A material adverse change clause decides who carries the risk if a business deteriorates between signing and closing. In Ontario, a buyer can refuse to close only when the change meets the agreement's own definition, is durationally significant to the target's earnings, and falls outside every negotiated carve-out; a drop in revenue alone rarely qualifies. The Ontario Superior Court made that point in Fairstone Financial Holdings Inc. v. Duo Bank of Canada, 2020 ONSC 7397, when it ordered a reluctant buyer to complete a share purchase despite the COVID-19 pandemic.
For buyers, the clause offers a narrow exit and some leverage. For sellers, careful wording keeps a buyer with cold feet from treating a soft quarter as an escape hatch. Both sides gain the most when the clause is drafted with the specific business, its industry, and its financing in mind.
At Beganyi Law, our mergers and acquisitions practice negotiates these provisions for buyers and sellers across Ontario, with tax advice integrated into the same file. If a deal is approaching signing, or a counterparty has raised a MAC concern, you can call us at +1 647-977-7749 or arrange a confidential consultation, including remotely, through our contact page.
Key Takeaways
- A MAC or MAE clause protects against fundamental, lasting deterioration in the target business itself.
- Carve-outs move systemic risks such as pandemics and market downturns back to the buyer unless the target is disproportionately affected.
- The party invoking the clause carries the burden of proof, so evidence, notice, and negotiation strategy shape the outcome.
How Do MAC and MAE Provisions Work Between Signing and Closing?
MAC and MAE provisions operate during the gap between signing and closing, giving the buyer a contractual basis to refuse completion only if the business suffers a defined, serious decline. They appear in several parts of an agreement, and they function differently in acquisitions than in loan agreements, where lenders hold far broader discretion.
What Do Material Adverse Change and Material Adverse Effect Mean?
A material adverse change (MAC) and a material adverse effect (MAE) describe the same core idea: an event that significantly harms the target's business, financial condition, operations, or results. Canadian drafters use both terms, and the label carries less weight than the definition attached to it.
A typical MAC definition has two parts:
- A broad opening statement covering any fact, circumstance, change, or event that has had, or would reasonably be expected to have, a material adverse effect on the target.
- A list of carve-outs excluding categories of events, even if they hurt the business.
The phrase "would reasonably be expected to" matters. In Fairstone, the court held that the buyer had to prove, on a balance of probabilities, that a condition was reasonably expected to cause an MAE. That requires more than a possibility or risk, and the evidence must be tied to realities, using quantitative or qualitative proof.
How Closing Conditions and Representations Work Together
A MAC clause usually appears in a purchase agreement in two linked places:
- As a representation and warranty that no material adverse change has occurred since a reference date, such as the last financial statements.
- As a closing condition or condition precedent, requiring that no MAC has occurred between signing and the closing date.
The bring-down of representations and warranties in Ontario business deals ties these together: the seller confirms at closing that its statements remain true. If a MAC has occurred, the condition fails and the buyer can decline to close or use the failure to renegotiate.
Timing also matters. In Fairstone, the buyer announced it would not close on the scheduled June 1, 2020 date, yet the court assessed whether an MAE existed as of the August 14, 2020 outside date, because the buyer had not terminated. Share purchase agreements and merger agreements that set an outside date effectively give the seller until that date to show the business has held up.
How Acquisition Protections Differ From Loan Agreement Protections
Lenders use MAC clauses in loan agreements and other financing agreements, and those clauses usually give the lender much more room. A loan MAC can operate as a condition precedent to funding, an event of default, or a borrower representation, and declaring one may allow the lender to demand repayment.
In Doman Forest Products Ltd. v. GMAC Commercial Credit Corp., the British Columbia courts considered a clause letting the lender determine a material adverse effect "in its sole discretion." The trial court applied the particular lender's standard of materiality, subject to the requirement that discretion be exercised reasonably and in good faith. It also looked at the borrower's EBITDA as an important indicator of financial condition.
Feature | Acquisition agreement | Loan agreement |
|---|---|---|
Who decides | Objective test, decided by a court | Often the lender's discretion |
Typical role | Representation and closing condition | Funding condition, default, representation |
Remedy if triggered | Refuse to close or renegotiate | Refuse advances or accelerate the loan |
Buyers relying on acquisition debt should compare the two clauses, since a lender may have an exit the buyer does not. The choice between a share and asset purchase also affects how financing and closing risk are packaged.
What Makes a Business Change Material Enough to Matter?
A change becomes material when it threatens the target's long-term earnings power in a way a reasonable buyer would view as fundamental. Short-term dips, known risks, and industry-wide shifts usually fall short, and the party alleging a MAC must prove it with evidence.
Assessing Financial Decline, EBITDA, and Durational Significance
In Fairstone, the Ontario court adopted the approach developed in Delaware: the event must be unknown, must threaten the target's overall earnings potential, and must have durational significance. Courts measure that significance over years, not quarters.
Practical indicators courts and advisors examine include:
- EBITDA and earnings trends against prior years, comparable periods, and the target's historical cycles.
- Expected duration of the decline, supported by credible forecasts. In Fairstone, pandemic effects expected to last into 2022 satisfied durational significance.
- Whether the decline reflects the business or the market, which feeds directly into carve-out analysis.
Financial losses in a single bad quarter, especially in a cyclical business, rarely meet this standard. No case law fixes a percentage threshold; materiality turns on the target's circumstances and the wording of the clause.
Evaluating Lost Customers, Regulatory Problems, and Operational Disruption
Non-financial events can also support MAC claims when they strike at the core of the business. Examples include the loss of a customer that generates a large share of revenue, revocation of a licence the business needs to operate, serious product safety or compliance failures, and the destruction of a principal facility.
Each must still be measured against the definition. A lost customer that was disclosed during diligence, or a regulatory change affecting the whole sector, is likely excluded. A customer loss triggered by news of the sale often falls within an announcement carve-out.
Thorough due diligence on an Ontario acquisition sets the baseline. Courts consider what the buyer knew at signing, and Canadian M&A authorities suggest that a sophisticated buyer who proceeds knowing of a problem will struggle to call that problem a MAC later.
What Ontario Authorities and Akorn v. Fresenius Illustrate About Proof
The burden of proof sits with the party invoking the clause. In Fairstone, the buyer had to prove the MAE and also carried the burden of showing the target was disproportionately affected by an excluded event. The court found that an MAE had occurred but held that three carve-outs applied, and it ordered specific performance.
Akorn v. Fresenius, decided by the Delaware Court of Chancery in 2018, shows the other side. The court allowed the buyer to terminate after the target suffered a sharp, sustained collapse in performance alongside serious regulatory compliance problems. It was the first Delaware decision to uphold an MAE termination, and it reflects how severe and lasting the decline must be.
Together, these decisions show that MAC claims succeed only on strong, documented facts. Expert financial evidence, contemporaneous records, and industry comparisons decide these disputes.
Which Carve-Outs Shift Risk Back to the Buyer?
Carve-outs place systemic risks on the buyer and leave company-specific risks with the seller. The Fairstone court described the carve-outs in exactly those terms, and most negotiated Ontario definitions follow the same structure, with an exception for disproportionate harm.
Economic Conditions, Regulatory Changes, Pandemics, and Acts of War
Common carve-outs exclude:
- General economic, financial, credit, or market conditions
- Changes affecting the target's industry as a whole
- Changes in law, regulation, or accounting standards
- Emergencies, pandemics, natural disasters, acts of war, and terrorism
These resemble force majeure language, though they serve a different purpose: they narrow what counts as a MAC. In Fairstone, the buyer argued the emergency carve-out did not cover the COVID-19 pandemic because pandemics were not specifically listed. The court disagreed, holding that the broadly worded, inclusive language captured it.
A seller should draft these exclusions broadly and inclusively. A buyer that wants certain risks to remain its exit should name them expressly and narrow the general wording.
Deal Announcements, Missed Forecasts, and Actions Taken With Consent
A second group of carve-outs addresses risks tied to the deal itself:
- Announcement or pendency of the transaction, covering employee departures or customer reactions to news of the sale.
- Failure to meet projections or forecasts. In Fairstone, the buyer's core complaint was that the target missed its financial plan, and the court applied this carve-out, noting the buyer could have bargained for stronger protection.
- Actions taken at the buyer's request or with its consent, and actions the agreement requires.
Consent provisions link closely with interim covenants. In Fairstone, the court held that, even if the target had operated outside the ordinary course, it would have been unreasonable for the buyer to withhold consent to prudent pandemic measures.
When Disproportionate Effects Bring an Excluded Risk Back Into Scope
Most market and emergency carve-outs apply only to the extent the target is not disproportionately affected compared with others in its industry. If a recession hits the target far harder than its peers, the excess impact can count toward a MAC.
This exception produces expert-driven disputes. The parties must define the comparison group, choose metrics, and show the gap. In Fairstone, the court preferred the seller's expert evidence and found no disproportionate effect.
When negotiating, you should specify:
- Which peer group or industry applies
- Whether the effect must be "materially" disproportionate
- Whether only the disproportionate portion counts
Clear wording on these points narrows the scope of any later dispute about risk allocation under the material adverse change (MAC) clause.
How Should Ontario Buyers and Sellers Negotiate and Respond?
The strongest positions come from drafting the clause around the actual target, aligning it with financing and interim covenants, and responding to a potential MAC with disciplined notice and evidence. The remedies available if negotiations fail, including specific performance and reverse termination fees, should be settled at the drafting stage.
Tailoring Definitions, Financial Benchmarks, and Financing Conditions
Generic definitions favour sellers in practice, because broad carve-outs absorb most real-world events. Buyers seeking dependable protection can add objective benchmarks, such as a specified EBITDA floor, minimum working capital, or retention of named customers or licences, as separate closing conditions. Those terms belong in early discussions, ideally reflected in the letter of intent.
Sellers should resist benchmarks that convert ordinary volatility into termination rights. Clarifying that the clause covers the target "taken as a whole" helps.
Financing deserves a separate review. Acquisition agreements and loan agreements often contain MAC language with different triggers, so a buyer can face a lender that refuses funding while the purchase agreement still requires closing. Matching the definitions, or negotiating financing conditions, reduces that gap.
Coordinating Due Diligence, Interim Covenants, and Tax Planning
Diligence findings shape the definition. Known issues are normally disclosed in schedules and excluded, so buyers should price them or obtain specific protection, such as an indemnity or escrow. Our due diligence reviews cover corporate records, material contracts, employment, regulatory status, tax exposure, litigation, and intellectual property.
Interim covenants work alongside the MAC clause. The Fairstone court interpreted "ordinary course" by reference to how the target responded to past recessions, and it declined to let the general covenant override the specific MAE provision. Ordinary-course covenants should state whether emergency responses are permitted and how consent is requested.
Tax planning, such as lifetime capital gains exemption purification or pre-closing reorganizations, often happens during the interim period. Those steps should be expressly permitted so they cannot later be characterized as covenant breaches.
Giving Notice, Preserving Evidence, and Considering a Negotiated Resolution
When a buyer suspects a MAC, it should act promptly and follow the agreement's notice provisions. In Fairstone, the buyer raised concerns in April 2020 and announced on May 27 that it would not close, and the court still measured the MAE at the outside date.
Practical steps for both sides:
- Review the exact definition, carve-outs, and notice requirements before taking a position.
- Preserve financial data, board materials, and correspondence.
- Retain financial experts early to model duration and industry comparisons.
- Respond to information requests fully. The Fairstone court viewed the buyer's late requests as a search for reasons not to close.
A MAC claim with real merit often produces a price reduction, holdback, or extended closing. Sellers backed by experienced sell-side representation can weigh a negotiated adjustment against litigation cost and delay.
Checking Termination Rights, Specific Performance, and Reverse Termination Fees
Before refusing to close, a buyer must know what happens if a court disagrees. Wrongful refusal can amount to repudiation, and Ontario courts can order specific performance. In Fairstone, the buyer conceded that specific performance was the appropriate remedy if it lost, and the transaction closed on January 5, 2021.
Agreements should address:
- Whether specific performance is expressly available to the seller
- Outside dates and extension rights
- Termination rights and their mechanics
- Reverse termination fees payable by the buyer in defined circumstances, such as financing failure
Reverse termination fees can cap a buyer's exposure and give the seller certainty, though they must be carefully calibrated to survive scrutiny as a penalty.
Align Deal Protection With the Business You Are Buying or Selling
MAC and MAE clauses work best when they reflect the target's real risks, its industry, and the deal's financing. Ontario law sets a high bar: the change must be serious and lasting, the excluded risks remain with the buyer unless the target is disproportionately affected, and the party alleging a MAC must prove it.
Effective risk allocation in a purchase agreement combines several tools:
- A definition tailored to the business, with deliberate carve-outs
- Objective closing conditions where a buyer needs certainty
- Interim covenants that allow prudent responses and permitted tax steps
- Clear notice, termination, and remedy provisions
Whether you are buying or selling a business, the MAC clause should be negotiated alongside diligence, financing, and tax structuring. Principal lawyer Ladislav Beganyi completes more than 20 commercial transactions each year, and we coordinate the legal documents with your accountant's financial plan before you sign.
Frequently Asked Questions
Does a drop in revenue automatically let a buyer cancel an Ontario acquisition?
No. A revenue decline must meet the agreement's definition of a material adverse change, have durational significance, and fall outside carve-outs for economic conditions, industry changes, and missed projections. Short-term or industry-wide declines rarely qualify.
Is there a fixed percentage decline that qualifies as a material adverse change?
No Canadian authority sets a fixed percentage. Courts assess the target's long-term earnings potential, the expected duration of the decline, and the wording of the clause, so parties wanting a numeric trigger must negotiate a separate financial closing condition.
Can a lender refuse funding when the acquisition agreement still requires closing?
Yes, if the loan agreement's MAC clause or conditions allow it. Loan agreements often give lenders discretion to determine a MAC, so a buyer may lose financing while still being bound to close, which is why financing conditions and matched definitions deserve attention.
Does a pandemic carve-out also excuse breaches of ordinary-course covenants?
Not automatically, because the two provisions are separate. In Fairstone, the Ontario court interpreted the ordinary-course covenant in light of the target's responses to past recessions and found no breach, while a Delaware court in AB Stable reached the opposite result on different wording.
Can a seller require the buyer to close after a disputed MAC claim?
Yes, where a court rejects the MAC claim and specific performance is available. In Fairstone Financial Holdings Inc. v. Duo Bank of Canada, the Ontario Superior Court ordered the buyer to complete the share purchase after finding the carve-outs applied.