Last June, Hexion Specialty Chemicals announced that it was walking from its $10.6 billion acquisition of Huntsman Corp. on the grounds that the capital structure for the combined entity was no longer viable and would render it insolvent. Hexion filed suit in Delaware, and on September 29, 2008, Vice Chancellor Lamb issued his opinion.
One of Hexion’s claims was that the “Material Adverse Effect” clause under the merger agreement had been triggered. I keep an eye on MAC litigation (I recommend using MAC rather than MAE as your defined term; see MSCD 8.57), as I attempted to address the subject somewhat comprehensively in chapter 8 of MSCD. More often than not the litigation is fact-driven and so of limited interest to me, and that’s the case with Hexion v. Hunstman, but the opinion did contain nuggets relevant to the contract drafter.
The court noted that any buyer seeking to invoke a MAE bears a “heavy burden” and has to show that the circumstances in question threaten the target business’s earnings potential in a “durationally-significant manner.” No surprise there—the IBP case (see MSCD 8.3) made that clear.
“Taken As a Whole”
In the Hexion–Huntsman agreement, MAE was defined to mean a material adverse effect on Huntsman and its subsidiaries “taken as a whole.” That led the court to reject the weight Hexion had assigned to problems at two Huntsman divisions in arguing that Huntsman had suffered a MAE. This seems straightforward, but it’s of interest if for no other reason than I can’t recall any recent MAC caselaw on taken as a whole.
Operation of Carve-outs
The definition of MAE contained a carve-out for industry-wide effects, unless they have a disproportionate effect on Hunstman. Hexion argued that determining whether an MAE had occurred required comparing Huntsman’s performance against that of the chemical industry in general. The court rejected this approach and held that the first step is to determine whether the target had suffered an MAE; only then do carve-outs come into play. This too stands to reason, but it’s useful to have it articulated.
How MAC Provisions Relate to Other Provisions
The court held that because in the merger agreement Hexion disclaimed reliance on any Huntsman projections, the question of whether Huntsman suffered an MAE shouldn’t be measured by how it performed compared with its projections:
Hexion agreed that the contract contained no representation or warranty with respect to Huntsman’s forecasts. To now allow the MAE analysis to hinge on Huntsman’s failure to hit its forecast targets during the period leading up to closing would eviscerate, if not render altogether void, the meaning of [the section disclaiming any representations regarding projections].
So this case can be added to the caselaw showing that in determining whether a MAC occurred under a given agreement a court might well take into account what is, or isn’t, included in the other provisions of that agreement; see MSCD 8.125–128.
Implications of the Field of Change
The court concurred with Huntsman’s expert that the terms “‘financial condition, business or results of operations’ are terms of art, to be understood within reference to their meaning in Reg S-X and Item 7, the ‘Management’s Discussion and Analysis of Financial Conditions and Results of Operation’ section” of SEC filings. In that section, companies are required to disclose their results for the reporting period as well as their results for the same time period in each of the previous two years.
That led the court to conclude that to assess whether changes in a company’s performance amount to an MAE, it’s appropriate to examine each year and quarter and compare it to the equivalent period in the previous year.
The cited terms are standard elements of what I call the “field of change” (see MSCD 8.86). I don’t think any meaning conveyed by those terms mandates the timeframe specified by the court, so I don’t see this part of the opinion affecting how MAC is defined.
Burden of Proof
The court held that Hexion had the burden of proof in showing that Huntsman had suffered an MAE. It suggested, in footnote 60, that one could specify by contract who has the burden of proof for establishing an MAE.
In that regard, here’s part of what I say regarding the burden of proof starting page 46 of my otherwise superseded law-review article on MAC (discussion of MAC burden-of-proof issues didn’t make the cut for purposes of MSCD):
If you want to address MAC-related burden-of-proof issues in a contract, state who has the burden of proof when a MAC provision or any carve-out is invoked and what the burden of persuasion is in each case. The alternative would be to have the contract be silent; if the issue were to arise in litigation, the courts would decide it. The latter approach has more to recommend it. For one thing, it seems a little unrealistic to expect a contract to address such matters comprehensively; the author has yet to see a contract that does.