The recent case of Decision Inc Holdings Proprietary Limited v Stephen Garbett, Anis El Mariesh [2023] EWHC 588 (CH) provides useful guidance as to how courts may consider materiality when construing a material adverse change warranty (MAC warranty).

MAC warranties (contractual confirmations given by sellers that there has been no material deterioration or adverse change in a target company’s financial position since its last accounts) are commonplace in share purchase agreements, and were included within the share purchase agreement for the purchase of shares in an IT consultancy which came under scrutiny in this case (agreement). In particular, the claimants alleged breaches by the sellers of the following MAC warranty: that there had been no material adverse change in the turnover or the prospects of the company.

The court, having regard to a decision from the Delaware courts amongst “a dearth of relevant English authority” on the meaning of material adverse change, adopted a three-stage process to assess the MAC warranty breaches:

1. Calculate the baseline figure - the expected or forecasted level of the relevant factor at the time of entering into the agreement.
2. Calculate the actual figure - the actual level of the relevant factor at the time of entering into the agreement.
3. Calculate the difference between the baseline and actual figures, and then objectively determine whether that difference is material: whether a reasonable person who entered into the agreement with the aims and objectives of the buyer would have sought to withdraw from or renegotiate the transaction had he known of the change. In a contractual context, the breach of a clause is material if, had it been known to the other party in advance, that other party would have either declined to proceed with the transaction or agreed to proceed but only after a renegotiation of the financial terms.

On the facts, applying the above tests, the court held:

1. There was no breach of the MAC warranty in respect of turnover. Reference to "turnover" is purely retrospective, so the baseline figure for the purpose of stage 1 above is the historic level of turnover of the company as set out in the financial information which they provided to the other party. Despite a significant drop in actual figures at the effective date of the agreement, the judge was not certain that the turnover figures were so far away from the long-run average for the company that a hypothetical reasonable seller would have concluded that there had been a fundamental change in the nature of the revenue flows.
2. There had been a breach of the MAC warranty in respect of prospects. The buyer had protected itself with a waterfall pricing structure whereby the price it offered deteriorated in line with a decrease in the target company's EBITDA (earnings before interest, taxes, depreciation, and amortisation).

This guidance is particularly useful for sellers when considering whether or not a disclosure is required against any MAC warranties, since the court has set out a specific objective test as to what may be considered a "material" difference.