Solicitors frequently use the term “material adverse effect” but what does it mean?

In BM Brazil I Fundo De Investimento Em Participacoes Multistrategia v Sibanye BM Brazil (Pty) Ltd [2024] EWHC 2566 this was considered by the High Court in relation to a no material adverse effects condition in the share purchase agreements governing the transaction.

The High Court considered whether the buyer was discharged from its obligation to complete the acquisition of two Brazilian mines by contending that a geotechnical event occurring in relation to one of the mines post exchange allowed termination under this condition.  The condition was defined as any “change, event or effect, that… 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 [target companies] …”.

The High Court ruled that the geotechnical event did not satisfy this condition and the buyer had wrongfully terminated the agreements.

Key observations were:

  • The condition must be interpreted in the context of the agreement as a whole, including other risk allocation provisions. In this case, the definition and its use as a condition indicated that it was concerned with matters occurring after signing and the language provided that a matter was only relevant if the “change, event or effect” was itself material and adverse. To this end, what might be revealed as a consequence of the “change, event or effect” and any investigations it triggered regarding issues in existence when the agreements were signed were irrelevant.

 

  • What “would reasonably be expected to be material and adverse” required an objective evaluative judgment rather than an assessment considering possible views. The likelihood implied by the wording was “more likely than not” making a chance risk of materiality insufficient.

 

  • Materiality required something significant or substantial. As there is no universally applicable test for materiality in all such clauses, a number of considerations should be taken into account in any particular case. Here, relevant factors included the size of the transaction, the nature of the assets, the duration of the sale process and the complexity of the agreements, all of which indicated that this was not a low bar. While the High Court held that a reduction in equity value of at least 20% would be material, with 15% potentially sufficient, but 10% too low in the circumstances, nevertheless, whichever threshold applied, the High Court considered the geotechnical event as not material based on the facts.

It is therefore important to make sure that when drafting such a clause that the intention is clear, and the assessment required for something to be considered material if this is to be relied upon as a condition.

If you would like to discuss any of the matters raised in this article, or share purchase agreements or commercial contracts generally, please contact Sing Li.