By Drew Salvest
A client is prudently engaging with its bank to put in place a credit facility to address working capital needs which it anticipates might grow due to the Covid-19 isolation measures causing its customers to reduce requirements for its services and to pay more slowly than during less distressed times. As the motivation for this client to enter into the facility was its potential exposure to the risks to general economic conditions arising from the pandemic, the client was understandably concerned about the lender’s insistence on the inclusion of a “Material Adverse Change” or “MAC” representation and event of default.
The client’s question to us, after vain attempts to remove the language and tepid protestations from its relationship manager that such clauses “are rarely relied upon”, was whether it had any reason to be concerned.
To be fair to the lender, MAC events of default are rarely relied upon to enforce an event of default. However, the Covid-19 pandemic and the government ordered lockdown is having an unprecedented impact on the UK and the global economy. One has to consider whether the changed circumstances arising from this event might have a similarly unprecedented change in the approach lenders take in limiting losses in their loan portfolios. More importantly, if it does, will a typical MAC clause assist them?
The Case Law
Judicial precedent interpreting MAC clauses under English law is limited. The leading English court decision on the interpretation of MAC clauses is that of Mr Justice Blair in Grupo Hotelero Urvasco v Carey Value Added SL and Another  EWHC (Comm) 1039 (“Grupo Hotelero”). Grupo Hotelero Urvasco, a Spanish hotel developer and operator, made a claim against its lender which had refused in June 2008 to advance committed funding, arguing that but for the lender’s refusal to advance the funds, it would have completed construction of the hotel and made sufficient profits from its operation to repay the loan. The lender argued that the collapse of the Spanish property market following the global financial crisis meant that a MAC to the borrower’s financial condition had occurred permitting it to withhold the funding.
The court noted that any MAC determination will depend on the relevant facts. However, it provided some guidance relevant to the circumstances arising from the Covid-19 pandemic on the evidence necessary to conclude that a MAC has occurred. In particular, the court suggested that evidence of general external economic or market changes (such as, in that case, the precipitous crash of the Spanish property market and the impact on the construction sector) would not of itself constitute a MAC as the borrower at issue may perform better (or worse) than the market. Instead, the ability to trigger a MAC should be tied to the actual financial or operating performance (depending on the actual wording of the MAC clause) of the borrower, not on general market conditions. Will the more significant economic impact of the coronavirus-related lockdowns change this analysis? We will need to wait and see. Nevertheless, our borrower client can take some comfort in the court’s analysis here provided it is confident that with the funding it will be able to keep operating and generate sufficient revenue to permit repayment. Lenders should also be cautious in invoking MACs without sufficient evidence that the current economic conditions are so overwhelming negative for a borrower in themselves that the lender is justified in calling the MAC.
Of course, our client has previously not been a significant borrower. Could the lender determine that simply because the borrower now had a need to draw funds that this was proof that its circumstances had changed?
The Grupo Hotelero court, fortunately, also provided some additional guidance particularly helpful to our current client. The court found that a MAC must involve a change in circumstances. As a result, a lender cannot trigger a MAC clause on the basis of circumstances it knew about at the time of agreement, unless these circumstances have themselves materially changed. As our client was entering into the facility in the midst of the Covid-19 pandemic, and was seeking the finance in response to what it anticipates may be potential difficulties, it should have no need to worry about its lender invoking the MAC clause unless the economic circumstances affecting its business evolve in further negative and unanticipated ways.