Material adverse change clauses (“MAC clauses”) are common in finance and acquisition agreements and are designed to address changes in the circumstances of one of the parties (usually the borrower or target business). For acquisitions, a MAC clause allows a party (usually the buyer) to pull out of the deal following exchange but before completion where there has been a MAC affecting the target company. In finance agreements, a MAC clause allows a lender to avoid paying out further funds to a borrower and/or to mitigate its risk regarding repayment of funds already advanced. For example, by enabling it to require further security or accelerate repayment of the loan.
But does COVID-19 constitute a MAC, either of itself or because of its direct or indirect consequences?
What counts as a MAC?
This will depend on the drafting of the clause and the specific facts of the change in question. Parties should consider.
- does the clause require that the parties act reasonably in determining whether there has been a MAC?
- does the clause carve out certain exceptions which will not be considered MACs?
- Does the MAC need to relate to the financial position of the business in question, or is it drafted more broadly?
External factors, such as COVID-19, will not necessarily be sufficient to invoke a MAC clause without evidence that these circumstances will affect the particular party. For example, the impact on the hospitality sector will look very different from the impact on businesses selling PPE equipment.
Whilst every case will turn on its particular wording and facts, the decided cases provide some indication as to how the English court is likely to interpret MAC clauses. In past cases the court has held that a MAC should not be temporary in nature. The longer-term impact (or not) of COVID-19 is not yet clear and so parties should consider carefully what evidence they will be able to put forward on this aspect.
When considering whether a change is “material”, it has been held that it is not sufficient for the change simply to affect the other party’s ability to perform its obligations under the agreement; the effect must be significant. The court will consider whether the affected party can continue to meet its payment obligations under the relevant agreement or whether the MAC puts it at risk of insolvency.
A party generally cannot rely on circumstances it was aware of when entering into an agreement. In the context of COVID-19 in due course the courts will likely have to consider what knowledge/awareness of the pandemic was required for a party to be prevented from relying on a MAC clause. Will the position be the same for contracts with MAC clauses entered into in late February as for those entered into in early/mid March? Each case will need to be considered on its particular facts and clause wording.
It is important to check the provisions of all related documentation for a transaction to ensure that the consequences of invoking a MAC clause are clear. There is a risk that a particular event or set of circumstances could constitute a MAC for the purposes of one contract involved in a deal but not for another (for example just because a lender may be able to invoke a MAC clause does not necessarily mean the buyer can walk away from the deal).
If triggering a MAC clause in a loan is an “event of default” this may also have wider consequences triggering “cross default” provisions in other contracts and perhaps leading to other lenders becoming entitled to make demands for immediate repayment of loans or enforce security.
Parties exercising a MAC clause must also comply with any notice provisions. Failure to observe the necessary provisions mean that the party relying on the MAC clause is not entitled to do so (at least until they have taken corrective action to send the proper notice).
Is it worth it?
Given the various considerations and uncertainties outlined above, except in the most clear cut of cases there is considerable risk that the affected party will bring a claim for damages alleging that the MAC clause has been invoked wrongfully. A party seeking to rely on a MAC clause should take early advice on the drafting of the clause and as to the consequences if a court finds that the provision was not triggered. It is important to consider carefully the key objective and whether the MAC clause is the best option or whether there are breaches of other obligations that could provide a “cleaner” exit. However, a MAC clause can be a useful tool to bring a party to the negotiating table and in the right circumstances can allow parties to walk away from deals that now look completely different in the new COVID-19 era.