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In June 2001 Vice Chancellor Strine of the Delaware Court of Chancery issued his much-awaited decision in IBP, Inc. v. Tyson Foods, Inc. Among other matters decided, the court determined that Tyson would not be permitted to terminate its merger agreement with IBP on the basis that a material adverse change (a “MAC”) to, or material adverse effect on, IBP’s business, assets, liabilities, or results of operations had occurred. In addition, to the surprise of many, the court granted IBP the remedy of specific performance, ordering Tyson’s acquisition of IBP to go forward despite the obvious animosity that now existed between the two entities.

Merger agreements normally provide MAC protections for the buyer and sometimes for the target as well. The merger agreement typically is drafted to permit one or either party to terminate the transaction if a MAC has occurred with respect to the other party or sometimes if events that would or could constitute such a MAC have occurred. The merger agreement between Tyson and IBP contained the following definition of a MAC with respect to IBP:

“a material adverse effect on the condition (financial or otherwise), business, assets, liabilities or results of operations of the Company and the Subsidiaries taken as a whole”

In ruling that there had been no material adverse effect or change (“MAC”) the court engaged in a detailed factual analysis. The court admitted that the question was a close call and, indeed, the decision turned on the determination as to who had the burden of proof; if the court were incorrect in its conclusion that New York law would place the burden on Tyson to demonstrate that a MAC had occurred, it noted it would have to reach the opposite conclusion.

• A post-Tyson survey of MAC clauses in merger agreements, however, has led some observers to conclude that the Tyson case has had no significant effect on how MAC clauses are negotiated and drafted. Nonetheless, the court’s analysis suggests a number of practical lessons for management on either side in drafting the merger agreement and, particularly, in its conduct in considering whether to terminate a merger agreement on the basis of MAC.
  
  
• The grant of the remedy of specific performance to IBP, ordering the acquisition to go forward was unusual. This appears to be the first time that a court has ordered one publicly traded company to acquire another. A determination that a MAC has occurred can be a close call. There is substantial risk that a court will not agree with the determination and the risk that specific performance might be ordered is one the parties may want to avoid. This risk can be eliminated by negotiating a limitations of liability and exclusive remedy clause that specifically excludes specific performance as a remedy for a wrongful termination of the merger agreement.
  
  
• In deciding whether to declare a MAC and terminate, management must examine the possible material change with reference to the appropriate “time horizon,” which requires accounting for the nature of the industry involved, the party’s strategic and investment goals in the transaction and the party’s specific knowledge of the historical performance of its contractual counterpart. Tyson had specifically relied on a two-quarter, significant decline in IBP’s performance. The court found that the event was too short in duration because Tyson’s strategy in the merger was long-term and because the cyclical nature of IBP’s cattle business was well known. In exploring whether to declare a MAC, management must be prepared to demonstrate that the “change” in its counterpart’s business has an appropriate degree of durability or permanence.
  
  
• MAC clauses will not alter specific allocations of risk in other parts of the agreement or risks clearly known to the party asserting the MAC and should be viewed as “catchall” or “backstop” protections. The Tyson court noted with disapproval that Tyson knew of, or had accepted in the representations and warranties, certain risks whose occurrence it now attempted to use as the basis for asserting a MAC. In considering whether to declare a MAC, management must examine whether the events giving rise to the MAC involve risks specifically undertaken by it in other portions of the agreement, or clearly known by it and accepted during the negotiations. If a MAC is to be asserted, it should be based on the occurrence of unanticipated events, or events whose risks or occurrence were not allocated in other parts of the agreement to the party now asserting that a MAC has occurred.
  
  
• On the flip side, if a party is particularly concerned about a specific risk, it needs to consider addressing it specifically in the representations and warranties; it is a dangerous strategy to depend on a general MAC clause as the basis for termination in the event the feared event occurs. Of course, should the other party reject the specific language, an evidentiary record that the event will not support termination may have just been created, so one must be sure that the issue is truly important.
  
  
• By the same token, if a party wants to exclude certain events from constituting a MAC or being considered in the mix of events that may constitute a MAC, it should consider negotiating appropriate carve-outs in the MAC clause. There are no truly “typical” carve-outs (the Tyson – IBP transaction had none) and their inclusion is based upon negotiating leverage. Following is a rather fulsome “target-friendly” example of MAC carve-outs from a recent public company transaction:
  
  

“In no event shall any of the following, in and of itself, be considered a Material Adverse Change or Material Adverse Effect: (a) any change in the market price or trading volume of such entity’s outstanding securities or the de-listing thereof from the NASDAQ listing or any litigation relating thereto; (b) any failure to meet internal projections or forecasts or published revenue or earnings predictions for any period ending (or for which revenues or earnings are released) on or after the date hereof; (c) any adverse change to the extent attributable to the announcement or pendency of the Merger, including any cancellations of or delay in customer orders, any reduction in sales or revenues, any disruption in supplier, distributor, partner or similar relations or any loss of employees; (d) any adverse change attributable to conditions affecting the industries in which the Company or Parent participates, the U.S. economy as a whole or foreign economies in any locations where the Company, Parent or any of their respective subsidiaries has material operations or sales except, in any such case, as the case may be, to the extent such effect on either Parent or Company, as the case may be, is materially disproportionate; (e) the pendency of any litigation instituted by a third party other than a Governmental Entity that challenges, or that may have the effect of preventing, delaying or otherwise interfering with the Merger or any of the transactions contemplated by this Agreement; (f) any adverse change arising from or relating to any change in accounting requirements or principles or any change in applicable laws, rules or regulations or the interpretation thereof.”

• Actions taken while determining whether a MAC has occurred as well as how that determination is communicated are important. The court noted that, prior to its decision to terminate, Tyson sought a new fairness opinion from its investment banker. Unfortunately for Tyson, the investment banker concluded that, even in light of new pessimistic assumptions, the acquisition price was still fair. In exploring whether to terminate a merger agreement management is in the constant process of creating evidence that will be used in court if its decision to terminate is challenged. In short, don’t ask the investment banker to prepare a new fairness analysis unless it is certain that the banker will determine that the price no longer is fair. The court also made much of the fact that Tyson had not stated the occurrence of a MAC in its original termination notice to IBP. This supported the court’s conclusion that the assertion of a MAC was a pretext for Tyson’s true motivation: buyer’s remorse. Again, management creates much of the evidence that will potentially be used against it later in court. Management needs to be careful in its letters, e-mails and other documents not to create evidence of a pretext claim and, in particular, must state all possible grounds and theories for a termination on which it may later rely.
  

While in the end the Tyson – IBP case did not really change the legal landscape regarding MAC clauses it does provide lessons on how they should be viewed. The negotiation of the MAC clause and the determination of the parties rights involve complex issues of law and are dependent on the specific facts of the given situation. Those underlying facts and circumstances need to be considered in the matters to be negotiated regarding the MAC and in the decision of a party who wishes to assert its rights to terminate an agreement based on the MAC clause. While designed to protect the party seeking to assert the MAC by allowing it to walk away from the transaction, doing so may result in an action for breach of contract by the other party with unforeseen consequences. On March 12, 2002, Tyson appealed the case to the Delaware Supreme Court. The reversal sought will have no practical effect on the transaction—Tyson's acquisition of IBP was completed last year. Tyson's apparent motive is to overturn certain of Vice-Chancellor Strine's conclusions that would serve to preclude a number of factual arguments Tyson will want to advance in defense of a class action by IBP shareholders who sold their stock when Tyson terminated the merger agreement. The lessons from the lower court decision—and the attitude of the Chancery Court—nevertheless remain important to observe.


David Gross is a Gray Cary partner and is Co-Chair of the Business and Technology Litigation Group.


Copyright © 2002 Gray Cary Ware & Freidenrich LLP