Covid-19 and Material Adverse Change

20th April 2020 Corporate

The financial impact and the business disruption of Covid-19 are being felt by businesses across the country and many businesses will be concerned about their financial position. In these difficult times, lenders are likely to be increasingly concerned about the prospect of recovering loans, especially to businesses in sectors that have been severely affected by the pandemic. In this article, we consider whether Covid-19 will entitle lenders to invoke material adverse change (MAC) clauses that are often contained within finance documents and loan agreements.

In this context, MAC clauses usually allow the lender to trigger a default if there is an adverse change in the position or circumstances of a borrower, obligor or the corporate group to which they belong. If a lender invokes such a clause, its usual rights are to refuse to lend further amounts, terminate the lending commitments, request extra security or accelerate repayment of the loan. Generally, the definition of MAC is wide in scope and vague as they are intended to cover the occurrence of unanticipated events, such as the pandemic caused by Covid-19. The scope of MAC clauses is usually defined in the agreement and is often heavily negotiated, therefore, the enforceability of each clause will turn on its specific wording.

Considerations to take into account before invoking a MAC

Often when potential events occur whereby a lender could invoke a MAC clause, the parties will re-negotiate the terms of the agreement. This will reduce the risk for both parties in the event that a MAC clause is incorrectly invoked. For this reason, case law on this area is limited.

Although guidance is limited, the leading case in the UK involved a lender relying on a MAC clause in 2008 during the financial crisis. The borrower, in this case, was involved in developing hotel and apartments on a prime London site. The judgment for this case provided the following guidance that can be helpful to gain an understanding as to how the courts might enforce MAC clauses in the current circumstances, although each case is fact-specific as the wording of MAC clauses varies:

  • To invoke a MAC clause, a change in circumstances is required. A lender could not trigger such a clause on the basis of circumstances of which it was aware at the time of the agreement. In relation to the current pandemic, when the agreement was entered into will be a relevant factor in determining whether a change in circumstances has occurred. For example, the ability to trigger a default pursuant to a MAC clause under an agreement made in early January 2020 is likely to be open to a lender as market conditions have seen significant changes since January 2020 (even though the lender may have been aware of the existence of Covid-19 at that time);
  • A change is only “material” if it affects a borrower’s ability to perform its obligations under the relevant agreement. As a result, lenders are likely to have difficulty invoking a MAC clause if the borrower otherwise continues to comply with its obligations; and
  • The court also held that evidence of general external economic or market changes would not itself constitute a MAC-event. This is relevant in the current market conditions as a borrower may actually perform better or worse than the sector they are operating in and their personal circumstances should be taken into account.

While the judgment offers guidance only and each case will turn on its own facts, it may ease concerns for some borrowers on the basis that the current situation may not itself be grounds enough for a lender to invoke MAC clauses.

MAC clauses often include a reference to the “prospects” of a borrower. Borrower’s will seek the certainty that a MAC clause based on their actual performance, rather than their projected performance, offers. Conversely, a lender will want to cast the net as broadly as possible and include prospective events that may affect the borrower’s ability to repay the loan. A lender friendly MAC clause will make a borrower more vulnerable in the current circumstances if their future financial performance is likely to be affected by Covid-19. It is important to note that if a lender attempts to rely on the current pandemic as the basis for a prospective determination that a MAC-event has occurred, that lender must be able to demonstrate that any deterioration of their borrower’s projected performance was as a result of the pandemic rather than any usually anticipated seasonal or cyclical fluctuation in the borrower's business.

Many businesses will have been forced to change the way in which they operate following the government’s lockdown which will be a further consideration for lenders. As the extent and duration of the lockdown is unknown and businesses do not know when they will return to being fully operational, the lockdown will undoubtedly affect the ability of some businesses to trade out of their current circumstances. However, it will be important for them to continually monitor the government’s announcements as we have already seen a number of initiatives being announced to support businesses of all sizes. A brief summary of announcements that the government have made can be found here.

It is worth noting that there are significant risks for lenders in invoking MAC clauses and this is likely to be a key factor as to whether they proceed on this basis. The main risk for a lender is a potential claim for breach of contract. As a consequence, MAC clauses are likely to be enforced with caution and often in circumstances where the lender has genuine concerns about the borrower defaulting, rather than a default position due solely to the current pandemic.

If you want to discuss any of the content in this article, please contact your usual JMW contact ​​​​on 0345 872 6666.

This article is for general guidance only and should not be used for any other purpose. It does not constitute and should not be relied upon as legal advice. We recommend that you review the daily updates and guidance issued by the government. 

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Scott Cameron is a Head of Department located in Manchester in our Banking and Finance/Corporate Recovery and Insolvency department

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