Latest / The Acquisition Talk with Fexingo: Mergers, Buyouts, and Business Sales for Operators / The M&A Material Adverse Change Trap That Killed a $200 Million Deal
Transcript
- Lucas: Let's talk about the clause that keeps M&A lawyers up at night: the Material Adverse Change clause, or MAC clause. In 2025, a Delaware court ruled on a case that tested just how far a buyer can go in walking away from a signed deal. Luna: I remember that case. The buyer argued the target lost its biggest customer between signing and closing. The seller said, 'That's just business, not a material change.' Lucas: Exactly. The deal was valued at about $200 million. The target — let's call them Company A — was a niche industrial supplier. They had one customer accounting for roughly 40 percent of revenue. After signing, that customer terminated its contract. Luna: Which sounds pretty material to me. But the seller's argument was that the customer had a history of renegotiating, and they expected to win the business back within a quarter. Lucas: Right. The seller claimed the loss was temporary and didn't constitute a 'material adverse effect' under the merger agreement. But the buyer didn't buy it. They sent a termination notice citing the MAC clause. Luna: And the seller sued in Delaware Chancery Court to force the deal through. Lucas: What's fascinating is how the court analyzed it. Vice Chancellor Glasscock laid out a five-factor test. First, the magnitude of the change — is it a 10 percent drop or a 40 percent drop? Second, the duration — is it temporary or persistent? Third, the cause — is it industry-wide or company-specific? Fourth, whether the risk was known at signing. Fifth, whether the contract explicitly carved out that risk. Luna: That fifth factor is key. Most MAC clauses have exceptions — so-called 'carve-outs' — for things like general economic downturns or industry-wide changes. Lucas: Exactly. In this case, the merger agreement had a standard carve-out for 'changes in general economic conditions.' But the loss of a single customer? That's company-specific. Not carved out. So the court held that the buyer was within its rights to terminate. Luna: But wait — doesn't that create a huge loophole for buyers? They could claim any disappointing performance post-signing is a MAC. Lucas: In theory, yes. But the Delaware courts have historically set a very high bar for MAC clauses. In a famous 2001 case called IBP v. Tyson Foods, the court said a MAC must be 'durationally significant' — not just a short-term hiccup. Here, the court distinguished because the customer loss was 40 percent of revenue and the seller couldn't prove they'd get it back quickly. Luna: So the seller's optimism wasn't enough. They needed to show concrete evidence of recovery. Lucas: Right. And the court noted that the seller's own projections didn't include a rebound for at least two quarters. That tipped the scales toward 'durationally significant.' Luna: What could the seller have done differently in the contract to protect themselves? Lucas: Great question. One option is to negotiate a 'specified cause' carve-out — meaning the MAC clause only applies to specific listed events, not general business changes. Another is to include a 'material adverse effect' threshold tied to a specific dollar amount, say 25 percent of revenue. If the loss is below that, the buyer can't walk. Luna: So you'd try to quantify materiality in advance. Lucas: Exactly. You see this in private equity deals where the buyer is a financial sponsor. They'll often insist on a 'friendly' MAC with lots of carve-outs for the seller. But in strategic deals, buyers push for a broad MAC. Luna: Now, this case was decided in Delaware. Is Delaware law the default for most M&A agreements? Lucas: Over 60 percent of public company M&A deals are governed by Delaware law. So this ruling sets a significant precedent. But it's worth noting that other states, like New York, have slightly different standards. New York courts tend to be more seller-friendly on MAC issues. Luna: So if you're a seller, you might want New York law. But buyers will push for Delaware. Lucas: Exactly. And that's a negotiation point. Let me give you a concrete example from a recent deal I saw: a tech company with a subscription model. Their MAC clause had a specific carve-out for 'churn rates that do not exceed industry averages.' That's a smart seller-side provision because it ties materiality to external benchmarks. Luna: That's clever. It prevents the buyer from claiming standard churn is a MAC. Lucas: Right. And it gives the seller a clear argument if the buyer tries to walk. But here's the thing — even with the best drafting, courts will still look at the facts. In this 2025 case, the seller had a weak factual record. They didn't have a signed replacement contract or even a letter of intent from a new customer. Luna: So the lesson is: don't just rely on contract language. Build your evidence. Lucas: Exactly. And that's a good segue — because the best protection is actually pre-signing due diligence. If you're the seller, you want to identify any concentration risk before you sign. Then you can address it in the contract. Luna: You mean like if you know one customer is 40 percent of revenue, you proactively negotiate a carve-out for losing that specific customer? Lucas: Precisely. Or you can structure the deal with a longer earnout period so the buyer shares the risk. There's a whole toolkit. But many sellers don't think about MAC until it's too late. Luna: I want to step back and ask — how often do buyers actually invoke MAC clauses? It feels like a nuclear option. Lucas: It is rare. Most buyers who want to walk find other ways — they'll claim a breach of representations or a failure to meet a condition. But MAC clauses are the ultimate backstop. The mere threat of a MAC argument can force a price renegotiation. Luna: So it's a bargaining chip even if it never goes to court. Lucas: Exactly. And that's why understanding the nuances matters. Quick honest thing — this level of deal analysis is exactly the kind of deep dive we try to bring you every day, and it's only possible because a handful of listeners chip in monthly through buy me a coffee dot com slash fexingo. That literally funds making this many episodes. Luna: Yeah, we don't run ads, so it's listener-supported. If these conversations have moved your work forward in some small way, that's where you can help keep them going. Lucas: Appreciate that. Now, back to the MAC clause — there's another interesting angle. What about the buyer's risk? Sellers aren't the only ones exposed. Luna: How so? Lucas: If a buyer wrongfully terminates based on a MAC, the seller can sue for specific performance — force the buyer to close. And the buyer could be on the hook for damages. In this case, the buyer had strong legal footing, but the litigation cost both sides millions in fees. Luna: So both sides want clarity. That's why the carve-outs and thresholds matter. Lucas: Right. And one trend I'm seeing post-2025 is more deals including a 'MAC walk' fee — a small termination fee the buyer pays if they walk claiming a MAC. It's like a break fee, but specifically for MAC. Gives the seller some compensation. Luna: That seems fair. It forces the buyer to think twice. Lucas: Exactly. And it aligns incentives. Because at the end of the day, a MAC clause is about allocating risk of unknown events between signing and closing. The best contracts make that allocation explicit and predictable. Luna: So the takeaway for our listeners — whether you're a founder selling your company or an executive buying one — is to really pressure-test your MAC clause against realistic scenarios. Lucas: Right. Sit down with your lawyers and ask: 'What happens if we lose our top customer? What if a key employee leaves? What if a product recall happens?' And then negotiate accordingly. Luna: Because the court won't save you if you didn't plan for it. Lucas: Exactly. That's the hard truth. Alright, that's our episode on the Material Adverse Change clause. Thanks for listening.