration of the target’s net asset value) which meant that the only question for the judge to answer was whether any such decrease was on the facts material. This question was answered in the affirmative, as the decrease went beyond “normal trade fluctuations”.137
While it seems plain that the judge preserved the intention of the parties, the adoption of a very clearly defined evaluation criterion by the parties means that the clause in question is much more akin to a specific MAC clause than to a general one.
The question that cannot be answered by this case is whether the same deterioration of one key metric, the target’s net asset value, would have been sufficient to constitute an MAE had it not been expressly identified and had the clause instead referred to a wider metric, such as the financial position of the target.
135 Queen’s Bench Division 04-11-1977, Levison v Farin, [1978] 2 All ER, p. 1156 136 Woolrich, MAC clauses, J.I.B.L.R. 2014/29(6), p. 375
Page 29 of 46 BNP v Yukos
In September 2003, a syndicate of banks led by BNP had made a loan available to Yukos.138 The case before Mr. Justice Evans-Lombe was an interim application by Yukos against the main action brought by BNP in which it sought to recover the outstanding sum under the loan agreement, amounting to $472,787,663.10, as a debt.139
The burden of proof was therefore not on BNP to demonstrate that an MAE had occurred but on Yukos to demonstrate that it “would be able to deploy a defence to the claim which had a real prospect of success”. If Yukos were successful, BNP would have to prove that an MAE had occurred and that the outstanding debt was indeed due to BNP.140
BNP argued that an event of default had occurred under the loan agreement because the MAC clause in the agreement had been triggered by events occurring at the end of 2003 and in the beginning of 2004.141
The agreement set out that an MAE was any event which “in the opinion of [BNP]” could have a material adverse effect on:
“(a) the business, condition or production or export capacity of the Group taken as a whole;
(b) the ability of any of the Offtakers, the Borrowers (including in its capacity as the Exporter), Energotrade, the Trader and the Trader’s Agent to perform its obligations under any of the Finance Documents; or
(c) the legality, validity or enforceability of any of the finance documents or the rights or remedies of any of the Finance Parties under the Finance Documents.”142
Limb (a) of this clause is similar to the general MAC clause introduced in Chapter 3 while limbs (b) and (c) are considerably more specific and relate directly to the loan agreement in which they are contained.
At the time when BNP had determined that an MAE had occurred, Yukos was facing considerable difficulties. Its CEO had been imprisoned, the Russian Ministry of Natural
138 Chancery Division 24-06-2005, BNP Paribas SA v Yukos Oil Company, [2005] EWHC 1321 (Ch), para. 3 139 Ibid, para. 1
140 Ibid, para. 2 141 Ibid, para. 12 142 Ibid, para. 7
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Resources was considering the revocation of Yukos’ licence for operations within Russia, it had been served with a claim for US$3.3bn in taxes for the year 2000 alone and its credit ranking with Standard & Poor’s had been downgraded twice. Yukos had in fact issued a press release in which it noted that further claims for historic tax were anticipated by Yukos and that these claims could lead to its insolvency.143
Unfavourable as the situation may have seemed, Yukos argued that no MAE had occurred. There were two strands to this argument. Firstly, that limb (a) of the MAE definition referred to the Yukos group as a whole which was arguably in a better position than the Russian business alone and, secondly, that Yukos’ ability to perform its obligations under the agreement was only endangered by the tax claim against which Yukos expected to bring a successful appeal.144
The court failed to agree with this argument145 as limb (b) of the MAE definition specifically referred to individual members of the wider Yukos group146. The judge also placed particular emphasis on the press release in which Yukos had warned investors of its possible insolvency.147
As in Levison, the court held that an MAE had occurred but again relied on a relatively specific evaluation criterion in the MAC clause. While the ability to comply with its obligations under the finance documents leaves more room for interpretation than the reference to net asset value in Levison, the facts in Yukos are so overwhelming that it seems reasonable for the court to have held that there was no prospect for Yukos to defend the claim.
Yukos therefore does not provide a conclusive answer to the main question posed by this
paper but demonstrates that, at least in extreme circumstances, English judges are willing to declare that MAC clauses have been triggered even if an element of discretion148 is involved. Considering how extreme Yukos’ position was, it also seems reasonable to assume that the court would have accepted that, if it had applied to the same individual entities as limb (b) did instead of to the group as a whole, limb (a), the general MAC clause, would have been triggered together with limb (b).
143 Ibid, para. 11 144 Ibid, para. 13.6 145 Ibid, para. 19 146 Ibid, para. 18 147 Ibid, para. 19
148 Consider that the court could have insisted on a closer investigation of Yukos chances of receiving a
