Material Adverse Change in Focus: Lessons for Private Equity Bidders

The controversy surrounding Mayne Pharma Group Limited (Mayne) and attempts by bidder, Cosette Pharmaceuticals, Inc, (Cosette), to get out of its scheme transaction serve up some important lessons for private equity bidders. These are:

• Onus and burden of proof: Bidders will have the onus of proving a material adverse termination right has been enlivened. They must meet a high evidentiary burden to prove they have the right to terminate.
• Not an earnings guarantee: The material adverse change provisions are not necessarily an earnings underwrite for the interim period. It is not enough that earnings were below expectations, there must still be an ‘event’. In this case, the loss of key members of the marketing team was enough to satisfy this requirement.
• Election to proceed: Care must be taken when acting in furtherance of the scheme once the bidder is aware it may have a termination right. Cosette entering into an amending agreement for certain minor changes to the deal agreement, without reserving their rights, was found to have been an election to continue to the transaction notwithstanding a potential material adverse change.
• Panel’s jurisdiction: The Takeovers Panel still has jurisdiction in a scheme of arrangement transaction. The Panel can decide on a situation generally quicker and has the power to make broader orders than the courts.
• Intentions in scheme booklet: The requirement to disclose the bidder’s intentions in respect of the target in the scheme booklet should be considered carefully. Cosette’s statements that it intended to continue the business and review operations after implementation were found by the Panel to be inconsistent with the decision before implementation to declare that it would shut down a plant important to FIRB’s consideration of the transaction.

Cosette is likely to get lucky here and be able to walk away from the deal, as the end date has been reached. However, as a result of this situation we expect targets will look to tighten various aspects of implementation agreements, with a greater focus on: 

• the construct of the material adverse change definition (and exceptions);
• obligations to satisfy the conditions precedent; and 
• reverse break fees and other consequences associated with condition precedent failure and breach of the agreement by the bidder.

Background

Mayne and Cosette agreed to a scheme of arrangement for Cosette to acquire 100% of Mayne. The scheme implementation deed (SID) was subject to the usual conditions, including no “Material Adverse Change” (MAC) and receipt of FIRB approval from the Treasurer.

Cosette subsequently attempted to terminate the SID following Mayne releasing a trading update that reported an expected decline in earnings relative to budget and market expectations. Cosette alleged a MAC had occurred, together with certain breaches of representations in the SID. Mayne challenged this in court, and the Court ultimately ruled in Mayne’s favour, finding no MAC had occurred and that the SID remained on foot.

With the Court rejecting Cosette’s purported termination of the SID, FIRB approval was essentially the final condition to the scheme becoming effective. 

After Mayne shareholders voted in favour of the transaction at the scheme meeting, Cosette notified FIRB (and Mayne) on or around 8 September that it now planned to “seek to dispose of or close” Mayne’s Salisbury manufacturing site. This was contrary to earlier statements in the scheme booklet by Cosette that it intended to continue with the business as currently operated and, after implementation, it may review operations. 

Mayne went to the Takeovers Panel to hold Cosette to its deal. The Panel swiftly made a declaration of unacceptable circumstances on the basis that the market for control did not proceed as generally expected for schemes and contravened the principles of an efficient, competitive and informed market as required by the Corporations Act.  To address this, the Takeovers Panel made orders that:

• Cosette must agree to any conditions reasonably required by the Treasurer regarding the Salisbury Site (provided they’re consistent with Cosette’s earlier disclosed intentions).
• Cosette and Mayne must immediately provide each other with FIRB-related communications (subject to redaction of competitively sensitive or privileged material).
• The Scheme’s “End Date” was extended by a few days to allow time for FIRB’s decision to be made without the deal ‘timing out.’ 

Ultimately, the Treasurer, on the advice of FIRB, was unwilling to grant approval on conditions that would allay its national interest concerns. This has led to the condition precedent failing and the scheme being unlikely to proceed. As at the date of this article, Mayne is considering its options and next steps.

Key takeaways 

The decisions by the Court and declarations by the Takeovers Panel provide valuable guidance for private equity firms in respect to MAC clauses in transaction agreements and general conduct in a scheme of arrangement transaction.

1. Onus of proof

The Court confirmed that the bidder bears the burden of proving a MAC. This evidentiary burden is onerous, requiring bidders to be well prepared with robust evidence before attempting to rely on a MAC clause. 

2. High bar for bidders

The decision underscores the high evidentiary threshold for establishing a MAC. The judge devoted over 100 pages to analysing the evidence, ultimately finding that the bidder had not met the agreed threshold. Courts remain reluctant to conclude that a MAC has occurred.

3. Importance of disclosure

Late-stage disclosures proved decisive. Mayne had provided an updated monthly cashflow analysis days before signing. Although not escalated to senior management, the SID deemed these matters disclosed, thereby excluding them from the MAC. This highlights the need for bidders to scrutinize disclosures carefully, particularly those delivered late in the process. 

4. MACs are not earnings guarantees

The Court rejected the notion that a MAC underwrites earnings performance. A missed forecast is not, in itself, an “event.” However, it may serve as evidence that an event has occurred. In this case, changes in the sales team were found to have contributed to declining sales. Drafting MAC clauses and carve-outs with precision is critical. If bidders intend to capture general earnings declines, the language must allow for this, although such provisions are often difficult to negotiate. Target’s will generally argue that the MAC is not a backdoor earnings underwrite, but designed to capture unexpected catastrophes.

5. Election to proceed

Cosette’s conduct after becoming aware of declining earnings proved fatal. By entering minor amendments to the agreement and progressing with scheme mechanics (such as the first Court hearing) after becoming aware of a potential termination right, Cosette was deemed to have elected to proceed, effectively waiving its right to terminate. The lesson: once aware of a potential MAC, bidders must act swiftly and cautiously to preserve termination rights.

6. Sunset dates matter

The transaction included a mid-November sunset date, after which either party could terminate. The judge emphasized the importance of timing, ensuring the case was resolved before the deal “timed out.” Going forward, bidders may push for sunset dates to be extended in the event of disputes, a practice already common in U.S. transactions.

7. Breach of warranties

The bidder also alleged breaches of warranties, including that due diligence materials were prepared in good faith and with reasonable care. The Court rejected this claim, finding the forecasts reasonable in light of contemporaneous disclosures. Standard disclaimers against forward-looking information further weakened the bidder’s position.

8. Takeovers Panel may act in schemes

The target’s application to the Takeovers Panel and its swift actions in making orders show that it will be willing to act in scheme transactions, where it does not cut across the jurisdiction of the Court. We think targets will be more willing to call on the Panel, who can generally act quicker and make a broader set of orders than the courts.

9. Bidder intentions in scheme booklets matter

The requirement for bidders to communicate their intentions for the target in a scheme booklet must be carefully considered. The Mayne situation shows that bidders will be held to their word, and these disclosures require careful consideration. This can limit bidders’ flexibility to respond to situations that emerge after signing and before implementation.

Conclusion

The Mayne situation is a rare instance of a bidder getting cold feet and their attempts to walk from the deal being tested both in the courts and the Takeovers Panel. While Cosette has been given reprieve from FIRB, one could easily envisage a situation where a bidder may not have been so lucky. Private equity bidders should focus on the lessons and ensure they are well armed to respond to situations that emerge after signing.

However, bidders should be prepared to defend against more pressure from targets on tightening provisions of an implementation agreement that may be used to get out of a deal.