Material Adverse Change - What does it mean?

Material Adverse Change - What does it mean?


Author: Anna Voss

Material adverse change (MAC) provisions appear in the majority of loan agreements. The recent Grupo Hotelero case included interpretation of MAC in the context of a representation that there had been no MAC in a borrower's financial condition.

Whilst adding some clarity, the case doesn't make a "no MAC in financial condition" representation any easier for a lender to rely upon.

MAC in loan agreements

MAC definitions come in many forms but generally refer to changes which have an adverse effect either on the borrower's business generally, its financial condition, and/or the ability of the lender to call on its security. A simple MAC representation requires a borrower to represent to the lender, at set times, that there has been no MAC since a particular date. If the borrower cannot provide this representation, it will ultimately lead to an event of default.

Lenders will usually require a "no MAC" representation (some banks' policies require it) as it is thought to offer the bank comfort in respect of unknowns. MAC clauses are often resisted by borrowers due to their potentially wide interpretation. That wide interpretation is also their down-fall and in reality they are rarely used as the sole basis to accelerate a loan because of the uncertainty around their interpretation. They are however occasionally used to stop future drawings and (more often) as a bargaining tool to re-negotiate/re-price loans.

Risks for Lenders

MAC clauses are rarely scrutinised by the courts; the recent case of Grupo Hotelero offers some guidance on interpreting a MAC clause as well as the reasons for lenders' reluctance to call on such clauses. As Mr Justice Blair acknowledged: ".the interpretation of such provisions may be uncertain, proof of breach difficult and the consequence of wrongful invocation by the lender severe, both in terms of reputation and legal liability to the borrower."

Grupo Hotelero

The case considered a representation in a loan agreement that there had been no MAC in the financial condition of the obligors and held that:

  • an assessment of 'financial condition' should begin with financial information, but is not limited to it if there is other compelling evidence. External economic or market changes should not be considered unless expressly incorporated
  • in the context of a loan agreement, a change in financial condition is material if it 'significantly affects the borrower's ability to repay the loan'
  • an anticipated funding gap in a development project was considered an issue in respect of prospective liabilities which had not yet been incurred and was therefore not in itself a MAC
  • MAC clauses should protect a lender from unknown changes - pre-existing circumstances or those which the lender was aware were likely to occur will not be a MAC
  • a MAC cannot be temporary. For example, fluctuations in exchange rates will not be a MAC until they directly impact on a borrower
  • it is up to the lender to prove the breach

Implications of the case

The case highlighted the difficulties lenders face when trying to invoke a MAC clause. It applied a narrow interpretation of the definition, making it more difficult for a lender to enforce on this basis alone. The relatively narrow interpretation in Grupo Hotelero may mean that lenders are less willing to have representations and undertakings qualified by MAC.

No doubt lenders will continue to include MAC clauses in their documentation to give them some comfort in relation to those "unknown unknowns" and to give a potential drawstop/bargaining tool.

However the difficulties in relying on the clause highlighted above mean that full due diligence, clearly drafted and comprehensive documents, remain as important as ever.

Grupo Hotelero Urvasco SA v Carey Value Added SL and another [2013] EWHC 1039 (Comm) (26 April 2013)