The recent dramatic decline in the value of the Turkish Lira (the Turkish currency has lost about 10 percent since mid-December) as well as the substantial increase in interest rates (the Turkish Central Bank ramped up interest rates on 28 January, a measure which has already shown some positive impact on the local currency) have stressed liquidity in borrowers and lenders alike and may lead purchasers in uncompleted transactions to reconsider their investment. Such stakeholders will wish to review their options: can a bank demand early repayment and will it be obliged to meet the next drawdown request? Is a borrower in jeopardy of seeing its loan accelerated and potentially security over its assets enforced? Can an investor safely walk away from an uncompleted deal? A close analysis of some of the "boilerplate" paperwork could be crucial.
Although other laws may view dramatic currency fluctuation as a force majeure event, if the deal is governed by English law (which is the case in most international style LMA-based loan agreements with a Turkish component as well as in a fair number of Turkish M&A transactions involving a foreign party), this will not of itself justify either party refusing to perform. However, many loan, investment or acquisition agreements include "material adverse change" (MAC) or the similar “material adverse effect” clauses (for brevity we shall refer to the loan scenario and to borrowers and lenders but similar principles can apply to other transactions).
Until 2013 MAC clauses have kept a very low profile in the English courts but last year two cases gave an insight into the difficulties they raise. MAC clauses vary considerably as they are often heavily negotiated in both equity and debt transactions, and these court decisions emphasised that in every case the particular provision will require careful review. If more than one agreement is potentially relevant each clause must be examined: the wording may differ, but even if it is the same, each clause must be viewed in the context of the agreement in which it appears and be applied to the factual position of the relevant party to that agreement. In Urvasco, only one of the three relevant provisions was triggered.
MAC clauses typically relieve a party (the lender or buyer) of its obligation to perform if there has been a MAC in the condition of the borrower or target company. MAC events can also be linked to a representation or an event of default, which can in turn trigger early repayment obligations.
Traditionally, and in particular in loan agreements, MAC wording is deliberately vague: its function is to provide protection against a range of essentially unforeseen circumstances. That is the power of the clause but also its weakness: its precise ambit is unclear and so reliance on it can be uncertain. The recent guidance from the English Courts gives increased clarity but caution remains important. This is also one of the reasons why, in M&A acquisition agreements, we have seen more and more MAC clauses which try to expressly capture specific events, whether by way of example or exhaustively, so as to make such clauses more easily enforceable and their effects more clearly foreseeable (e.g. an actual or foreseen specific loss in turnover or profits, and even devaluation of the relevant currency over a certain threshold).
MAC clauses vary in important ways. The biggest structural difference lies in whether the clause is objective or subjective: must there have actually been a change (objective) or is it sufficient that the lender believes there has (subjective)? In Cukorova the Privy Council confirmed that a subjective clause requiring only such belief is effective. The Lender must prove (by evidence) that the belief was in fact held by a real person (whose belief is to be associated with its own belief). However, it is enough that the belief was held, even if it was incorrect (although the Privy Council confirmed that the belief must be honest and rational).
It is then necessary to check what must have changed to trigger the clause: does the clause cover only change in the borrower's financial condition or does it extend to wider changes e.g., to its business or even, in some circumstances, to the general market conditions.
In Urvasco the Commercial Court interpreted a clause triggered by a MAC in the borrower’s "financial condition" as being limited to a change in its financial ability to meet the obligations the subject of the clause (e.g., to meet interest and capital payments). The fact that it may have become less likely to able to meet future liabilities would not be sufficient. Changes in the wider business environment (such as currency deterioration) should not be sufficient unless they have already had the relevant type of adverse effect on the borrower's own position (or, of course, unless specifically captured). Urvasco also illustrated that, although such adverse effect will usually be proved by the borrower's accounts, other "compelling" evidence of a change in its ability to pay will be accepted.
It is important to note how the Court reached the conclusion that the term "financial condition" must be read in this limited way: this flowed from the requirement that the change must be “material”, which in turn posed the question “material to what?” The Judge said "unless the clause is read in this way, a lender may be in a position to suspend lending and/or call default at a time when the borrower's financial condition does not fully justify it, thereby propelling it towards insolvency … to be material, the adverse change must be material in a substantial way to the borrower's ability to perform the transaction in question…the adverse change will be material if it significantly affects the borrower’s ability to repay".
That analysis suggests (but not with complete certainty) that a similar conclusion would have been reached if the word "financial" had not been included. However, many clauses extend to include adverse changes to the borrower's "business" rather than simply its financial condition. This is clearly a wider term than “condition” and so would not be limited to changes in the financial condition. However, the logic of the Urvasco decision suggests that materiality will still be judged by the effect it has on the borrower’s ability to meet its payment obligations. It follows that the practical effect of using this wider term could be rather limited.
The MAC clause will only be triggered if there has been a "Change": pre-existing conditions will not qualify. More controversially, the Court in Urvasco said that a foreseeable development of such conditions would also not qualify, although the Judge conceded that they would be sufficient if they worsened sufficiently to make them materially different in nature. That dividing line is likely to prove hard to identify and an uncertain basis for action.
It must be shown that the change existed at the relevant date when the MAC clause was invoked to suspend performance/ accelerate repayment. Proving that it occurred after the relevant date will be insufficient. Moreover, the change must not be "temporary". Although this does not mean it must be permanent, the Court gave no guidance as to where the line must be drawn.
US Courts have considered MAC clauses more frequently than UK Courts but usually in the context of sale and purchase agreements. In a New York law court case, the buyer wanted to terminate its agreement to acquire the target because of material adverse change, based on the target’s poor earnings performance over two quarters and a small asset write-down. The court held that the broadly drafted MAC clause should be read as a backstop, protecting the buyer from the occurrence of unknown events that substantially threatened the overall long-term earnings potential of the target. The determination of materiality should look at the long-term effect on earning power over a commercially reasonable period measured in years rather than months. The decision also indicated that it is difficult to use the clause as protection from the consequences of a problem disclosed to the other party, since the buyer is deemed on notice of the reasonably foreseeable consequences of that problem.
Many Turkish Court decisions on Turkish law governed contracts following the ‘94, ‘99 and ‘01 crises accepted currency devaluation as a reason to rescind contracts, but only as a means of protecting consumers, under housing or other consumer loan agreements. Such court decisions were motivated by the fact that the basis/cause of the agreement was no longer in place, a different but similar argument to force majeure. As far as commercial loans are concerned, it is unlikely that courts would reach a similar conclusion in the absence of a specific MAC or similar clause, since, as stated in a 2003 decision of the Council of Courts of Appeal, businessmen are expected to be prudent enough to foresee that such devaluation may occur anytime. Any economic downturn may have dire consequences under Turkish law “general loan agreements” entered into following the local standard - even where they do not include a MAC clause, such loans can basically be accelerated at will, leaving the entire loan amount due and payable. This is one of the reasons why, during the ‘01 crisis, the Turkish government had taken the initiative to save companies and enacted a law requiring the banks to enter into restructuring agreements with the businesses distressed due to devaluation, as courts would/could not take any such decision.
MAC clauses can be a very powerful tool protecting parties from events and circumstances that may alter the prospects of their deal, but also one which is particularly difficult to interpret and the effects of which are particularly difficult to grasp and anticipate. This is why parties negotiating debt and equity transactions should be mindful about including carefully crafted MAC provisions, adequately protecting their interests. Also, before terminating or accelerating an agreement in reliance on a MAC clause, the parties should seek legal advice to make sure they stand on solid grounds. If a party unlawfully triggers a MAC, it may be exposed to significant damage claims, given the usually dire consequences of MAC-based termination. A MAC clause may not only allow a party to unwind a transaction, but can also be used as leverage in negotiating a price reduction or better terms for the deal, if a MAC occurs.
On the other hand, the party who is under the threat of a MAC-based termination should seek legal advice to check the strengths of the argument of the counterparty and prepare its strategy. For instance, one consequence of a MAC-based default may be to allow the lender to enforce security- however, if the borrower can refinance in time it may be possible to seek relief from forfeiture.