Law Reporter: April 2014

The Ministry of Corporate Affairs (MCA) has notified that effective April 1, 2014, every company must have at least one resident director. Resident Director has been defined as one who has stayed in India for at least 182 days in the previous calendar year.

As per provision of Section 149, this needs to be complied with immediately and there is no transition timeline in this. This provision applies to all Companies including private companies. Foreign Companies with Indian Subsidiaries but with only foreign directors will be impacted by this provision and they will now have to start having Indian Directors on the Boards.

In case of any contravention, then a penalty of up to INR 10,000 will be imposed on the company and every officer of the company. Further, in case of continuing default, a fine of INR 1,000 per day till the date this default continues is applicable.

Outline:

The phrase material adverse change (referred to here as “MAC”) is a prominent feature of contracts. It has received much attention in recent years. Skittishness due to the 2001 downturn in the economy, the terrorist attacks of September 11, 2001, and the prospects of war with Iraq in 2003 prompted deal parties, and the business and legal communities as a whole, to consider anew on what basis a MAC provision could allow a party to get out of a deal. Also prompting interest in the subject was the decision in a case dealing with MAC provisions of the Delaware Chancery Court in IBP, Inc. v. Tyson Foods, Inc. And Johnson & Johnson’s threat, in November 2005, to walk away from its proposed $25 billion acquisition of Guidant because Guidant had suffered a MAC served as a reminder that MAC provisions remain an important topic.

But for all the focus on MAC provisions, what had been lacking is a methodical parsing, from the perspective of the contract drafter, of the full range of issues raised by MAC provisions. The author has offered elsewhere Papa Bear and Mama Bear versions of such an analysis; here is the Baby Bear version.

Issues raised by MAC provisions fall into two categories: those relating to using MAC provisions and—since MAC is generally used as a defined term—those relating to how MAC is defined.

Where is it Used :

MAC provisions are used in different parts of a contract. They occur most commonly in representations, where they can be used in two different ways. First, a party can make a representation regarding non occurrence of a MAC since a given date. a MAC provision can serve to modify a representation as to some aspect of a party’s operations so as to indicate the absence of anything leading to a MAC.

“Material Adverse Change’’ Mean

The adverse change part of material adverse change means, evidently enough, a change for the worse. It is material that is problematic, in that not only is it vague, it’s also ambiguous.

One meaning of material is that conveyed by case law. In cases addressing securities laws violations, suppression of evidence in criminal prosecutions, and a variety of other matters, courts have held that whether a fact is “material” is a function of its effect on a given decision. Hence Black’s Law Dictionary defines material as meaning “of such a nature that knowledge of the item would affect a person’s decision-making process.”

But material can also mean, less precisely, “significant” or “important enough to merit attention.” This definition is unhelpful because it can be unclear how one determines significance. If, for example, in an asset purchase agreement the seller represents that it has disclosed all material litigation currently pending to which it is party, and if it is not made clear somehow that the materiality of a fact is a function of its effect on a given decision, then what standard does one use to determine if any undisclosed litigation is material? Its significance—however established—to the seller? To the buyer? The ratio of undisclosed cases to the total number of cases? Or what is at stake in the undisclosed cases (measured in dollars or otherwise) as compared to what is at stake in the other pending cases?

This vaguer definition—material meaning “significant”—may be the one that most transactional lawyers have in mind when they negotiate materiality.

In terms of case law supporting the view that material adverse change means any adverse change that would have had an effect on a given decision, the leading case is IBP v. Tyson Foods, in which the court held that “the Material Adverse Effect should be material when viewed from the longer-term perspective of the reasonable acquirer.” Presumably if the case before the IBP court had concerned a target claiming that because a MAC provision had been triggered it was entitled to terminate the merger agreement, the IBP court would have applied a “reasonable target” standard. And if the case had involved termination of a license agreement by the licensor, it would presumably have applied a “reasonable licensor” standard.

Material Adverse Change in What?

Defining MAC requires that one determine what needs to suffer a material adverse change in order for a MAC to occur; in the following discussion, this is referred to as the “field of change.” When representing a buyer acquiring a company, an appropriate field of change would consist of the business, results of operations, assets, liabilities, or financial condition of the target, but the exact formulation depends on the kind of transaction involved.

For example, if the acquisition is in the form of an asset purchase, one might want to expand the definition so that it covers a MAC in the assets being acquired. And in merger agreements it is commonplace to include within the field of change any event that has a material adverse effect on the ability of one or more of the parties to complete the merger.

If at the time a deal is signed Target is planning to enter into a new line of business, Buyer’s counsel might want to have the field of change refer to the business (as it is currently being conducted or as Target currently proposes to conduct it). If the plans to enter into a new line of business are sufficiently developed, a more precise alternative to appending a parenthetical to the business and relying on an absolute MAC representation or condition would be to craft representations or conditions that address circumstances relating to the proposed expansion.

“Prospects”

The buyer and the seller of a business often engage in a predictable little dance regarding whether to include prospects in the field of change. The buyer wants it included—the future of the business, it says, is a legitimate concern, since the buyer is acquiring the business so as to operate it in the future. The seller wants it excluded—it is willing, it says, to stand behind how the business is currently being operated, but future operations are the buyer’s concern. More often than not the seller wins this battle.

Conclusion

This note can be boiled down to the following observations and recommendations. They reflect the perspective of someone—in the context of an acquisition, generally buyer’s counsel—drafting an agreement that incorporates MAC provisions benefiting the drafter’s client.

Using MAC

a. MAC provisions can occur in representations, conditions to closing, obligations, termination provisions, and default provisions.

b. There are two kinds of MAC provision, the “absolute,” which refers directly to non occurrence of a MAC, and the “modifying,” which modifies a noun or noun phrase.

c. Here is a basic form of absolute MAC representation: Since December 31,2005, no MAC has occurred.

d. Here is a basic form of modifying MAC representation: Acme’s books and records contain no inaccuracies except for inaccuracies that would not reasonably be expected to result in a MAC.

e. Given the uncertain meaning of material, use it only in MAC provisions and find other ways of expressing other levels of significance.

f. For instance, use MAC if a bring down closing condition needs to be qualified by materiality. There are various pro-buyer and pro-seller ways that a bring down condition can be tweaked.

g. In terms of verb use in modifying MAC provisions, a reasonable buyer–seller compromise would be the formulation would [or would not] reasonably be expected to result in a MAC, meaning that a reasonable person would or would not, as applicable, expect the matter in question to result in a MAC.

h. To extend an absolute MAC provision so that it covers, in the manner of a modifying MAC provision, the possibility of future MACs, tack on a modifying MAC provision: Since December 31, 2005, there has not occurred any MAC or any event or circumstance that would reasonably be expected to result in a MAC. This sort of modifying MAC provision serves to backstop the modifying MAC provisions contained in representations addressing specific aspects of the representing party’s operations

In India, it would be beneficial to the Corporate restructuring as MAC clauses often feature in public and private M&A transactions. In the context of a public M&A transaction a MAC clause will usually seek to enable a bidder to withdraw its bid if a material adverse change occurs to the business, assets or profits of the target company prior to the bidder announcing its offer and such offer being declared unconditional. In a private M&A transaction a MAC clause will seek to allow the buyer to walk away from the acquisition of the target company if certain events occur which are detrimental to the business, assets or profits of the target company.

Law Reporter

MCA notifies a majority of sections of Companies Act, 2013

Resident Director to be compulsorily appointed w.e.f. 1st April, 2014

New MCA E-forms to be available from 28th April, 2014

Material Adverse Change -Needy Change in Merger and Amalgmation Deals in India