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Is COVID-19 a Material Adverse Change?

Covid-19 virus

With the current uncertainty in world markets and commentators predicting worsening economic and financial conditions, the need for lenders and borrowers to consider their obligations under their finance documents has become even more pressing.

Many facility agreements include a material adverse change (MAC) clause. A MAC clause is a sweeper clause intended to provide lenders with protection against unforeseen events which have, or may have, a significant detrimental effect on the borrower’s business. A MAC clause is likely to contain a number of provisions based on MAC, including a representation that nothing has happened, that has or will have a material adverse effect on the borrower’s business, financial condition or ability to perform its obligations. MAC clauses are rarely relied upon, generally due to their inherent imprecision and limited judicial consideration.

With COVID-19 now categorised as a global pandemic, MAC clauses are coming under closer scrutiny. Experts expect the proliferation of the pandemic to last many months, with consequences for particular businesses being long term and enduring. Is it time to consider these clauses again?

It is difficult to say with any certainty whether global events are examples of a MAC event. Examples of globally significant events are relatively rare and examples of MAC provisions being called upon in such circumstances are even more rare.

It should be noted that material adverse effect definitions are negotiated heavily and differ from debt document to debt document so the precise wording of each document will need to be analysed carefully. In such circumstances, key considerations which should be taken into account include:

  • The permanence of the deterioration of a borrower’s business. If the effect is unlikely to be permanent or have a persistent and long-term effect on the borrower’s business, it is unlikely to count as material.
  • The uniqueness of the adverse change on the borrower’s business. Usually, the cause of a MAC is specific to the business in question. In the current climate the actual effect on the borrower’s business will need to be proven rather than on businesses of a similar type to the borrower’s.
  • Whether the MAC clause is specifically triggered by pestilence, pandemic or subsequent government action. This is most probably unusual in a standard facility agreement.

The general rules indicate that it would be difficult for a lender to rely on a MAC clause due to the pandemic since (1) the pandemic is an event affecting the country and the wider economy and is not specific to any one borrower and (2) the pandemic is a transitory event.

However, a case may be made depending on whether the MAC clause in question is drafted subjectively or objectively. If the MAC clause is drafted to confer any discretion on the lender to determine the extent of the event, this will allow for a wider interpretation of the effects of the adverse effect. If the clause is drafted objectively, however, the lender must establish the event as an objectively verifiable fact and the burden of proof is quite onerous.

In conclusion, each case will turn on the drafting of the facility agreement. Given the reasons mentioned above, lenders are less likely to call a default on a MAC clause and are more likely to rely on a more obvious default clause, such as a financial covenant. Financial covenants provide more certainty and are usually more reliable to enforce. It is therefore, more important than ever, for borrowers to maintain a good working relationship with their lenders, to enable any adverse issues to be addressed at the earliest opportunity.

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