Construing material adverse effect/material adverse change clauses

BM Brazil I Fundo De Investimento EM Participacoes Multistrateg ia v Sibanye BM Brazil (Pty) Ltd [2024] EWHC 2566 (Comm)

The question

How did the courts go about construing a material adverse effect definition (MAE) in a share purchase agreement (SPA) to determine whether an event constituted a MAE so as to discharge the buyers from their obligation to close the transaction?

The key takeaway

To be “material” in the context of the SPA the event must be significant or substantial, and there is no bright line test, with each case determined by its own facts (including size of the transaction, the nature of the assets, the length of the process of the sale, and the complexity of the SPA). In this case a 20% reduction in the equity value of the target would be material, a 15% might be material, but a 10% reduction, where the contract had particular characteristics, was too low to count as material for the purposes of the MAE provision.

The background

The parties had entered into two share purchase agreements (SPA) for the acquisition of two mines in Brazil by Sibanye. However, two weeks after the signing of the SPAs, between the signing and closing, a geotechnical event (GE) occurred at one of the mines. Following a blast, a portion of a slope at the mine pit displaced by up to two meters, with resulting cracks extending for a total height of approximately 84 meters. No injuries or material losses occurred.

The relevant SPA contained a Material Adverse Effect (MAE) clause allowing the purchaser to avoid the transaction if a material event occurred between the signing and closing of the SPAs.

“Material Adverse Effect” means any change, event or effect that individually or in the aggregate is or would reasonably be expected to be material and adverse to the business, financial condition, results of operations, the properties, assets, liabilities or operations of the Group Companies, taken as a whole, excluding any such change, event or effect arising out of, in connection with or resulting from (a) general global, national or regional economic, business, political, market, regulatory or social conditions […] [emphasis added].

Following the GE, Sibanye purported to terminate the SPAs on the basis that the GE constituted an MAE under the relevant SPA. The sellers subsequently commenced proceedings against Sibanye for declaratory relief and damages for wrongful repudiation and/or renunciation of the SPAs.

The key issue was: was the GE a MAE?

The decision

The court found that, at the date of termination, the GE was not and would not reasonably have been expected to be material, and therefore that Sibanye was in breach of the SPAs in terminating the purchase.

In reaching this conclusion the court applied the ordinary principles of contract construction, as stated in the main authority: Wood v Capita Insurance Services Ltd [2017] UKSC 24, ascertaining the objective meaning of the language and considering the contract as a whole and the factual background.

In its judgment the court provided guidance, that is more generally applicable, on issues of construction including whether and how the MAE provisions apply to “revelatory occurrences”; the question of whether the “change, event or effect” “is or would reasonably be expected to be material and adverse…”; and the meaning of “material”.

Revelatory effects

The sellers argued that even if there had been a revelatory effect of the GE in revealing wider problems, that did not qualify the GE as a MAE. The court agreed with the sellers that the terms of the MAE definition dictated that a matter was only a MAE if that ‘change, event or effect’ was itself material and adverse, and not just a ‘change, event or effect’ indicating the possibility that there may be other problems which existed at the time of the signing of the SPA.

What “would reasonably be expected”

The assessment of what “would reasonably be expected to be material and adverse” required an objective test, to be made from the perspective of a reasonable person in the position of the parties at the time when cancellation on the basis of the alleged MAE is notified. On the further question of what degree of likelihood is implied by “would reasonably be expected,” the judge determined that a mere risk that a matter may turn out to be material was not enough. The assessment was whether a reasonable person would have considered it more likely than not that the matter would turn out to be material.

Materiality

On the question of materiality, the court considered that it was important to examine whether a company has suffered a MAE in its business or results of operations that is consequential to the company’s earnings power over a commercially reasonable period (a period of years rather than months). ‘Material’ was also intended to mean ‘significant or substantial. There was no bright line test for what constitutes materiality which would be applicable to all MAE clauses. The size of the transaction, the nature of the assets, the length of the process of the sale, and the complexity of the SPA were all relevant.

In considering the US authority cases, the court reasoned that 20% reduction in the equity value of the target would be material and 15% might also be material, but that a 10% reduction in the value of the company in the present case, where the contract had particular characteristics, was too low to count as material for the purposes of the MAE provisions.

Having established this, the court turned to the ultimate question: was the GE a MAE?

The court examined the qualitative and quantitative aspects of the GE (but showing scepticism about the relevance of the qualitative aspects) and found that the GE was not a MAE because materiality was not satisfied. Key factors supporting this conclusion were: GEs often happen at open pit mines, with 166 recorded at the mine in question in 2021, it was by no means large, no one was killed or injured, no equipment was lost, operations at the mine resumed on the same day, and there were no adverse regulatory consequences.

Additionally, the financial effect of the GE incident at the date of termination in terms of cost of waste actually removed by then, or planned ore not mined by that date was immaterial. The subsequent associated remediation was not considered to be material at a sum of more than US$20 million, which was well below 5% of the mine purchase price.

Why is this important?

The judgment’s examination of UK and US authorities and wider guidance on construing the MAE definition will be of use to those drafting MAE/MAC clauses. The case also provides practical examples of what constitutes “materiality” (applied in a mining setting).

Any practical tips?

Consider in advance the specific types of material events or effects that would warrant the buyer terminating the transaction. Where a buyer wishes to protect itself from a specific event, this should be inserted as a separate condition rather than seeking to rely on the general MAE provision.

Given the likely difficulty in establishing materiality, a buyer may also wish to provide for alternative provisions it can rely on such as the termination clause so as not to have to rely solely on the MAE provision.

A commercial or financial impact must usually be suffered by the target for a period of years rather than months for a MAE to be found to have occurred. If the risk is more likely to arise from a more short term event or effect, ensure the MAE contains appropriate timeframes.

MAE provisions are judged in the context of the SPA as a whole, including the other risk allocation provisions such as warranties and indemnities. Ensure these are not inconsistent with the aims of the MAE.

Winter 2024