2021 is already a record year for mergers and acquisitions – and it’s not over yet. According to a KPMG survey, 804 transactions were closed only in the first half – an increase of 55% over the same period in 2020 and a record for the last ten years. By October 2021, this percentage increases to 60% in comparison to the same period of the previous year.
The moment is of a certain “euphoria” – in a good way – and among the main players in these transactions are many publicly-held companies. These companies, in addition to raising funds in the capital market, end up using their own shares as another source of payment to the selling shareholders of the companies or assets object of their invested companies.
And it is precisely in this context of acquisitions by publicly-held companies that a problem of enormous relevance to the success and completion of transactions has arisen: Could a significant negative impact on the stock market, resulting in a significant drop in the value of shares of the purchasing publicly-held company (or seller) be considered as a “material adverse effect” – a concept widely used in M&A transaction contracts – and give the right to one of the parties not to close the transaction?
Quickly explaining: “material adverse effect” is one of many concepts “imported” from the American and European legal tradition and “Brazilianized” by local lawyers. It refers to any event, change or circumstance that causes a material adverse effect on the financial position, business, assets and operations of the parties involved in a transaction, or any economic, regulatory, political or health conditions affecting the industry or the market in which the parties act.
It can be used in different contexts in an M&A contract, but one of its main uses occurs in the conditions precedent section for the completion and closing of the transaction between the parties. Some contracts usually provide, as a condition for the effective completion of the deal, that, between the date of signature of the binding contract and the closing date, there is no “material adverse effect” with respect to the parties or the company/asset to be acquired.
So, returning to the focus on Brazil: Could a publicly-held company allege the existence of a “material adverse effect” in case of market conditions that resulted in an abrupt drop in its share price (and, consequently, in its valuation) so as not to close a transaction – even after having signed a binding contract (and after having already disclosed to the market the information on the acquisition)? Could a seller whose payment had been based on receiving part of the shares of the purchasing public company, under the same conditions described above, also allege the existence of a “material adverse effect” and jump out of the “virtually closed” deal?
These are complex issues that depend on a number of factors. There is no exact answer, but clarity of contracts is needed more than ever in these cases.
Companies and their advisors need to be very attentive to this issue and work in detail on the wording of contractual clauses that deal with the concept of “material adverse effect” and which can, eventually, lead to the undoing of the deal. It is relatively common for advisors not to spend enough – and necessary – time to make this concept really clear and executable for that specific business. Making sentences and terms clearer, bringing to the document new hypotheses suited to reality, creating materiality of value for damage resulting from an “adverse effect” are just some of the paths that need to be taken.
Technique, attention and sensitivity to the world around us and to the real desires of the parties involved are fundamental to the survival of many businesses that, in the view of the parties, “are closed and there is no way to go wrong once they are signed!” But are they really?
Just look at the political and economic instability that Brazil is experiencing (and will probably continue in 2022 with the coming of the next presidential elections) and the impact that many publicly-held companies have been suffering in the capital market. In times of post-pandemic and this scenario, negotiating and writing good contracts will be essential to guide companies to the success of their operations or through difficult arbitration and legal disputes.