Legal development

Material adverse change clauses in finance documents

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    As the economic headwinds indicate that borrowers will continue to face financial pressures in 2023 and beyond, lenders are seeking ways to exercise more leverage as “covenant-lite” facilities prevail.

    At times of increased stress and distress, we tend to come back to the same question: is it possible for a lender to rely on a material adverse change clause in circumstances where the borrower is experiencing financial difficulty due to acutely adverse prevailing macroeconomic conditions?

    This article aims to serve as a brief reminder of the principles underpinning this legal concept.

    Where are MAC clauses used?

    The use of material adverse change (MAC) clauses is common in various financial contexts, including loan agreements and mergers and acquisitions (although its use in M&A is not the focus of this article). In the loan agreement context, the concept of a MAC is generally used:

    i. as an event of default (the Loan Market Association’s standard drafting provides that a MAC event of default can be triggered in various circumstances, including where there is a material adverse effect on the business, operations, property, condition (financial or otherwise) or prospects of the borrower’s group taken as a whole);

    ii. in the borrower’s representations and warranties to the lender (for example, at the time of signing the facility agreement, the first drawdown and subsequent drawdowns, as well as on each interest payment date); and

    iii. in a wider context and in the variation concept of material adverse effect, to introduce a materiality threshold to certain (typically factual) covenants, representations or warranties made by the borrower (for example, by qualifying that a default will occur only if the breach is likely or reasonably likely to have a material adverse effect).

    A MAC event of default is a potentially powerful tool: proving that a MAC event of default has occurred will generally permit a lender to cancel any outstanding commitments and accelerate and demand immediate repayment of all amounts accrued and outstanding (among other things). However the road to successfully arguing that a MAC has occurred is not a well-travelled one. Few MAC clauses have been tested before the English courts and, as a result, there is little guidance on how they are likely to be interpreted or indeed enforced.

    How have MAC clauses been interpreted by the English courts?

    The English courts have generally been reluctant to provide guidance on enforcement of MAC clauses, not least because each case will vary according to its facts and the way the MAC clause has been drafted (on account of their being heavily negotiated).

    Nevertheless, as a starting point, we know that a MAC event of default contained in an English law-governed agreement will be interpreted in accordance with general contract law principles. This means that a MAC clause will be capable of being enforced only if it clearly expresses the intention of the parties to the agreement, which the courts will assess by reviewing the agreement as a whole. Whether a material adverse change has occurred will then be determined as a matter of fact. In this regard, the High Court set out some general guidance for the interpretation of MAC clauses in a leading case, Grupo Hotelero Urvasco SA -v- Carey Value Added SL (Grupo).1

    General Guidelines

    Grupo concerned a MAC representation clause which provided that “there has been no material adverse change in [the obligors’] financial condition (consolidated if applicable)” since the date of the loan agreement. In alleging that the borrower was in breach of this representation, the lender argued that the term “financial condition” should not be limited to particular parts of a company’s accounts (for example, net current assets or profits), rather it should encompass all aspects of a company’s finances in addition to the state of the markets in which the company operates. The Court dismissed this argument and held that there had not been a MAC to the borrower’s financial condition. While the decision in Grupo turned on the wording of the clause in question, the Court provided some guidelines for the interpretation of MAC clauses that may be applied more generally:

    i. If a MAC clause requires a change in the “financial condition” of the borrower, the change will be assessed primarily by reference to the borrower’s financial information (ie interim financial information and/or management accounts), although other compelling evidence may be accepted (an example of such evidence in Grupo was that the borrower had ceased to pay its bank debts). There is a distinction between the terms “financial condition” and “business or financial condition”, as the latter is broader in scope. The Court’s focus on the specific wording of the MAC clause indicates that each clause must be reviewed carefully in order to understand its scope and parameters. For example, does the clause relate only to certain obligors in the borrower’s group, or does it relate to the group as a whole? Does the change have to affect the borrower’s (or the group’s) payment obligations, or its obligations in general?

    ii. An adverse change will be material only if it significantly affects the borrower’s ability to perform its obligations under the relevant agreement.

    iii. A lender cannot trigger a MAC clause based on circumstances of which it was aware at the time of entering into the relevant agreement, unless these circumstances “worsen in a way that makes them materially different in nature”.2 This is particularly relevant for lenders who are considering calling a MAC event of default on the basis of the prevailing economic climate: if, for example, a loan agreement was entered into while the economy was already experiencing a downturn, it would be more difficult to argue that the lender was not aware of these specific economic circumstances.

    iv. Any change relied upon for the purposes of enforcing a MAC clause must not be temporary.

    v. The party seeking to enforce the MAC clause has the burden of proving that a MAC has occurred.

    In certain circumstances, an event does not have to have an objectively adverse effect. For example, in Cukurova Finance International Ltd -v-Alfa Telecom Turkey Ltd,3 a MAC event of default was drafted as follows:

    Any event or circumstance which in the opinion of [the lender] has had or is reasonably likely to have a material effect on the financial condition, assets or business of [the borrower].

    The event relied upon by the lender to enforce this clause was the making of an arbitration award that could potentially result in significant damages being awarded against the borrower. It was agreed that the drafting of such a clause did not require an event to have an adverse effect from an objective perspective: all that was required in this case was for the lender to believe that the event had such an effect and for this belief to be both honest and rational. As a result, the lender was able to successfully rely upon the MAC event of default.4

    What is also clear is that a MAC clause must be triggered by a specific change. In Levison -v- Farin, sellers of a target company warranted that “there shall have been no material adverse change in the overall net asset value of the [target] company”. This was relied upon by the buyers even though they had been informed prior to the acquisition that the target was running at a loss. The court held that the buyers were entitled to damages for breach of the warranty, because a 20% decrease in net asset value was material and this was not a “normal trade fluctuation”: it was a MAC that had not been covered by the general disclosure of the cause of future losses prior to signing.5

    Extreme Circumstances

    While the interpretation of a MAC clause is likely to depend heavily on the way in which the MAC clause is drafted and the specific facts of the case, there are of course circumstances in which a borrower’s financial condition has so obviously declined that its ability to repay a lender is in serious doubt and invoking a MAC event of default is appropriate (in order to prevent a lender from “throwing good money after bad”6). For example, if a borrower’s assets are frozen such that it defaults on interest payments and imminent insolvency becomes a real possibility, the court may decide that there are no reasonable grounds for challenging a MAC event of default (as it did in BNP Paribas SA -v- Yukos Oil Co,7 where the freezing of US$3 billion of a borrower’s assets caused it to default on its interest payments).

    Can we look to the US courts for additional guidance?

    While there is some US case law in relation to MAC clauses, the majority of such cases relate to MAC clauses in acquisition agreements because MAC event of default clauses are not typically included in US leveraged finance documents (due to the shift towards using high-yield structures). In the M&A context, the New York and Delaware courts have generally set the bar high when it comes to finding that a MAC has occurred. Indeed, only one Delaware Chancery Court case to date has held that a MAC has occurred, thereby enabling a buyer to terminate a merger agreement.8 Like their UK counterparts, US MAC cases depend heavily upon the circumstances of the case and the wording of the MAC clause in question.

    Are there any risks to watch out for in seeking to rely upon MAC events of default?

    In the light of the above, using a MAC event of default clause to “default” a borrower is not a straightforward process and it gives rise to the possibility that a borrower may sue for damages for breach of contract (particularly if a lender’s unjustified acceleration of a loan leads to cross-defaults in other finance documents). Given the nuances of interpretation, a court judgment may often be the only way to determine whether a MAC has occurred, which can be time-consuming, expensive and impractical. You should therefore carefully consider reputational and economic implications before taking this route. In the light of all the above, the circumstances in which it can provide a bullet-proof, or even sufficiently robust, means to trigger an event of default (and possibly a consequent acceleration of financial liabilities) are likely to be specific and limited.

    Authors: Olga Galazoula, Partner; Jacques McChesney, Partner; Charlotte Harvey, Associate


    1. Grupo Hotelero Urvasco SA -v- Carey Value Added SL [2013] EWHC 1039 (Comm)
    2. Grupo Hotelero Urvasco SA -v- Carey Value Added SL
    [2013] EWHC 1039 (Comm) [362].
    3. Cukurova Finance International Ltd -v- Alfa Telecom Turkey Ltd
    [2013] UKPC 2.
    4. This approach was confirmed by Lombard North Central Plc -v- European Skyjets Ltd
    [2022] EWHC 728 (QB).
    5. Levison -v- Farin
    [1978] 2 All ER 1149.
    6. Grupo Hotelero Urvasco SA v Carey Value Added SL
    [2013] EWHC 1039 (Comm) [336].
    7. BNP Paribas SA v Yukos Oil Co
    [2005] EWHC 1321 (Ch).
    8. This was the case in Akorn, Inc -v- Fresenius Kabi AG,
    2018 WL 4719347 (Del. Ch. Oct. 1, 2018).