Material adverse change or ‘MAC’ clauses provide lenders with a potentially powerful means of protecting their interests in the current environment, where the financial condition of a borrower group can change quickly, and not always for reasons within its direct control.
It is generally accepted by both lenders and borrowers that a loan agreement will contain a ‘material adverse change’ or MAC warranty, undertaking and event of default.
However, lenders traditionally shy away from enforcing on the basis of a MAC clause because of the potential for dispute (compared to a payment default, which is typically easier to enforce).
To date, there has been little guidance from Australian courts as to the circumstances in which a lender can solely rely on a MAC clause as a means of triggering a default.
However, a recent decision by the High Court of England and Wales provides some welcome guidance as to how Australian Courts may themselves decide the circumstances in which an MAC clause can be successfully relied upon by a lender – even though the lender in that case was ultimately unsuccessful.
The Grupo Hotelero decision – some guidance from the United Kingdom
In Grupo Hotelero Urvasco SA v Carey Value Added SL & Another, the lender refused to lend further funds to the borrower, arguing that any draw would cause a breach of the MAC warranty in the loan document (the warranty was repeated as a condition of each draw under the loan document), and hence it was not required to issue further funds to the borrower.
The precise wording of the MAC warranty in the loan document was that, at the relevant time, including at the time of each draw, there had been ‘no material adverse change in the financial condition (consolidated if applicable) of the Borrower since the date of the loan agreement’.
The argument put forward by the lender to support its decision not to provide further funding was that the term ‘financial condition’ was a general phrase which had no inherent limitations. It was not, for example, limited to particular parts of company accounts such as net current assets or profits, and allowed the court to consider all aspects of the company's finances including balance sheet items (assets and liabilities), profit and loss account items and cash-flow or liquidity items, and the impact on these of the state of the markets in which the company was operating.
As such, the lender was entitled to rely on the information it received to come to the decision that the financial condition of the borrower had been adversely affected, and that the impact was material.
The borrower countered by arguing that the purpose of a company's accounts was to provide a picture of the financial state of the company, so any consideration of a company's financial condition by a lender looking to rely on a MAC clause should begin with an assessment of the company’s position as shown in financial statements as at the relevant date.
On that assessment alone, the borrower’s financial condition may have been affected, but that impact was not material or overly adverse such that it should entitle the lender to cease further funding on that ground alone.
Key commentary from the decision
The High Court made it clear that financial information alone was not sufficient to rely on a MAC clause, and that there should also be ‘…compelling evidence to show that an adverse change sufficient to satisfy a [MAC] clause has occurred, even if an analysis limited to the company's financial information might suggest otherwise.’
The High Court provided some further guidance on what amounted to a ‘material’ adverse effect, concluding that ‘…unless the adverse change in its financial condition significantly affects the borrower's ability to perform its obligations, and in particular its ability to repay the loan, it is not a material change… any change must not merely be temporary.’
Finally, the High Court made two conclusions that all lenders should keep in mind when considering whether to rely on a MAC clause:
- a lender cannot trigger such a clause on the basis of circumstances itwas aware at the time of the agreement; and
- it is up to the lender to prove the breach.
Key points to take away from the decision
There are a number of points that both borrowers and lenders can take from this case, and potentially consider when next considering the ‘standard’ MAC clause in their documents:
- MAC clauses are hard to enforce, but not impossible – as courts tendto interpret such clauses narrowly, the MAC triggers should be cast asbroadly as possible (from the lender’s point of view), and expresslyrefer to material adverse change of a borrower’s financial position,operating or commercial operations and prospects, and prevailingmarket, environmental and even political conditions at the time;
- more defined terms – to minimise the potential that a court could readdown concepts such as ‘financial position’, ‘market conditions’ orsimilar key terms, consider defining these even further in the loandocumentation; and
- introduce subjectiveness – again, to minimise the likelihood that thecourt will apply an objective assessment to a lender’s decision toinvoke a MAC clause, a lender might consider making any MAC clausesubjective by inserting wording along the lines of ‘in the opinion of thelender, there has been an MAC’, perhaps balanced somewhat with arequirement for such opinions to be reasonable.