As a result of the credit crisis, lenders are placing greater reliance on market material adverse change (market MAC) provisions in commitment letters. These clauses remain untested in Canadian courts, and it is highly likely that a duty of good faith applies. Nevertheless, by carefully negotiating and exercising a market MAC, lenders may significantly improve its enforceability.
A market MAC (also known as "market out") relieves a lender of its obligations under a commitment letter in the event of a "material adverse change" in financing, banking or capital markets. The objective is to protect lenders against the risk that a loan cannot be syndicated (at least on its original terms) due to unanticipated changes in the markets generally.
Usually, a market MAC clause expressly provides that it is within the lender’s discretion to determine that a "material adverse change" has occurred. Various terms may be used to describe the lender’s discretion; these include "opinion" or "sole judgment."
No matter how strongly stated, language describing a lender’s discretion will be interpreted as requiring an exercise of good faith. The Ontario Court of Appeal has consistently held that contractual discretion must be exercised honestly and in good faith. Depending on the contractual term and facts, the exercise of good faith may be measured on a mixed subjective and objective standard.
In addition to general jurisprudence on contractual discretion, a court deciding a case regarding a market MAC might also have regard to emerging US case law. Leading US cases in this area involve provisions directed at changes in the target of a merger or acquisition, so they arise in a different context. Nevertheless, an Ontario court may be influenced by US decisions holding that parties seeking to invoke a "material adverse change" provision bear a "heavy burden."
When negotiating a market MAC, a lender should consider:
- Whether "material adverse change" can be defined in objective terms so that its occurrence is difficult for the borrower to deny, and difficulties associated with the duty of good faith are avoided.
- If "material adverse change" cannot be defined objectively, use strong language to describe the lender’s discretion, such as "sole discretion."
- If there are existing adversities in the market, as is the case today, make sure they are incorporated into the definition of "material adverse change" so that even a slight deterioration will be sufficient.
- Avoiding pre-contractual statements to the effect that the "market MAC" is only boilerplate, and including an entire agreement clause, in order reduce the risk that the borrower could rely on such statements in litigation.
McCarthy Tétrault Notes:
When deciding whether to exercise a market MAC, remember that a duty of good faith will almost surely apply, so a rigorous, well-documented analysis should be undertaken. The record should be one the lender could confidently defend in court, if necessary. Fortunately, invoking a market MAC often results in a renegotiation of terms, rather than litigation, but it is better to hope for the best and plan for the worst.