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Is the outbreak of Covid-19 the material adverse change lenders could rely on?

Posted: 26/03/2020


Material Adverse Change (MAC) provisions are commonly found in finance documents such as loan agreements. They safeguard the lender’s position in the event that there is (or there will be) a material adverse change in the borrower’s business, financial condition or ability to perform its obligations, in which case the lender is not required to advance the money in accordance with the loan facility.

As the courts are generally reluctant to enforce MAC provisions in favour of the lending entity, lenders do not tend to rely on such provisions but, in these unprecedented times, could Covid-19 trigger the ability for lenders to lawfully rely on MAC provisions?

Difficulties in relying on MAC provisions

MAC provisions generally do not identify a particular event or loss as a trigger which makes reliance on them notoriously difficult.

The judgment handed down in Grupo Hotelero Urvcasco v Carey Value Added SL and Another[1], (Grupo Hotelero) is often cited in discussions about a lender’s reliance on MAC provisions. The case in point involved a lender’s refusal to advance funds in accordance with its obligations under a facility agreement.  The loan was going to be used to fund a property development following the 2007-2008 financial crisis. The lender claimed it was entitled to do so because the Spanish property bubble had burst and there had been a MAC to the borrower’s financial position.

The court in this instance held that the lender was not entitled to conclude this and that, in refusing to advance the money, it had breached the terms of the facility agreement.

In coming to this decision, the court noted that a change is only material and adverse if it affects the lender’s ability to repay the loan under the facility agreement and that, in any event, the change must be sufficiently significant. It follows, therefore, that a temporary adverse change would neither be material nor significant.

Accordingly, while external economic and market changes may, to an extent, evidence the economic difficulties that an entity could suffer at a particular time, these external changes would not themselves constitute a MAC for the borrower who could be affected differently in these circumstances to that which was expected.

Due to the aforementioned difficulty in proving a MAC has occurred, rather than being a legally contentious point, MAC provisions have instead more commonly provided a basis for which contract terms can be renegotiated between lenders and borrowers.

Could Covid-19 be different?

Unfortunately, the outbreak of Covid-19 has posed such a significant threat to human life that governments worldwide have been forced to put in place national controls such as lockdowns in an attempt to contain it. With such controls being the most stringent and drastic we have seen since World War Two, it is clear that this outbreak is causing and will continue to cause inherently different economic difficulties from those experienced in the 2007-2008 financial crisis and other pandemics such as swine flu.

Presently, the travel, leisure, aviation and hospitality sectors have been hit hardest by this pandemic. In association with these industries in particular, lenders may be worried about recovering the money they advanced under loans and also their obligations to advance further money under scheduled draw downs. In the circumstances, it may be possible that the decision in Grupo Hotelero would not appreciate the severity of the economic effect of Covid-19. Nonetheless, the long-term effects of Covid-19 are currently unknown and, as such, it is difficult to judge whether it is causing or will cause a MAC to companies in these and other industries.

It is important to note that refusal to advance money pursuant to a loan agreement by virtue of the MAC provision will need to be carefully considered in respect of the borrower’s particular circumstances and not just the external effect Covid-19 is having on the economy generally. Lenders would need to consider whether the borrower will be able to fulfil its obligations under its specific loans despite this.

[1] [2013] EWHC (Comm) 1039

This article has been co-written with Ellis van der Vos, an associate, and Iris Bajraktari, a trainee, in the corporate team


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