By David van Dijk MRICS
The current market conditions are unprecedented, leading many buyers, sellers and financiers to reconsider envisaged acquisitions, divestments and financing.
MAC clauses in real estate transactions
Unlike in M&A and corporate finance deals, the inclusion of a material adverse change (MAC), material adverse event (MAE) or material adverse effect (also MAE) clause in a purchase agreement is not yet standard in Dutch real estate transactions. Some agreements contain a MAC clause but most don't.
In M&A and corporate finance transactions, a MAC or MAE is a change in circumstances that significantly reduces a company's value. In real estate transactions, whether structured as an asset deal or a share deal, the target's value is generally represented by the underlying real estate, not the business of the company owning the real estate. A key characteristic of real estate investments is that they are usually relatively unaffected by short-term economic changes and interest rate fluctuations, due to long-term leases. For this reason, real estate investments have historically been considered an important hedging tool, used to obtain a diversified investment portfolio. The value of the real estate owner - and the value of the underlying real estate for that matter - will generally not be as affected by material external events or changes as that of regular companies (meaning companies whose sole purpose is not to own real estate).
Parties to real estate purchase agreements that contain a MAC clause may be allowed to request changes to the agreement or to withdraw from the transaction altogether, depending on the wording of the MAC clause and other circumstances of the transaction.
One relevant circumstance is the time the agreement is entered into. If a purchase agreement containing a MAC clause was entered into before the COVID-19 crisis, the parties may be able to use the clause to renegotiate the agreement or withdraw. However, if the agreement was entered into after the COVID-19 outbreak, they will most likely not be able to do so as the event was already known at the time the agreement was concluded which, in most cases, will render the MAC or MAE clause inapplicable.
A MAC clause may contain a carve-out for pandemics. This is actually not unusual, as MAC clauses also tend to exclude events such as terrorism and natural disasters. In that case, the MAC clause will most likely not provide the parties with relief either.
Ratios and metrics
To avoid uncertainty, parties are advised to include specific ratios and metrics in the contract to determine precisely when a negative impact exists. In the absence of such arrangements, the court will have less contractual guidance and will have to interpret the intent of the parties and determine the existence of a MAC based on its own assessment of the relevant ratios and metrics.
Reasonableness & fairness and unforeseen circumstances
As mentioned above, due to the nature of real estate as an asset class, MAC clauses are not that common in purchase agreements in the Dutch real estate sector.
What does this mean when a party wishes to amend or exit a deal between signing and closing due to the current COVID-19 situation?
All may not be lost.
Several provisions of the Dutch Civil Code (e.g. Arts. 6:2.2, 6:248 and 6:258) recognise that an agreement can be considered unreasonable in certain situations, resulting in it being partially invalidated by operation of law. Moreover, Dutch law recognises that circumstances can change through no fault of either party and that these changes can be so significant that it would be unreasonable for a party to expect the other party to adhere to the agreement. In these situations, the parties can argue that a certain part of the agreement is no longer valid or ask the court to amend the agreement to bring it into line with what would be deemed reasonable in the specific circumstances or even to invalidate the agreement altogether.
Obviously, the rule of law requires that parties in principle be able to rely on their agreement, as long as it is within the limits of the law. This means that the concepts of reasonableness and fairness and the existence of unforeseen circumstances do not provide the parties with carte blanche to get out of an agreement or change its conditions. The threshold to apply these concepts is high, and the courts are generally reluctant to do so. However, the law does provide for an escape hatch in extreme cases where, in view of the consequences, it would simply be unreasonable to expect a party to comply with the agreement (in unmodified form).
What about COVID-19?
Does COVID-19 qualify as a circumstance that could trigger the application of these concepts? If the contract was entered into before the crisis, the answer to this question is probably yes.
Does this automatically mean the agreement is invalid or can be amended? No, not automatically. This is a completely separate assessment, the outcome of which will depend on the specific circumstances and the consequences of the COVID-19 crisis on the commercial position of both parties.
COVID-19 considerations when drafting real estate purchase agreements
- Expressly stipulate in the terms of the agreement that the current COVID-19 crisis has been taken into account.
- Consider what this means exactly. Do the parties assume the situation will be over in three or six months? What is meant by “over”? What if the circumstances last longer or if the time between signing and closing is longer? Will this have an impact?
- Anticipate consequential effects. It is important to take into account not only the COVID-19 crisis but also, for example, what will happen if tenants go bankrupt between signing and closing as a result of the crisis.
- Agree on specific ratios and metrics to be used to determine whether a MAC has occurred.
- In turnkey development projects, address what happens if the general contractor goes bankrupt as a result of the COVID-19 crisis.
Please click here for more information on the COVID-19 crisis.