Material Adverse Change Clauses hold great importance for dealmakers in structuring a financing, and to litigators in confronting financings gone wrong.
Material adverse change (MAC) clauses are provisions often found in loan and other financing documents which allow lenders to refuse to fund if such a change occurs. MAC clauses often hold great importance both to dealmakers in structuring a financing, and to litigators in confronting financings gone awry.
The purpose of the MAC clause is to provide the lender with protection such that if a major adverse change (such as the types discussed below) occurs from the date a financing agreement is signed, then an event of default is triggered and the lender can essentially pull out of the transaction and often demand immediate repayment of any funds already lent to the borrower, together with interest and any other costs payable.
What do MAC clauses cover?
The definition and use of MAC clauses in financing documents vary widely, depending on the type of transaction, the market standards at the time of negotiation, the relative bargaining powers of the parties, and sometimes jurisdiction-specific factors such as political and economic stability. It is common to see lenders structure – and enforce – MAC clauses more aggressively during economic downturns, forcing borrowers to accept terms that they would otherwise refuse.
In facility agreements, for example, it is common to see a MAC clause cover any adverse change within the following areas, among others:
the business, operations, property and financial condition of the borrower; the borrower’s or the borrower group’s ability to perform its obligations under the financing documents; the validity, effectiveness, enforceability or ranking of any security granted under the financing documents; and the international financial markets.
The MAC clause would typically provide that if a material adverse change occurs in relation to any of the above – this determination is often made at the lender’s sole discretion – then an event of default is triggered and the lender can stop the financing and demand repayment of all borrowings and costs to date.
How are MAC clauses defined?
The definition of the MAC clause is one of the most important and heavily negotiated definitions in any finance documentation, and can play a key role in legal disputes over financings.
Lenders typically seek to keep the definition as wide as possible and may require that an event of default is triggered if an event has a material adverse effect on the borrower’s ability to perform any of its obligations under the finance documents. Conversely, borrowers seek to keep the definition as narrow as possible and will seek to agree that an event of default is only triggered if a material adverse change affects its ability to comply with its financial covenants or payment obligations under the finance documents.
While many of the negotiations surrounding finance documents often seem more theoretical than practically applicable, the MAC clause is, in fact, a clause which can be and is invoked. We have recently seen two cases in Oman where Omani banks have invoked the clause, causing the relevant borrowers to have to refinance their loans as a result.
Where a lender has successfully negotiated that it will determine the occurrence of a material adverse change “in its sole discretion”, it is usual for borrowers to negotiate that the lender “act reasonably”. Borrowers also seek to negotiate materiality qualifications, i.e., that if a material adverse change has occurred that it will have a material effect on a material obligation. This is to avoid an event of default being triggered over a trivial breach or the breach of a trivial term.