Is Coronavirus (COVID-19) a Material Adverse Change?

The financial impacts of COVID-19 are starting to be felt. This may prompt lenders and borrowers alike to review their financing agreement for protections and/or vulnerabilities. Lenders exposed to industries particularly affected by the COVID-19 outbreak may consider invoking material adverse change (MAC) provisions to demand early repayment and/or to draw stop further lending.

But will COVID-19 qualify as a MAC?

MAC provisions

MAC provisions are routinely included in financing agreements. But they are rarely relied upon. This in no small part reflects their inherent imprecision and limited judicial consideration.

A loan agreement will often record that a lender has no obligation to lend (and may demand repayment of amounts advanced) if a borrower suffers a MAC. A MAC may refer to a variety of different aspects of the borrower group, its business, operations, property, condition (financial or otherwise), prospects or its ability to perform certain of its obligations under the agreement.

So is COVID-19 a MAC event?

In some instances, it could be – but it is difficult to say with any certainty. Globally significant events are relatively rare and examples of MAC provisions being called upon in that setting are rarer still.

Research suggests there are no litigated examples in the UK or the US of MAC provisions being invoked as a result of epidemic or pandemic events (such as the 2003 SARS epidemic, the 2009 swine flu pandemic or various outbreaks of MERS starting in 2012).

Similarly, major adverse global political and economic events, including the of 9/11 terrorist attacks and the 2007/8 global financial crisis, have not contributed significantly to the limited body of case law in this area.

Perhaps the COVID-19 outbreak will be different. The manufacturing, logistics, distribution, tourism, leisure and travel industries in particular are experiencing significant disruption. For some businesses, like airline FlyBe which entered administration last week, the COVID-19 outbreak may deal a final blow.

But what is very clear is that there is no one size fits all answer to whether COVID-19 will constitute a MAC. The precise phrasing of the MAC provision and the specific circumstances and factual matrix impacting the counterparty will determine the outcome.

Precedent (or lack of it)

There is relatively little English law authority on the interpretation of MAC provisions. There is some guidance in judgments on the subject from the United States and some useful (but not binding) guidance from regulatory bodies. The picture these authorities paint, however, is not clear. If there is a discernible theme it is that time and again courts and regulatory bodies have found against the party asserting that a MAC has occurred.

In 2013, the English High Court handed down a rare judgment on the interpretation of MAC provisions in Grupo Hotelero Urvasco SA v Carey Value Added SL (Carey). At the heart of the argument was an assertion by one of the group's lenders that a MAC had occurred as a result of a deterioration in the financial condition of the group brought about in part by the 2007/8 global financial crisis and in particular by foreign exchange fluctuations and reducing property values in Spain. The lender relied on a repeating representation that "there has been no material adverse change in its financial condition…" (emphasis added).

The court found that a MAC had not occurred. It ruled that on the specific drafting of the particular MAC it was for the lender to prove an adverse change in financial position significant enough to affect the borrower's ability to repay the loan and the Lender had failed to do so.

The court provided the following guidance:

• MAC provisions will be construed in accordance with usual principles of contractual interpretation. So the precise words used really do matter;
• to be material, the adverse change must substantially affect the borrower's ability to perform the transaction in question. In Carey, given the disputed provision related to financial condition only, this meant the borrower's ability to repay the loan;
• the change in question cannot be temporary or transitory; and
• a lender cannot found a MAC on the basis of circumstances of which it was aware at the time of the agreement, although it may do so where conditions worsen in a way that makes them materially different in nature.

MAC and COVID-19: our guidance

The economic impact of the COVID-19 outbreak will likely be uneven and unpredictable. Applying the guidance in Carey (and other authority) we suggest the following:

• Pandemic: circumstances of a generic/sectoral or global nature are unlikely (on their own) to be sufficient to establish a MAC.¹ That said, the impact of the COVID-19 outbreak could generate negative consequences for individual businesses significant enough to constitute a MAC.
• Temporary?: some experts suggest the proliferation of COVID-19 may last many months if not years. Others predict warmer weather will bring welcome and early respite. The challenge for those invoking MAC will be to show the consequences for the particular business are enduring and/or terminal rather than temporary and/or recoverable.
• Says who?: a MAC provision where the determination of materiality is in the sole discretion of the protected party will be the most robust. Absent other factors (including the oft included requirement to act reasonably) the protected party will simply have to show the determination made is 'honest and rational'.²
• Look forward: unless expressly stated, a party asserting that a MAC has occurred will not typically be able to rely on an assessment of the future earnings or performance of the borrower group. A MAC provision which includes a reference to the prospects of a borrower could do so, but the asserting party would have to prove that such deterioration in anticipated performance was a result of the COVID-19 outbreak and not the result of other pre-existing reasons or seasonal or cyclical fluctuations in the borrower's business.
• Give it a go?: whilst the need to act decisively may weigh heavily, lenders should tread carefully before invoking MAC provisions in reliance on COVID-19 - the repercussions of which change daily. Any lender found to have wrongfully called a MAC will face reputational damage and (perhaps more so than usual in this context) the risk of paying out substantial compensation for consequential loss to wrongly defaulted counterparties.
• New deals: any lenders originating new loans to borrowers in affected sectors during the COVID-19 outbreak will find it even harder to establish that a MAC has occurred. In such circumstances, lenders should consider including more targeted objective covenants to provide an 'emergency exit' if required.

1. Hooley, MAC Clauses After 9/11.
2. Cukurova v Alfa Telecom (Privy Council, January 2013)