We have received an increasing amount of queries regarding Material Adverse Change (MAC) clauses over the last few months, which are a common feature of most facility agreements, leases and mandate letters.
However, these clauses begin to attract considerable interest from lenders (or lessors) and borrowers (or lessees) at specific times, such as during an economic downturn or when a particular political event occurs (for example, the current economic situation or the terrorist attacks in the United States of America on 11 September 2001).
The nature of the MAC clause gives rise to two main issues: the negotiation and drafting of the clause; and ensuring that sufficient grounds exist for a lender to invoke and rely upon the MAC clause correctly.
Often the most negotiated part of any MAC clause is the actual definition of “Material Adverse Change”. The lender will usually want this to be drafted as widely as possible (and possibly to capture other entities such as the borrower’s group), with a subjective assessment of the material adverse change itself, i.e. that the event “in the Lender’s opinion” falls within the MAC definition.
On the other hand, the borrower will want to achieve the opposite: narrow the scope of the clause and replace the subjective test with an objective one. The borrower will likely also resist attempts to include ‘potential’ material adverse changes within the definition and instead insist on limiting the MAC clause to events which have had or definitely will have a material adverse affect.
As a general rule, the MAC clause is designed to capture unpredictable and unforeseen events or circumstances which would otherwise be difficult to cater for. It is important to identify, at the outset of a transaction, which events the MAC clause is designed to cover (or not to cover) - if there are any specific risks associated with the transaction or the borrower it is preferable to cater for these as ‘specific’ events of default within the document.
One of the major benefits of MAC clauses are that they can be used to cover a wide range of subjects, including:
- the business, operations, property, financial condition or prospects of a borrower or its group;
- the ability of a borrower, or a member of its group, to perform its (or their) obligations under the transaction documents; or
- the validity, enforceability, effectiveness or ranking of any security granted in connection with the transaction documents.
Unfortunately the main benefit of the MAC clause may also be its major drawback. MAC clauses may be drafted so widely that they become unworkable, and leave the parties exposed to an uncertain position when faced with a certain set of circumstances. This may lead to serious consequences if a MAC clause is invoked by a party, and the transaction terminated, without the grounds to do so.
Invoking the Material Adverse Change clause
One of the main questions we are asked (by both lenders and borrowers) is whether, on a particular set of facts, there are sufficient grounds to invoke a MAC clause?
This is not always a straightforward question to answer, and much will depend on the particular set of circumstances involved and the wording of the MAC clause. However, the following questions may form a useful guide at an early stage when considering the above:
- Wording - is the wording sufficiently broad in scope and subjective enough to cover the event that has occurred?
- Knowledge - does the party have any prior knowledge of the particular circumstance which they wish to use to invoke the MAC clause? If so, this may prevent that party from relying on the event for the purpose of claiming that a MAC has occurred or is occurring.
- Certainty and evidence - can the party support its allegations that a breach of the MAC clause has occurred?
Historically, (and possibly due to the factors discussed) MAC clauses are rarely called and there have been few instances of these coming before the English courts. It is difficult to predict how an English court would interpret them.
One of the few cases to come before the English courts to deal with a MAC clause has been the case of Levison v Farin1. A purchase agreement included a MAC clause which included the wording:
“Save as disclosed the vendors hereby jointly and severally warrant to and undertake with the purchasers that between the balance sheet date and the completion date: (i) the overall financial position of the company will not have changed adversely in any material way allowing for normal trade fluctuations; (ii) there will have been no material adverse change in the overall value of the net assets of the company on the basis of a valuation adopted in the balance sheet allowing for normal trade fluctuations”
Following the purchase of the company, a 20 percent drop in the net asset value of the company was discovered. The court considered the wording of the MAC clause and the set of circumstances to determine whether the 20 percent drop could be considered as ‘material’. It was held in this case that the 20 percent drop was material and that the purchasers were correct to call upon the material adverse change clause.
Because of the issues associated with MAC clauses, they are rarely relied upon as a sole basis for terminating a loan agreement or a lease, as it is often difficult to be certain that a material adverse change has in fact occurred. Because of this, they are more often used in conjunction with other specific events of default which may have occurred (or are occurring) to give extra weight to a claim or to bring the parties back to the table to re-negotiate a deal on more favourable terms.
Patrick Farrell, Partner
David Murphy, Trainee
Norton Rose LLP, London
- Levison v Farin  2 All ER 1149