'Material Adverse Effect' provisions in a share purchase agreement

James Hayden, solicitor in the Lexis®PSL Corporate team, considers the factors that the court will look at in assessing whether revisions to financial forecasts fall within a definition of material adverse effect (MAE).

Original news

Ipsos S.A. v Dentsu Aegis Network Ltd (previously Aegis Group plc) [2015] EWHC 1726 (Comm), [2015] All ER (D) 234 (Jun)The proceedings arose out of the acquisition by the claimant from the defendant of one of its business divisions. The claimant claimed damages for loss it said resulted from fraudulent misrepresentations made by the defendant in respect of the forecasts on which the claimant relied, and damages for breach of contract. The defendant applied to strike out the particulars of claim or, alternatively, for summary judgment. The Commercial Court held that, in the circumstances, the defendant was entitled to the relief sought in one regard.

What is the background to this case?

This case is the latest action arising from the acquisition by Ipsos S.A (the Buyer) of Synovate (the Target) from Dentsu Aegis Network Limited, formerly Aegis Group plc (the Seller), for a purchase price of £528.8m, pursuant to a share purchase agreement dated 26 July 2011 (the SPA). The transaction completed on 12 October 2011 (completion being conditional because of Seller shareholder approval requirements and certain anti-trust and competition clearances). The purchase price was based on the application of a multiplier of ten to the forecast underlying profit for the Target for 2011.In a recent action, a warranty claim by the Buyer was struck out because it had failed to comply with the claim notice provisions in the SPA (see Construing a notification of claim in share sale agreements (IPSOS v Dentsu Aegis)).The applications before the court turned on the construction of MAE provisions in the SPA (the occurrence of a MAE being a condition to completion in respect of the period between exchange and the expected completion date of 30 September 2011).The Buyer issued proceedings against the Seller claiming damages:

  • for loss it said resulted from fraudulent misrepresentations made by the Seller in respect of forecasts concerning the Target's financial performance, on which the Buyer relied, and
  • for breach of contract (based on standard provisions in the SPA requiring the Seller to notify the Buyer of matters which were reasonably likely to give rise to an ability for the Buyer to rely on the occurrence of a MAE)

The Buyer alleged a loss of between £134m and £232m, on the basis that had it known the full picture as to the Target's performance (which was withheld from it by the Seller), it would have invoked the MAE provisions and either not completed the transaction or completed at a different contractual price. Specifically, the Buyer pointed to the following forecasts which were withheld from it:

  • mid-month flash results produced in September 2011, which disclosed sales and revenues behind forecasts
  • revised F3 forecasts produced in September 2011, which forecast a substantially reduced operating profit for 2011, and
  • full month flash results produced at the beginning of October 2011, which also disclosed sales and revenues materially behind the forecasts

The Buyer alleged that the Seller's continuing representations (that the RF2 forecasts provided in August 2011 and September 2011 remained the best forecasts of likely 2011 financial performance) were false since these forecasts did not remain the Seller's best estimates and therefore there did not remain reasonable grounds for the forecasts. The Buyer further contended that the occurrence of a material adverse effect was reflected in the actual full-year profits being only £20.866m, a reduction of £31m from the RF2 forecast profit.

The matter before the court is an application by the Seller to strike out the Buyer's particulars of claim or for summary judgment, which therefore presents the opportunity to consider the merits of the Buyer's arguments in relation to MAE provisions.

Why is this case interesting for corporate lawyers?

The inclusion and negotiation of MAE provisions in any share or asset purchase agreement (where there is split exchange and completion) may be a point of significant contention and difficulty, given the potential for the invocation of such provisions (as conditions to completion) to:

  • unravel the transaction (prior to completion), or
  • form the basis for a buyer to take legal action against the seller (after completion) for misrepresentation or breach of contract which prevent a buyer from invoking MAE provisions (as in this case)

Corporate lawyers drafting share or asset purchase agreements to include MAE provisions therefore need to consider very carefully how they would be interpreted and applied by the court in different scenarios. The judgment in this case gives some guidance in this respect, especially where the use and interpretation of financial forecasts are at the heart of the dispute.

What are the key issues coming out of the case?

The core question which the court had to consider was whether the fact that forecasts concerning the Target were materially revised downwards and/or information was received which indicated that those forecasts would need to be materially revised downwards, fall within the definition of MAE in the SPA.MAE is defined in the SPA as follows:

'Material Adverse Effect' means an act or omission, or the occurrence of a fact, matter, event or circumstance, affecting the Sapphire Group giving rise to, or which is likely to give rise to, a material adverse effect on the business, operations, assets, liabilities, financial condition or results of operations of the Sapphire Group taken as a whole, but excluding any of the foregoing: which has occurred prior to the Signing Date arising out of, resulting from or attributable to:

  • which has occurred prior to the Signing Date;
  • arising out of, resulting from or attributable to:
    • any change in the conditions generally affecting international, national or regional financial, monetary or securities markets or economic, business, legal or political environments or conditions (including interest rates, credit availability, exchange rates, trading volumes or commodity prices), unless, in each case, such changes or conditions have a disproportionate effect, relative to other industry participants, on the Sapphire Group;
    • any change in law, regulation, practice or otherwise, and including authoritative interpretations thereof affecting all or any of the sectors in which the Sapphire Group operates unless, in each case, such changes or conditions have a disproportionate effect, relative to other industry participants, on the Sapphire Group;
    • any national emergency, natural disaster, pandemic, act of terrorism, war, conflict, outbreak of hostilities or not ot other civil distrubance;
    • any seasonal fluctuation in sales or earnings that are consistent with the past operating history of the Sapphire Group; or
    • the announcement of the Transaction or performance of the Transaction Documents, including any conduct required or permitted by any of the Transaction Documents or otherwise consented to by the Purchaser;
    • any loss of customers resulting from or attributable to any of the matters listed in subparagraphs (a) to (e) of this paragraph (ii); or
  • arising from the loss of employees or contractors in the period between the Signing Date and Completion; or
  • (save for the purposes of the Completion Condition set out in paragraph 3 of Schedule 1 (Completion Conditions) which occurs after the MAE Completion Date.'

The court found that:

  • the revision of the forecasts 'did not fall naturally' within the first part of the definition of MAE in the SPA (ie 'an act or omission or the occurrence of a fact, matter, event or circumstance')—the court agreed with the Seller's submission that the MAE definition wording was deliberately narrower than the Seller's warranty concerning MAE ('there has been no material adverse change in the financial or trading position of [the Target] taken as a whole')
  • the fact that the forecasts were revised was insufficient to meet the second part of the definition of MAE in the SPA, namely that it must have a causal effect 'giving rise to, or which is likely to give rise to, a material adverse effect on the business, operations, assets, liabilities, financial condition or results of operations'—the court commented that 'It is obviously true to say that things may follow from the revision of the forecast, but this has to do with what underlies the revision, rather than the fact of the revision itself'
  • it did not make 'commercial sense' to find that revised forecasts constitute MAE (as per the Buyer's claim), because doing so 'results in substance to a warranty in respect of the forecasts given after the Signing Date'—in doing so, the court noted that the SPA explicitly provided that the Seller did not provide a warranty as to pre-exchange forecasts, but rather the SPA's limitations on liability schedule contains a provision that:

    [the Buyer] acknowledges and agrees [the Seller] does not give or make any warranty as to the accuracy of forecasts, estimates, projections, statements of intent and statements of honestly expressed opinion provided to [the Seller] on or prior to the Signing Date

  • including forecasts within the definition of MAE would 'be productive of uncertainty, which is highly undesirable in the M&A market'

For the reasons described above, the court did not consider that revisions to the forecasts fell within the definition of MAE in the SPA. The court's reasoning provides useful drafting and interpretation guidance, based as it is on a fairly standard definition of MAE and other warranty/limitation provisions. What is particularly interesting is the court's willingness to look beyond strict interpretation of the drafting of the MAE definition to:

  • recognise that permitting revisions to forecasts to fall within the definition of MAE would in effect provide the Buyer with a warranty concerning revisions of forecasts between exchange and completion (ie, a warranty 'in substance' if not 'in form'), and
  • take into account the parties' intentions in the warranties and limitations provisions (viewed together) and recognise the relevance of the fact that the parties did not make provision for any warranties concerning forecasts and, further, explicitly excluded the giving of any such warranty in the limitations schedule

What was the outcome of the case?

The court granted the Seller the relief it sought to strike out the Buyer's pleading that the revised forecasts fell within the SPA's definition of MAE.The court dealt separately with the matter of whether the Buyer's pleading that the Target's actual performance in September 2011 fell within the SPA's definition of MAE should be struck out. It found that the Buyer had an arguable case and therefore could not be ruled on at this stage.

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