Quick facts
- Also called: material adverse effect, MAC or MAE
- What it does: lets a buyer refuse to close if the target deteriorates badly
- Delaware standard: a backstop against unknown, durationally significant events
- Not enough: a short-term drop in earnings
- Almost never invoked successfully, until Akorn in 2018
A material adverse change clause, often written as material adverse effect, is the provision that lets a buyer walk away between signing and closing if something seriously bad happens to the target.
Every merger agreement has one. Almost nobody wins on it.
In plain English
Signing and closing are not the same day. Months can pass while regulators review the deal and shareholders vote. During that gap the target keeps trading, and it might deteriorate.
The clause allocates that risk. It says the buyer only has to close if the business has not suffered a material adverse change. What "material" means is the entire fight.
The standard Delaware applies
In re IBP, Inc., Shareholders Litigation supplies the formulation everyone still uses. A buyer "ought to have to make a strong showing to invoke a Material Adverse Effect exception to its obligation to close," because merger contracts "are heavily negotiated and cover a large number of specific risks explicitly."1
Even a broadly drafted clause, the court said, "is best read as a backstop protecting the acquiror from the occurrence of unknown events that substantially threaten the overall earnings potential of the target in a durationally-significant manner."1
Then the sentence that decides most disputes: "A short-term hiccup in earnings should not suffice; rather the Material Adverse Effect should be material when viewed from the longer-term perspective of a reasonable acquiror."1
Three requirements sit inside that. The event must be unknown at signing, it must threaten overall earnings potential rather than one quarter, and it must be durationally significant, meaning it lasts.
Why buyers almost always lose
A buyer with signing remorse has an obvious incentive to characterise ordinary bad news as a material adverse change. Delaware's response is scepticism, for a reason worth understanding: the buyer chose the price, did the diligence, and negotiated specific representations about specific risks. If a particular risk mattered, it should have been addressed directly rather than left to a general clause.
The practical consequence is that the clause is usually leverage rather than an exit. A buyer threatens it, and the parties renegotiate the price.
The carve-outs, which do most of the work
Sellers negotiate exceptions, so that a material adverse change excludes effects arising from:
- general economic, financial or market conditions
- conditions affecting the target's industry generally
- changes in law or accounting standards
- the announcement of the transaction itself
- acts of war, terrorism, natural disasters and pandemics
- the target's failure to meet internal projections, on its own
Each carve-out typically carries a disproportionate effect qualifier: the exclusion does not apply where the target is affected materially worse than its peers. That qualifier is where negotiation concentrates, because it converts a systemic event back into a company-specific one.
Note the projections carve-out in particular. Missing forecasts is usually excluded in itself, though the underlying cause can still qualify. Sellers should insist on that distinction, and buyers should understand they cannot rely on a missed number alone.
The exception that proves the rule
For years no Delaware decision had allowed a buyer to terminate on these grounds. Akorn, Inc. v. Fresenius Kabi AG changed that in 2018, when the Court of Chancery permitted Fresenius to walk away from its acquisition of Akorn.2 The Delaware Supreme Court affirmed.3
What distinguishes Akorn is instructive. The case did not turn on a market downturn or a disappointing quarter. It involved a dramatic and sustained collapse in the target's performance alongside serious regulatory compliance failures, which is precisely the profile the IBP standard describes: unknown at signing, company-specific, and durable.
The lesson is not that these clauses became easier to invoke. It is that the bar sits where IBP put it, and one deal finally cleared it.
What this means for a founder
If you sign a purchase agreement for your company, this clause is the buyer's option to reconsider, and the period it covers is the period when you are least able to run the business normally.
Three things are worth negotiating. Push the carve-outs hard, especially for industry conditions and the effects of announcing the deal, since the announcement itself often unsettles customers and staff. Insist that failing to hit projections is not itself a material adverse change. And pay attention to the outside date, the deadline after which either side may walk, because a buyer who wants out may simply wait rather than argue.
Then behave as though the clause is live, because it is. The gap between signing and closing is not the time to lose your largest customer or discover a compliance problem you had not disclosed.
Related reading
- Break-Up Fee covers what is payable when a deal dies for other reasons
- Go-Shop Provision covers the window for finding a better offer before closing
- Earnout covers the other clause that keeps price open after signing
- Tender Offer covers the structure that shortens the gap