In a decision last month, the High Court considered the factors required to
be taken into account by a Lender when deciding whether there has been a breach
of a Material Adverse Change (MAC) representation in a loan agreement. Although
the decision was largely based on the facts of the case, the court did apply a
surprisingly narrow interpretation of the MAC representation which may require
lenders to reconsider how such representations are drafted in the future.
The MAC representation was drafted as follows:
“there has been no material adverse change in [the] financial condition [of
the obligors] (consolidated if applicable) since the date of this Loan Agreement”.
In deciding that there was no breach of the MAC representation, the court
implemented the following four stage test:
- Financial condition should be determined primarily by reference to a
company's financial information at the relevant times. Therefore, a
lender trying to demonstrate a MAC needs to show an adverse change over that
period by reference to the obligor’s financial information. Moreover, the
reference to “consolidated” implied consolidated accounts. Although other
compelling evidence may be considered, such as a company ceasing to pay bank
debts, financial condition does not include issues such as a company’s
prospects or external economic or market changes unless expressly stated.
- A change in financial condition is only materially adverse if it
significantly affects a company's ability to perform its obligations under
the relevant agreement, and in particular its ability to repay a loan.
The court held that without such narrow construction, a lender could
nevertheless suspend lending and/or call a default propelling the company
- A lender cannot call an event of default on the basis of
circumstances of which it was aware when the facility agreement was entered
into. This also applies to a situation which is likely to occur when the
agreement is entered into, since it cannot be claimed that the manifestation
of the change would have prompted the lender not to lend at all or on
materially varied terms. The judge relied on academic authority stating that
“general and/or sectoral economic decline that was known to, or should have
been foreseen by, the party relying on the clause when they entered into the
contract is unlikely to be held to constitute a material adverse change
unless the wording of the clause is particularly clear on the point”.
- A change must not be merely temporary. The judge did not provide
guidance as to the meaning of this, other than to quote an American case,
which construed it as being “durationally significant”! We therefore suggest
using points 1-3 above as a more useful guide.
For further information, please contact one of the authors: Marc Isaac, +44 20 7632 1720, or Noreen Ahmed, +44 20 7632 1716, or a member of the
debt finance team.