Material Adverse Change (MAC) clauses and COVID-19
As many businesses grind to a halt amid the COVID-19 outbreak, borrowers and lenders alike will be assessing the ability of companies to service loans and the position under existing and pending contractual arrangements.
A pressing issue is likely to be the applicability of so-called ‘MAC’ clauses in financing agreements. Such clauses may be relied upon by lenders to seek further security, refuse drawdowns, or call an event of default and/or accelerate repayment of a loan. MAC clauses may therefore offer lenders a means to avoid or mitigate the risk of advancing funds to businesses in struggling sectors, and ending up substantially out of pocket should those businesses fail.
However, invoking a MAC clause can be high-risk. If a lender wrongly refuses further funding or calls an event of default when it was not entitled to do so, it risks being liable to the borrower for substantial damages for repudiatory breach of contract. The outcome of any litigation may be affected by a judge’s view of the lender’s conduct, which may be highly subjective. In the present pandemic, a lender invoking a MAC clause also risks criticism and associated reputational damage for failing to make adequate allowance for the unprecedented challenges that businesses are currently facing.
GHU v Carey: background
The leading English case on the interpretation of MAC clauses remains Grupo Hotelero Urvasco SA v Carey Value Added SL  EWHC 1039 (Comm);  Bus LR D45. The case concerned the financing of what is now called the “ME London”, a five-star hotel designed by Foster & Partners on the Strand opposite Somerset House.
The hotel complex was originally to be developed and operated by the Urvasco Group, a Spanish construction and hotel business. The project was to be financed, in part, by a loan provided to Grupo Hotelero Urvasco (GHU) by Carey, a Spanish fund that invested in hotels. The financing agreements contained “plain vanilla” MAC clauses by which the relevant company represented, on each drawdown, that there had been no material adverse change in its financial condition since the date of the agreement.
In mid-June 2008 Carey suspended further payments under its loan agreement with GHU, amid concerns about the severe downturn in the Spanish property market and the Urvasco Group’s deteriorating financial position. Construction stopped soon afterwards, and in 2009 receivers were called in and the project was sold.
GHU issued proceedings against Carey for breach of contract, for failing to advance funding under the loan agreement, and claimed damages of some £70 million representing the profits it contended it would otherwise have earned on the hotel’s operation. Carey denied any breach, on the basis that it was not obliged to continue to lend. Part of its case was that a MAC had occurred in respect of the financial condition of the relevant Urvasco Group companies, which falsified representations made as at June 2008 so as to amount to a default under the loan agreement.
In the event, the Court rejected Carey’s arguments that a MAC had occurred in respect of two of the companies, at least by June 2008 when drawdowns were suspended. The Court accepted that a MAC had occurred in respect of the guarantor, but Carey had not shown that, as at June 2008, any representation was made in respect of the guarantor. Carey was nonetheless successful in establishing that other defaults had occurred, and therefore that it had been entitled to withhold further payments under the loan. GHU was accordingly liable to repay all sums paid out under the loan facility.
GHU v Carey: MAC clauses
Blair J’s judgment offers helpful guidance to lenders presently considering the meaning of their MAC clauses, and whether to invoke them ([335-364]), although every case will turn on the specific facts and wording of the relevant provision. The following points are worth emphasising:
- Where a clause refers to a MAC in respect of a company’s “financial condition”, as in Carey, this is likely to be assessed principally by reference to the company’s financial information, such as its interim financial information and/or management accounts. However, other compelling evidence may also be taken into account, such as evidence of missed debt payments.
- Blair J held that the adverse change must be “material”, in the sense that it “significantly [affected] the borrower’s ability to perform its obligations, in particular its ability to repay the loan”. The change must be significant, as otherwise “a lender may be in a position to suspend lending and/or call a default at a time when the borrower’s financial condition does not fully justify it, thereby propelling it towards insolvency”. A less restrictive approach may apply where the wording of the MAC clause is not limited to a company’s “financial condition” (for example, see Minumbra Lancewood Pty Ltd v AM Lancewood Investment Nominees Pty Limited  NSWSC 1929 (“the business or financial condition of the Borrower”)).
- Carey is authority that evidence of “external economic or market changes” (such as, in that case, the collapse of the Spanish property bubble) will not generally suffice to trigger a MAC clause, since an individual borrower may perform better, or worse, than the sector as a whole. However, the impact and severity of the COVID-19 pandemic may cause lenders and the courts to take a more expansive approach. Where whole sectors have effectively ceased trading, there may be little scope for arguments that individual businesses will outperform the rest of the sector. Nevertheless, a lender will still be well advised to identify matters specific to the borrower that are relied upon as constituting a MAC.
- The change must not merely be temporary. The fact that a company has experienced a dramatic collapse in revenues may not qualify as a MAC if those revenues are likely to bounce back in the near future. At present, the duration and effect of the COVID-19 pandemic are uncertain, as is the extent to which sectors will recover as government restrictions are eased. Lenders may wish to wait until matters are clearer before invoking MAC clauses. However, there is scope for argument that businesses in some sectors may not recover quickly, or at all, and that in such cases MAC clauses can properly be invoked.
- A lender cannot trigger a MAC clause on the basis of circumstances of which it was aware at the time of the agreement, unless those conditions worsen in a way that makes them materially different in nature. This will be of particular relevance where financing agreements are currently pending, and a lender may seek to rely in future on events or circumstances that are (or may arguably be) attributable to COVID-19.
- The burden of proof lies on the lender.
The clarity of language used will aid or hinder a lender’s ability to invoke a MAC clause. For those presently drafting agreements:
- Consider the intended scope of the provision. A range of wording is possible, from clauses that expressly capture a deterioration in the borrower’s “business, operations, property or prospects” (most favourable to a lender) to clauses that only apply when a specific test is satisfied, such as a change to the borrower’s credit rating (most favourable to a borrower). Defining the criteria (e.g. what is meant by “financial condition”) should help to avoid uncertainty and future litigation.
- Consider whether clear obligations might be imposed on a borrower promptly to respond to questions raised by the lender as to its financial condition, perhaps on a regular basis throughout the loan period. Given that the burden of proof is on the lender to demonstrate a MAC, the irony is that the key information will generally be held by the borrower.
- Consider whether the clause should allow a lender to invoke the MAC clause where in its opinion a MAC has taken place, or whether the existence of a MAC is to be determined objectively. Another option might be to entitle the lender to suspend further advances if it bona fide believes a MAC has occurred, with the contract to remain on foot pending investigation and clarification of the facts.
- Consider at what stage the MAC clause can be invoked, i.e. whether the event or circumstance must already have caused a MAC, or whether the lender should be able to take action on the basis that a MAC will, or may likely, occur in future as a result of the event in question.
Lord Grabiner QC and Douglas Paine (with Manus McMullan QC and Andrew de Mestre QC) appeared in GHU v Carey for the lender (Carey).