In light of the significant business downturn occasioned by the COVID-19 pandemic, we anticipate that the meaning and effect of 'Material Adverse Change' or 'MAC' clauses will be of critical potential importance to all businesses reliant on debt financing, and the professionals who advise them.
MAC clauses are commonplace in loan facility agreements and are provided for in substantially all loan facilities on the Loan Market Association standard forms (save for certain investment grade debt). MAC clauses are also found in business acquisition agreements (most typically, in the UK at least, in public acquisitions) and other more general contracts (such as long-term supply agreements in the commodities context). In the interests of brevity we only consider in this article the paradigmatic case of MAC clauses in loan facility agreements. However, the principles applicable to the consideration of MAC clauses in loan facility agreements will have general application to MAC clauses in other business contexts.
Where are MAC clauses typically found?
While their meaning and effect obviously turn on their precise terms, MAC clauses are often found in the following instances:
- as 'event of default' clauses that provide that in the event of a generally unforeseeable event that materially effects the borrower, the lender will have the option to accelerate the debt due or to place a stop on drawdowns;
- as part of a borrower's representations and warranties to the lender either between the signing of the loan facility and first drawdown, or before each drawdown e.g. there has been no material adverse change in the financial condition of the borrower since the most recent borrower's audited financial accounts provided to the lender; and
- as an important qualifier to certain covenants, representations or warranties provided by the borrower to the lender (e.g. the borrower is not in breach of any covenants where such breach would give rise to a Material Adverse change in the borrower's business).
Guidance from the Court
The leading English case on the interpretation of MAC clauses is Grupo Hotelero Urvasco SA v Carey Value Added SL  EWHC 1039 (Comm).
The case concerned the financing of a hotel in London by a Spanish fund that invested in hotels (Carey). Grupo Hotelero Urvasco (GHU) was involved in developing the hotel and had entered into a loan agreement with Carey in 2007. The agreement contained a 'plain vanilla' MAC clause pursuant to which GHU represented that there had been 'no material adverse change in its financial condition'. The representation was made and repeated at specified times. Carey ceased lending in 2008 after it become concerned about GHU's financial position given the decline in the Spanish economy due to the collapse of the Spanish property bubble. Work on the hotel development stopped and GHU claimed damages for breach of contract. Carey argued that it was entitled to refuse drawdown because a MAC to GHU's financial position had taken place.
Though the interpretation of the MAC clause turned on the specific wording of the clause in question Blair J's judgment in Carey provides some helpful guidance as to the approach a Court is likely to take (see [334- 364] of the Judgment). In particular:
- If the MAC clause requires a change in the 'financial condition' of the borrowing company that condition will be assessed primarily by reference to the company's financial information (interim financial reports and/or management accounts), though other information relevant to the company's financial condition can be taken into account (such as missed debt payments in Carey). If the clause in question refers to the 'business and financial condition' it is likely that a wider range of matters can be considered.
- Evidence of 'external economic or market changes' (e.g. the collapse of the Spanish property bubble in Carey) will not generally be sufficient to trigger a MAC clause. This is because the individual borrower may perform better or worse than the sector in question. However it is worth noting that evidence of external economic or market changes may be more relevant and persuasive in the context of the COVID-19 pandemic than it was in the context of the collapse of the Spanish property bubble. This is because the strict lockdowns imposed across the world have meant that certain sectors have simply been unable to trade at all such that questions about a company's ability to perform better or worse than others in the same sector do not arise in the same way.
- There must be a change. Therefore a lender cannot rely on circumstances that it was aware of when the agreement was entered into unless 'conditions worsen in a way that makes them materially different in nature'. This is most relevant to contracts entered into after the pandemic was under way.
- The change must be 'material'. It must affect 'the borrower's ability to perform its obligations, in particular its ability to repay the loan'. Further it must 'significantly' affect that ability because otherwise 'a lender may be in a position to suspend lending and/or call a default at a time when the borrower's financial condition does not fully justify it, thereby propelling it towards insolvency' and the impact must not be temporary (even if the event causing the impact is).
- The burden of proof is on the lender (or party seeking to rely on the MAC clause). The importance of the quality of evidence required was emphasised in Decura IM Investments LLP v UBS AG London Branch  EWHC 171 (Comm).
Key considerations when interpreting/drafting a MAC clause
Given the above, the key considerations when interpreting an existing MAC clause or drafting a new one include:
- Scope of the clause: What needs to have changed? Is it only a change in a company's financial condition that will suffice or are other matters taken into account? There is a wide range of possible wording from clauses that allow a range of generally defined matters to be taken into account (finances, business, prospects and property for example) to clauses which are triggered on the occurrence of a specific narrowly defined event (a particular change in the company's accounts or a downgrading of its credit rating for example).
- Timing: Does the clause require the material change to have occurred or is it enough to point to an event that has occurred and a change that is likely to (or may) occur. If the latter, what is the standard that is to be reached?
- Whose assessment: Is the lender's subjective assessment enough or is the position to be determined by some objective criteria, and if so, what? On appeal from a decision of the British Virgin Islands Court of Appeal, the Privy Council in Cukurova Finance International Ltd v Alfa Telecom Turkey Ltd  A.C. 293 considered a MAC clause in a facility agreement that provided 'Any event or circumstance which in the opinion of [the lender] has had or is reasonably likely to have a material adverse effect on the financial condition, assets or business of [the borrower].' It was common ground between the parties that the MAC clause only required the lender to believe that the MAC clause engaged and that such belief had to be both honest and rational. The Privy Council considered that the lender would have to convince the Court by admissible evidence that it had in fact formed the requisite opinion and that such opinion was honest and rational. See also Torre Asset Funding Ltd v Royal Bank of Scotland Plc  EWHC 2670 (Ch) where the MAC clause was conditioned on 'the reasonable opinion of the [agent for certain lenders]' with the effect that the MAC clause was not triggered even though another event of default relating to the borrower's finances was.
Wider clauses are usually considered 'lender friendly' (and outside of the lending context friendly to the party entitled to trigger the clause if the relevant change occurs in its counterparty's finances). However it is worth bearing in mind that the interpretation and application of a clause drafted in wide and general (sometimes even intentionally vague) terms is inherently more unpredictable than a clause referring to a specific, narrowly defined event or events. Some lenders may prefer certainty especially given the risk of becoming liable to the borrower for a repudiatory breach of contract if a MAC clause is triggered when no material change has occurred. This could prove costly especially if the financing in question is central to the borrower's business (such that without it the borrower would become insolvent) or a particularly lucrative business venture.
In addition to the above matters, when drafting a MAC clause it is also important to consider practical matters such as what documents are likely to be required in assessing whether a MAC has taken place. As set out above the burden of proving a MAC is on the lender but the borrower will likely hold the most relevant information about its finances (and, if relevant, business prospects, property etc.). A lender may therefore wish to include express contractual obligations on the borrower to e.g. hand over relevant information periodically or when prompted to do so.
When drafting a clause it is also crucial to consider what the MAC clause is intended to achieve. Some MAC clauses can simply be relied on to trigger an event of default. Others allow for a wider range of outcomes and can be relied on to trigger an obligation to provide further security for example. There is a range of possibilities. It should not be assumed that a lender will always wish to call an event of default. In the current unusual circumstances where entire sectors of the economy are under threat a lender may reasonably take the view that it would be better to allow a borrower to try and (eventually) 'trade out' of a dire financial situation with the hope of keeping that company (or sector) as a client in the future. But such a lender may still wish to rely on the MAC clause to trigger further security or other similar protection in the event of a material change in the borrower's finances or business.
The meaning of each MAC clause will obviously turn on its wording. While perhaps the conventional reading of Carey is that a downturn in general or sectoral market conditions would not generally be sufficient to trigger a MAC clause, it may be arguable that the effects of the COVID-19 pandemic raise such widespread and novel circumstances that the English Courts will take a more expansive approach.
Shortly before publication of the Quadrant Chambers Special Edition of International Corporate Rescue and well after our article was initially published, Cockerill J handed down her decision in Travelport Limited et. al. v. Wex Inc.  EWHC 2670 (Comm). The case raised complex factual issues which, for reasons of both time and space, are not addressed in this brief Stop Press. The case concerned the construction of the provisions of a Share Purchase Agreement and in particular the construction of a 'Material Adverse Effect' clause. The Judge expressly referred to Carey and described it as the leading English authority on point even though on the facts of the case in Travelport it was of limited assistance. Carey concerned a banking transaction, and not a share purchase agreement. The Judge reviewed many of the leading US decisions on MAC clauses including the case of Akorn Inc. v. Fresenius Kabi AG (Del. Ch. 1 October 2018). In Akorn, the Vice-Chancellor of the Delaware Chancery Court had observed that: 'The typical MAE clause allocates general market or industry risk to the buyer, and the company specific risks to the seller.' Cockerill J derived some, albeit limited, assistance from these US authorities while noting at paragraph 176 of the judgment that: 'there is a dearth of English authority on point ... those [US] authorities will obviously not be binding or formally persuasive, but to ignore the thinking of the leading forum for the consideration of these clauses, a forum which is both sophisticated and a common law jurisdiction, would be plainly imprudent – as well as discourteous to that court.' On the main issue of construction, Cockerill J ultimately found for Wex on well-established principles of contractual construction.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.