Mythical Adverse Effect

The material adverse effect (“MAE”) definition in mergers and acquisitions agreements is one of the most intensely negotiated, litigated, and studied contract provisions ever. Practitioners and scholars alike encourage attorneys to bargain extensively over these definitions, which are among the most contentious terms in the world’s largest transactions. Challenging this longstanding conventional wisdom, this Article shows that endemic efforts to customize MAE definitions’ language are in fact inefficient and counterproductive. Each of the purported benefits commonly attributed to extensive MAE negotiation — most notably, risk allocation and incentives to settle disputes through renegotiation — is illusory under Delaware law, which governs most major M&A agreements. Careful analysis of that state’s jurisprudence, including recent cases emerging from the COVID-19 pandemic, reveals that standardized definitions could provide all the same benefits without any of the substantial but overlooked costs of protracted negotiations. Rather than fine-tune and fight over MAE definitions, lawyers could achieve their underlying goals more effectively by devoting their limited negotiating capital to other contract provisions. By refocusing the conversation from failure to success, this alternative approach should eventually facilitate contractual innovations that promote deal completion without the wasteful brinkmanship that pervades today’s transactions. Analogous analysis extends beyond M&A to all types of business contracts. Finally, this Article’s findings regarding MAE definitions cast doubt on a basic tenet of orthodox contract theory, revealing that “front-end” transaction costs and “back-end” enforcement costs have a more intricate relationship than scholars have long supposed.