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. Last Updated: 07/27/2016

Invoking the ?Act of God' Clause

NEW YORK -- For investment bankers it is the equivalent of an insurer's "acts of God" clause.

It's called the "material adverse change," or MAC, proviso, and it can enable companies to back out of all sorts of business deals.

Certainly, last week's terrorist attacks brought adverse change. And MACs are now among the many vagaries on a wounded Wall Street, as deal-makers try to revive the deal-making side of the business world. "There was an expectation that after Labor Day we'd have a flurry of deals throughout the rest of the year," said Richard Peterson, chief market strategist at Thomson Financial Securities Data. "Now it's a new ballgame. The slate is wiped clean."

Few expect a wave of deal failures, or that financing will dry up. But new uncertainties could undermine dozens of pending mergers and acquisitions and countless other financial transactions, lawyers and investment bankers said. And beyond the corporate implications for companies that may now delay or cancel transactions, Wall Street is expected to be especially hard hit without the fees it would typically earn for advising clients -- in a year in which business had already been bad.

In the flush of patriotic defiance and esprit de corps with which many in the financial world are responding to the crisis, bankers said some companies still planned to press ahead and announce new deals in the coming weeks -- if simply to help bolster the resolve and strength of investors and the economy.

But some deals may also be in jeopardy, after other companies began quietly asking their lawyers last week if and how they can back out of transactions they fear may plummet in value after the resumption of stock trading.

One big imponderable for investment banks and their clients is the near-term uncertainty of the value of stock, which is often used as currency to make acquisitions. Typically, activity in mergers and acquisitions drops off when stocks fluctuate, as companies retreat from the aggressive strategy of buying to a defensive strategy of hunkering down.

And then there are the MACs and other contractual terms that could allow possible exits to one or both parties under certain circumstances. Some companies that had already entered into agreements not yet completed could use the terrorist attacks as a reason to abort deals that no longer seem as attractive.

It will be some time before parties to a merger know for sure whether one of them intends to invoke a MAC clause. Most deals that would have been consummated last week or this week have simply been postponed, lawyers say, with the ultimate outcomes still uncertain.

"People will probably wait and see what happens" in the days after the markets reopen, said Kenneth Lefkowitz, co-chairman of the mergers and acquisitions group at Hughes Hubbard & Reed. "Even if people have signed agreements, I don't think anyone's going to decide to terminate immediately."

Backing out of a merger agreement would probably require more than simply citing a general stock market decline, if one occurs, said Mel Immergut, chairman of law firm Milbank, Tweed, Hadley & McCloy. "You would likely have to come up with something in an M&A deal that would affect the particular business of the company involved, as opposed to saying that there was a drop in the stock market," he said.

For example, a company that agreed to buy a hotel chain that operated resorts in the Middle East might have a strong case that the seller had suffered a material adverse change and its business was now worth substantially less, said Leonard Chazen, partner in the corporate securities practice at law firm Covington & Burling. "You'd have a much stronger case that these events actually relate that they have a pretty close connection to the viability of that project."

The situation is different for corporate finance transactions, Immergut said, because contracts governing debt and equity sales usually allow the underwriter, who guarantees the sale of the stock or debt for a minimum price, to back out if something forces an unscheduled closing of the stock market, for example.

"That's happened," Immergut said, and that means that some investment banks may choose to exercise their "market out" clauses.

No investment firm takes such a step lightly, he and other lawyers said. "Underwriters very rarely exercise this right," Lefkowitz said, because of the adverse impact on client relations. "It would be a hard thing for them to do."

In the end, as with so many business matters, it may all depend on the fine print. Trying to use a MAC or a "market out" argument will depend heavily on the particular language of the contracts.

"It depends on how they're drafted," Chazen said. Usually, "general economic conditions or general industry conditions can't be a basis for invoking a MAC clause, and even if it's not drafted that way, we're not in the Depression." He paused. "At least I hope not."