As parties to merger or acquisition agreements carefully review their agreements to see what, if any, impacts the COVID-19 pandemic may have, the recent decision from the U.S. District Court for the Southern District of New York in Newmont Mining Corp. v. AngloGold Ashanti Ltd.[i] provides meaningful guidance for the interpretation of Material Adverse Effect (“MAE”) provisions in agreements governed by New York law. On March 18, 2020, in Newmont Mining, the Southern District of New York granted summary judgment for the seller, AngloGold Ashanti, Ltd. on the buyer’s, Newmont Mining Corporation’s, claims for damages arising from the alleged breach of an MAE provision. The decision in Newmont Mining, while decided under New York law, reinforces the established principle under Delaware law that buyers face an uphill battle when trying to establish an MAE.
An MAE provision in a merger or acquisition agreement typically includes three parts: 1) the definition of an MAE; 2) exclusion from that definition; and 3) exceptions to the exclusions. This article will discuss each part in turn, and discuss the Newmont Mining court’s reasoning for granting summary judgment to the seller relating to each part. Before diving into the details, however, it is worth keeping a few general principles about the interpretation of MAE provisions in mind.
When determining whether there is a breach of an MAE clause courts take a “seller-friendly perspective” that requires a buyer to “make a strong showing” to invoke its rights under MAE provisions.[ii] Thus, the Delaware Chancery Court has quipped, “[a] contractual material adverse effect . . . is like a . . . tornado—frequently alleged but rarely shown to exist.”[iii]
Courts consider the MAE provision as a “backstop protecting the [buyer] from the occurrence of unknown events that substantially threaten the overall earnings potential of the target [company] in a durationally-significant manner.”[iv] As a result, courts “consider whether the alleged material adverse change was within the contemplation of the parties at the time they executed the agreement, whether it was within the control of the parties, and the magnitude of the impact on the relevant party’s business.”[v] MAE provisions are “read in the larger context in which the parties were transacting.”[vi] Thus, as the Newmont Mining court noted, “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.”[vii]
Lastly, while the law in New York and Delaware regarding the interpretation of MAE provisions is largely consistent, the burden of proof required differs. Specifically, under Delaware law, a buyer must prove an MAE with “clear and convincing evidence,” whereas, in New York, the standard is a “preponderance of the evidence.”[viii] In Newmont Mining, this distinction, along with factual differences, led the court to distinguish Akorn, Inc. v. Fresenius Kabi AG[ix] – the 2018 Delaware Chancery Court decision that made headlines because it found the existence of an MAE sufficient to terminate a merger agreement.[x]
THE DEFINITION OF AN MAE
Agreements typically define an MAE as any event, development or condition occurring that has had, or would be reasonably expected to have, a material adverse effect on the business, financial condition or results of operations of the company and its subsidiaries taken as a whole. For example, in Newmont Mining, where the buyer acquired a gold mine (the “Mine”) that contained a high grade mill (the “Mill”) that the seller was building as part of its Mine Life Extension project (“MLE2”), the MAE provision in the stock purchase agreement (“SPA”) defined a “Company Material Adverse Effect,” in relevant part, as “any change, effect, event, occurrence, circumstance or state of facts that . . . (ii) is or would reasonably be expected to be materially adverse to the business, results of operations, condition (financial or otherwise) of . . . the Mine.”[xi]
Importantly, the MAE provision referenced the Mine as a whole, not the Mill. This was of critical importance in Newmont Mining, where the only MAEs alleged by the buyer resulted from alleged problems with the Mill.[xii] As the court explained: “the construction of the Mill was not the only component of the MLE2 project… Moreover, Newmont bought the entire Mine, not just the one Mill, and was aware that the Mill was still being commissioned at the time the transaction closed.”[xiii] Thus, the court reasoned:
If Newmont wanted the Company MAE definition to include materially adverse effects measured in terms of the Mill, it should have bargained for such a definition. Notwithstanding Newmont’s assertion that the Mill was a “hugely important piece of the [M]ine,”… and that it was the “centerpiece” and “jewel” of the… transaction… under the plain language of the SPA, Newmont must demonstrate that its Alleged MAEs had a materially adverse effect on the Mine as a whole.[xiv]
It thus concluded that Newmont had not established an MAE occurred because, “[w]hile the percentage of gold expected to be recovered from Mill processing is not insignificant, and there may well be circumstances where an event involving the Mill does in fact constitute a materially adverse effect to the Mine as a whole, such circumstances are not present here.”[xv]
Additionally, the Newmont Mining court highlighted that the buyer’s post-acquisition valuation of the Mine as a whole showed that no MAE had occurred. Specifically, the buyer’s post-acquisition valuation models showed that the Mine had increased in value after the transaction closed.[xvi] Thus, the court concluded that even if the Mill was underperforming, the buyer’s own analyses showed that the Mine as a whole did not suffer an MAE.[xvii]
EXCLUSIONS TO THE DEFINITION OF AN MAE
Second, MAE clauses usually exclude specified events, such as weather events, terrorism or military actions, general economic downturns, conditions existing generally within the company’s industry, and other broad categories of market or credit conditions. In Newmont Mining, the SPA expressly listed certain exception to the definition of a Company MAE, including, among others, changes or circumstances relating to (a) “the industries in which [the sellers] operate, (b) “general economic effects or conditions affecting the Unites States or anywhere else in the world, (c) “foreign exchange, equity or debt market conditions,” (d) “acts of God (including earthquakes, storms, fires, floods and natural catastrophes,” and (e) “the failure to meet any projections or forecasts (it being understood that that [sic] the facts or causes underlying or contributing to such failure may be considered in determining whether a Company Material Adverse Effect has occurred unless otherwise excluded pursuant to any of the other clauses of this definition).”[xviii]
In Newmont Mining, the court found that the exclusions of projections and forecast was dispositive. The buyer’s alleged MAEs were tied to the Mill’s alleged inability to achieve two forecasted metrics, a design throughput of 250 short tons per hour, and a gold recovery rate of 76.5%. The court rejected the buyer’s argument that its alleged MAEs were premised on the underlying causes of the missed projections and not the projections themselves. The court so held because the buyer’s interpretation “would transform an otherwise narrow carve-out into an exception that swallows the rule, as it would allow virtually any set of circumstances to constitute a Company MAE as long as it could identify a purported underlying cause for a failure to meet projections or forecasts.”[xix] Thus, the court determined that the parties’ intent in including the parenthetical excepting underlying causes from the exclusion for projections “was to clarify that, where an underlying cause or set of facts fits within the Company MAE definition but also results in a failure to meet a projection, that underlying cause or set of facts may still be asserted as a Company MAE even though it contributed to a missed projection.”[xx] Thus, for example, if the Mill was destroyed, that event would not be excluded from the definition of an MAE simply because it also caused the Mill to not achieve certain projections.
EXCEPTIONS TO THE EXCLUSIONS
MAE provisions typically state that, with respect to some or all of the specified exclusions, they will not be excluded to the extent that they have disproportionately adversely affected the company and its subsidiaries (taken as a whole) as compared to others in the same industry. The exception to the specified exclusions was not an issue in the Newmont Mining decision; however, such exceptions may become a focus of litigation in this post-COVID world. For example only, we expect that notwithstanding the severe economic impact that COVID-related disruptions have had on all businesses, buyers may attempt to find footing arguing that the impact on their recently-acquired or to-be acquired business was disproportionate or otherwise unique. The adjudication of such arguments will be fact intensive and require expert analysis.
COVID-19 will bring MAE provisions into the spotlight in M&A litigation as parties evaluate the impact to their soon-to-be or recently-acquired business. The Newmont Mining decision provides helpful guidance with respect to the requirement that alleged MAEs impact the acquisition target as a whole, and the interpretation of exclusions regarding the projections and forecasts that are typically included in MAE provisions.
[i] Newmont Mining Corp. v. AngloGold Ashanti Ltd., et al., Opinion and Order, No. 1:17-cv-08065 (S.D.N.Y. Mar. 18, 2020), ECF No. 143 (“Newmont Mining”).
[ii] In re Ibp S'holders Litig. v. Tyson Foods, 789 A.2d 14, 144-45 (Del. Ch. 2001) (“Tyson Foods”).
[iii] Chyronhego Corp. v. Wight, No. 2017-0548-SG, 2018 Del. Ch. LEXIS 258, at *22 (Del. Ch. July 31, 2018)
[iv] Tyson Foods, 789 A.2d at 144.
[v] Newmont Mining at 34.
[vi] Tyson Foods, 789 A.2d at 141-42, 144.
[vii] Newmont Mining at 35 (quoting Tyson Foods, 789 A.2d at 68).
[viii] Tyson Foods, 789 A.2d at 94.
[ix] Akorn, Inc. v. Fresenius Kabi AG, et al., Memorandum Opinion, No. 2018-0300-JTL (Del. Ch. Oct. 1, 2018) (“Akorn”).
[x] Newmont Mining at 46 n.30.
[xi] Id. at 2-3, 32-33 (emphasis added).
[xii] Id. at 39.
[xiv] Id. at 39-40 (emphasis in original).
[xv] Id. at 40.
[xvi] Id. at 51-52.
[xviii] Newmont Mining Corp. v. AngloGold Ashanti Ltd., et al., The AGA Defendants’ Local Rule 56.1 Statement in Support of Their Motion for Summary Judgment at ¶242, supra note i, ECF No. 110.
[xix] Newmont Mining at 37.