While the impact of the EU referendum decision on outstanding financing transactions is still to be determined, both lenders and borrowers may be wondering if the ramifications of Brexit have or could be considered to constitute a ‘material adverse effect’ (MAE) thereby triggering a ‘material adverse change event of default’ under their financing documents. The likelihood of this will depend on both the particular factual circumstances of the obligors and the negotiated position under the documentation.
The Brexit vote itself is unlikely, in itself, to constitute an MAE, but the effects of the vote, most notably (in the short terms at least) currency fluctuations on non-hedged transactions, could be viewed as sufficient to constitute an MAE. Whether this is true in any case will depend on the drafting of the particular MAE clause in the financing documents, with such clauses typically taking one of two approaches. Under the first approach the MAE analysis is objectively determined and narrowly focused on the obligors and their ability to meet payment obligations. Under the second approach the MAE analysis is determined in the lender(s’) reasonable opinion and focuses not just on the ability of obligors to meet payment obligations, but also more broadly on the business, operations, and prospects of the obligors.
The particular drafting of the MAE clause will vary across documents and could fall within the two approaches set out above, or some variation thereof. Loan documentation typically includes as an ‘event of default’, an event or series of events, which in the lender(s) opinion, could be expected to have an MAE. If an MAE event of default occurs, lenders are able to exercise any rights and remedies available to them under the applicable documentation, including the right to enforce security, accelerate repayment of a loan and cancel commitments.
Generally speaking, lenders are reluctant to call an event of default solely on the basis of the occurrence of an MAE alone. We don’t see this situation as likely to change in the immediate future, at least in so far as it relates to the enforcement of security following an MAE event of default.
It is possible that such reluctance may not extend to the cancellation of commitments, however. The EU referendum clearly caused immediate upheaval in markets across the world, but the long lasting effects of that on both a macro and individual basis are not yet clear. Anxious lenders with broadly drafted MAE clauses will likely be keeping a close eye on future events or developments and how those developments impact on their specific obligors. They may soon take the view that a default has occurred under their documents.
Careful consideration of MAE clauses by both lenders and borrowers is important. For lenders, they may want to ensure that they can utilise all available tools to mitigate against risk. Borrowers may want to consider what, if any, actions they can take to avoid a lender determining that an MAE has occurred.