No Exit

MAC clauses are supposed to protect buyers, but in a seller's market the burden may fall to the buyer's CFO.

Divorcing for irreconcilable differences may be legal in most states, but it won’t get you out of a merger. Just consider the 2006 court battle between marketing-services firm Valassis Communications Inc. and direct-mail firm ADVO Inc.

Designed to create a co-op mail giant, the $1.3 billion deal was signed in July but fell apart a month later when updated financial statements showed quarterly operating income at ADVO running 30 percent below what Valassis management expected. In response, Valassis filed suit in Delaware Chancery Court seeking to be released from the agreement. ADVO management, Valassis charged, had “materially misrepresented the financial health of the company and failed to reveal internal-control deficiencies,” triggering the contract’s material adverse change (MAC) clause.

The legal briefs contained juicy charges of fraud and cover-up and countercharges of buyer’s remorse. But nine days after the trial started, Vice Chancellor Leo E. Strine Jr. closed his courtroom to confer with both parties.

What transpired there has never been made public, but it is widely assumed that Strine reminded them of his 2001 decision involving Tyson Foods’s attempt to get out of a merger with IBP Inc. on the basis of a change in quarterly performance (see “Steak and Eggs,” August 2001). In what was then and remains the definitive ruling on MAC clauses, Strine required Tyson to complete the merger at the agreed-upon price.

Two days later, Valassis management announced that a deal they had only recently said would cause the company serious financial harm was going ahead. And while Judge Strine never got to rule because of the settlement, his earlier warning to buyers still rings true: after due diligence is done there are few exits to a merger. As Lou Kling, a partner with Skadden, Arps, Slate, Meagher & Flom, told an audience at Harvard Law School last year, for a MAC clause to apply, a problem must be “a hundred times worse than what the client actually thinks it has to be.” In most instances, the client underestimates “by multiples how bad that effect has to be to get a court to say it was a material adverse effect.”

Specific Triggers

The Valassis/ADVO case is unusual because it actually went to trial. Despite being standard fare in any M&A deal, MAC clauses are rarely invoked and even more rarely litigated. “In a couple of decades of investment banking, I have never been in a position where one of these was invoked,” says Jeffery Bistrong, managing director and head of the technology group at M&A advisory firm Harris Williams & Co.

But the rarity of their exercise only underscores the gravity of the situation they address: a collapsing deal with potentially enormous repercussions for both parties. “This is one of the most important clauses in the contract because both sides get hurt if the deal blows up, but usually the seller gets hurt much more,” says H. Rodgin Cohen, chairman of law firm Sullivan & Cromwell in New York.

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