The High Court Signals a Narrowing in the Interpretation of Material Adverse Change

May 23, 2013

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:

  1. 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.
  2. 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 into insolvency.
  3. 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”.
  4. 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 McGuireWoods London debt finance team.