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There are several clauses in M&A contracts where the parties attempt to manage the risks associated with unanticipated future change. Who bears the risk in the event an unforeseen change impacts the performance of the seller’s business? Material adverse change (“MAC”) and material adverse effect (“MAE”) clauses are one mechanism used to avoid or manage the risk of litigation if an unplanned external event changes the nature of the deal.


Whenever there is a period of delay between signing and closing a deal, parties can address the potential risk of material changes that may occur by negotiating and agreeing to a MAC or MAE. In a standard scenario, the clause permits the purchaser to refuse closing where the seller’s business has been impacted by a material change.

MAE and MAC clauses contain several typical components. The first is a closing condition requiring that “no Material Adverse Effect has occurred since the date of the original agreement”.[1]

Broad introductory language is often used to define what the parties consider to be a material adverse change or effect. A typical clause may define a MAE or MAC as:

any change, event, occurrence, effect or circumstance that, individually or in the aggregate, would reasonably be expected to have a material and adverse effect on the business, affairs, operations, assets, liabilities, financial condition or results of operations of the Company…

The second component of such a clause carves-out events that will not be considered “material”. Generally, these carve-outs exclude systemic or industry-wide events from falling within the definition of MAE or MAC. Common carve-outs include:

  • Any changes in financial or securities markets in general
  • Natural disasters
  • Pandemics or outbreaks of illness
  • Any changes in applicable laws (such as compulsory government suspension orders)
  • Worldwide, national, provincial or local emergencies

The purpose of carve-outs is to allocate the risk of systemic or industry wide risks to the purchaser. As such, the final component of a typical MAE or MAC clause limits the carve-outs by stating that they only apply in circumstances where the industry-wide event has not disproportionately impacted the seller in relation to its peers. In other words, they do not apply in circumstances where the change has had a “materially disproportionate adverse impact on the Acquired Companies relative to other Persons in the industries or markets in which the Acquired Companies operate.”[2]

If the systemic or industry-wide events has uniquely impacted the target company compared to its industry peers, then the carve-out will not apply. From a different perspective, MAC and MAE clauses are generally designed to assign the risk of industry-wide changes to the purchaser (and prevents them from refusing to close), while the target entity is assigned the risk associated with changes that uniquely impact their business.

The COVID-19 pandemic put MAE and MAC clauses under the microscope

The COVID-19 pandemic put MAE and MAC clauses under the judicial spotlight. Since 2020, there have been several Canadian decisions that now provide guidance on how MAC and MAE clauses will be interpreted in the event they are relied on.

Existence of an MAE or MAC

The first issue is whether a material effect or change has occurred. In general, the party seeking to rely on the clause must prove that a MAC and MAE has occurred. When assessing this, Justice Koehnen’s decision in Fairstone Financial Holdings Inc. v. Duo Bank of Canada is instructive: “The test, however, remains clear: one must determine whether the event would affect the decision of a reasonable investor in the circumstances of the purchaser with the information available to it. The subjective views of the purchaser about whether something was a MAE are irrelevant.”[3]

Durational Significance

When assessing whether a material change has occurred, the court will assess how long the change or event is anticipated to last. As Justice Koehnen states: “A short-term drop in earnings does not suffice. Instead, the change must be material when viewed from the longer-term perspective of a reasonable acquirer.”[4] However, the matter depends on the circumstances: “[t]he length of the durational requirement depends on the context. For a short-term speculator, the durational requirement may be relatively short to constitute a MAE.”[5]

No Prior Knowledge

In addition, the change or effect complained of must be unforeseen. In general, courts are unwilling to permit a party to rely on a MAE or MAC clause in circumstances where the change was foreseeable at the time that the original contract was entered into. As the British Columbia Court of Appeal stated in a 2002 case: “If a fact or information were already known to the defendant, or if the defendant did not rely on it, the failure of the plaintiff to disclose it or information related to it would be of no consequence to the defendant's decision to buy and therefore would not be material or adverse to the defendant.”[6] In short, the court is not likely to step in to relieve a purchaser from circumstances that were knowable. In those circumstance, the court may find that the purchaser knowingly accepted the risks at the time they entered the contract.

Materially Disproportionate Adverse Impact

The final question is to assess whether the event or change complained of disproportionately impacted the target company in comparison to its industry peers. As mentioned above, MAC or MAE clauses are only triggered in circumstances where there has been a material change or event. Most clauses exclude certain events from the definition of “material” (including natural disasters, war, pandemics, etc.). However, these events will still be considered material where the target has suffered disproportionately in comparison to its industry peers.

This is an analysis that will often require expert evidence. Expert evidence will assist the court in assessing the specific impact on the seller in relation to its peers, and questions around what metrics should be used to assess this.

In short, purchasers cannot refuse to close in circumstances where there has been an industry-wide downturn: the risk of these events occurring generally remains with the purchaser. However, where one of these industry-wide events has disproportionately impacted the target company, then this remains within the definition of MAE or MAC that would permit a purchaser to refuse closing.

What’s Next

In Cineplex v. Cineworld, the failure of Cineworld to satisfy the court that a MAE has occurred resulted in the court compelling it to close its transaction to purchase Cineplex. The MAE in that case carved out outbreaks of illness from the definition of MAE. This meant that Cineworld, as purchaser, assumed the risk of a pandemic occurring and could not claim that this was a MAC or MAE that would justify refusing to close.[7]

Beyond the COVID-19 pandemic, other changes are bound to occur that materially change the nature of the deal originally entered into. In these circumstances, it is inevitable that purchasers are inherently assuming some form of risk every time they enter into an agreement to purchase a business. MAEs and MACs, properly drafted, can be a tool for parties to negotiate and agree on how the risks of future events (and what events in particular) are to be allocated between them.

[1] See for example the similar clause at issue in Cineplex v. Cineworld, 2021 ONSC 8016, at para. 44

[2] See for example the clause at issue in Fairstone Financial Holdings Inc. v. Duo Bank of Canada, 2020 ONSC 7397, para 110.

[3] Fairstone Financial Holdings Inc. v. Duo Bank of Canada, 2020 ONSC 7397, para 86

[4] Fairstone Financial Holdings Inc. v. Duo Bank of Canada, 2020 ONSC 7397, at para 78

[5] Fairstone Financial Holdings Inc. v. Duo Bank of Canada, 2020 ONSC 7397, at para 78

[6] Inmet Mining Corp. v. Homestake Canada Inc., 2002 BCSC 61, at paragraph 128, cited in Fairstone Financial Holdings Inc. v. Duo Bank of Canada, 2020 ONSC 7397

[7] Cineplex v. Cineworld, 2021 ONSC 8016

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