Material adverse change clauses: a recent case gives rare guidance on interpretation

This article was produced by Olswang LLP, which joined with CMS on 1 May 2017.

Material adverse change (or MAC) clauses are commonly found in finance and corporate agreements. A recent decision involving a MAC clause in a loan agreement provides some helpful guidance as to how such clauses might be interpreted in an area where there has been little case law to date. We look at the practical implications for borrowers and those negotiating such provisions in other types of agreement.

The dispute in Grupo Hotelero Urvasco SA v Carey Value Added SL & Another arose when a lender refused to advance further sums to a borrower less than six months after the date of the loan agreement, and the borrower sued for breach of contract. The lender argued it was not in breach of the loan agreement on the basis that it was not obliged to continue to lend as (amongst other things) the borrower was in breach of the representation it was deemed to have given on each drawdown date, that 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 court found that, in the circumstances, there was no MAC (although the lender was ultimately successful as a separate event of default was found to have occurred). The judgment provides some helpful guidance as to how courts will approach the interpretation of MAC clauses.

Practical points arising from the case for companies with finance arrangements

• Loan agreements typically require the borrower to give a warranty/representation on every drawdown of funds that there has been no MAC since the date of the loan agreement. Such MAC clauses require an objective assessment of the position in order to determine whether a company is in breach.
• Where a MAC representation is given by reference to a borrower's "financial condition", the case shows that this will be fairly narrowly interpreted, primarily by reference to whether the borrower's financial information (i.e. annual accounts, management accounts etc) reveals any MAC and not by reference to any change to the company's prospects or in external economic or market conditions. Other compelling evidence may also be relevant in assessing "financial condition", for example, if the company has stopped paying its creditors.
• An adverse change will only be material if it significantly affects the borrower's ability to perform its obligations (for example, its ability to repay the loan) and is not merely temporary.
• A lender cannot claim for breach of a MAC clause on the basis of circumstances of which it was aware on entering into the loan agreement.

MAC clauses in other circumstances

• The points of interpretation above should be borne in mind when drafting and negotiating MAC clauses in other circumstances. For example, sale and purchase agreements where exchange and completion do not occur simultaneously, often contain both a warranty (repeated at completion) that there has been no MAC since the date of the last annual accounts and a specific termination right for the buyer if a MAC occurs during this period.
• MAC clauses can be hard to enforce and so if the party taking the benefit of the MAC clause has particular concerns, for example, in relation to the termination of key contracts, these should be referred to specifically. It should then try to negotiate a general MAC clause which is drafted widely and refers not only to changes in the company's financial position, but also to its trading position and prospects, the on-going operation of its business and, where appropriate, changes in the wider economic climate or the sector in which the company operates.
• Conversely, the party against whom the MAC clause may be invoked will want to narrow the clause as much as possible, for example by removing references to the company's "prospects" etc. It will also want to carve out the effect of any events affecting the market or economic conditions in general and ensure, as a minimum, that in order to invoke the clause, any change needs to be materially adverse in the context of the wider group or business concerned, and not just a particular part of it.
• The party with the benefit of the MAC clause should also consider whether it would be beneficial to define materiality, otherwise it will be reliant on the court's interpretation. As shown by the Grupo Hotelero case and the US case of IBP v Tyson (2001), this is likely to be a high hurdle to clear.
• The majority of MAC clauses, including the one in the Grupo Hotelero case, require an objective assessment of whether, in all the circumstances, a material adverse change can be said to have occurred. A party proposing a MAC clause could try to negotiate a subjective standard, for example: "in the reasonable opinion of the Buyer there has been a material adverse change ...". The court would have to be convinced, by admissible evidence, that the relevant party had in fact subjectively formed the view that a MAC had occurred. A written record (for example, by way of a set of board minutes) will assist in fulfilling this evidential burden.

Any information contained in this article is intended as a general review of the subjects featured and detailed specialist advice should always be taken before taking or refraining from taking any action. If you would like to discuss any of the issues raised in this article, please get in touch with your usual Olswang contact. This article was included in our Olswang Corporate Quarterly Summer 2013 publication.