Many facility agreements include a material adverse change (MAC) clause. A MAC clause is a sweeper clause intended to provide a lender with protection against unforeseen events which have, or may have, a significant detrimental effect on the borrower's business. The clause may be a repeating representation from the borrower about the absence of any MAC, or it may be an event of default. In either case, the ultimate purpose is to give the lender the right to accelerate the loan if the MAC occurs. With COVID-19 already adversely affecting businesses across a wide range of industries, it is not surprising that MAC clauses are coming under closer scrutiny.

The question of whether a MAC clause has been triggered by a particular event or circumstances will generally hinge on the drafting of the clause, and how it applies to the facts. It is not possible to say categorically that certain types of event will always fall inside or outside the scope of a MAC clause. Nevertheless, the (relatively few) English cases involving disputes over MAC clauses in facility agreements, together with judgments and rulings on MAC clauses in other contexts, offer useful guidance when considering the potential relevance of MAC clauses in English law facility agreements in the context of COVID-19.

Grupo Hotelero Urvasco SA v. Carey Value Added [2013] EWHC 1039 (Comm)

In this case, the High Court looked at the interpretation of a repeating MAC representation. The representation was "there has been no material adverse change in [the] financial condition [of the obligors] (consolidated if applicable) since the date of this Loan Agreement".

The dispute focused on the general deterioration in the obligors' financial position over the relevant period, rather than on any particular event or events. The court found there was no breach of the representation on the facts. However, in coming to that decision, it outlined some useful principles for interpreting MAC clauses:

  • If a lender is trying to show there has been a MAC in a company's "financial condition", this will be determined chiefly by reference to its financial information covering the relevant period. "Financial condition" would not usually cover a company's prospects or more general economic or market changes.
  • A change in financial condition is only materially adverse if it significantly affects the company's ability to perform its obligations under the relevant agreement, and in particular its ability to repay a loan.
  • A lender cannot enforce a MAC clause based on circumstances of which it was aware when it entered the agreement.
  • A change must not be merely temporary.
  • The burden of proof is on the lender to show the event or circumstance described in the clause has occurred.

Key points (i) how permanent is the change?

Of particular relevance in the context of COVID-19 is the penultimate point above – a "merely temporary" deterioration in a borrower's business on account of COVID-19 is unlikely to count as material. As a first instance decision, the Grupo Hotelero decision does not create a binding precedent in English law. However, its approach on "temporary changes" is consistent with how MAC clauses have been considered in other contexts. For example, the Delaware courts have held that an adverse change on an entity's business had to be "durationally significant" to trigger a MAC clause in a merger agreement.

Of course, it is possible that a temporary change in economic conditions could have a permanent or long-term impact on a borrower's ability to perform its obligations under a facility agreement through a "tipping point" effect. However, it is likely to be difficult for a lender to satisfy a burden of proof on this prospectively.

Key points (ii) does the adverse change need to be unique to the relevant business?

We are not aware of the English courts having considered a MAC clause in the context of a single event affecting businesses across different sectors globally or regionally. Usually any alleged cause of a MAC is specific to the business in question – for example, an adverse court or tribunal judgment (as in Cukurova Finance v. Alfa Telecom [2013] UKPC 2) or an asset freeze (as in BNP Paribas S.A. v. Yukos Oil Co [2005] All ER (D) 281 (Jun)). However:

  • In 2001 the UK Takeover Panel ruled on the subject of a MAC condition in the context of the 9/11 terrorist attacks. WPP had made an offer for Tempus Group plc. WPP argued that the attacks had caused a MAC to occur. The Panel accepted that in certain circumstances a party could rely on economic change affecting a broad industry as the basis to invoke the MAC clause. However, a causal link still needed to be established between the unforeseen event and the adverse change to the relevant business. Of course, this is a decision of a non-judicial body interpreting the City Code – courts may not take exactly the same approach.
  • In Socomex Limited v. BBL [1996] Lloyd's Law Reports 156 the court accepted, in the context of a loan agreement, that poor economic conditions across a specific industry in which the borrower operated (the coffee market) entitled the bank to "reasonably conclude that Socomex's ability to perform its obligations … had been materially and adversely affected". However, the case was decided on other grounds.

Our view is that it is possible for a single event with a global, regional or cross-sector effect (such as COVID-19) to be the ultimate cause of a MAC. However, despite the approach taken in Socomex, the burden of proof will generally be on the lender to show the actual effect on the borrower's business, rather than on businesses of a similar type to the borrower's.

Conclusion

There are broader reasons to believe that, for most borrowers, the MAC risk on account of COVID-19 is likely to be low, at least at this stage:

  • However broadly drafted a MAC definition is, and however adverse an event or circumstance is on a borrower's business, there will often be a degree of doubt about whether a particular event or circumstance falls within the scope of the definition. Where the agreement includes a loose subjective test of whether a MAC has occurred (i.e. whether the lender believes a MAC has occurred) rather than an objective test, a lender may feel more confident in its rights to trigger a MAC clause in some circumstances. However, lenders generally want certainty before calling events of default, so rarely seek to enforce MAC clauses. A breach of financial covenants will in most cases be a greater risk for affected borrowers.
  • More generally, we anticipate that, for relationship and reputational reasons, most lenders will be reluctant to take precipitous enforcement action against previously performing borrowers solely on account of COVID-19. The position may be different if an already struggling business has been pushed to the point of no return.