Coronavirus: The effect of Material Adverse Change clauses
In our Coronavirus: Commercial Contract and Supply Chain FAQs we look at the effect of Force Majeure provisions in commercial contracts, and how they might operate in the context of the Coronavirus outbreak. However, in some types of agreements it is more common to see a Material Adverse Change (“MAC”) clause to deal with changes in circumstances. This is particularly the case in financing documentation such as Facility Agreements where there are obligations to provide future funding, for example revolving credit facilities or development finance, and also in corporate transactions that have a split exchange and completion with a potentially length interim period. In this article we consider how MAC clauses may alter contractual provisions in the light of the Coronavirus outbreak.
MAC clauses are usually bespoke and sector-specific; for instance, in the sale of a care home business, this could be linked to occupancy and Care Quality Commission ratings, whereas in the sale of a hotel business this could be linked to advance bookings levels (something which could clearly be affected by the Coronavirus outbreak). This is also the case for MAC provisions in financing agreements, where drafting can vary significantly from agreement to agreement, and it is often a clause that is negotiated in detail. This means that, regardless of the type of agreement, the court’s interpretation of any individual MAC clause will be very fact-specific and language-specific, and so each clause must be assessed carefully on its own wording.
When looking at the effect of Material Adverse Change clauses on your contracts, we ask the following key questions:
1. Is the Coronavirus outbreak a Material Adverse Change?
What “Material Adverse Change” means will depend on how it is defined in your contract. Unless the MAC clause specifically references a pandemic (or equivalent wording), the fact that we are in the midst of a pandemic is not likely to be considered a MAC in itself; however, it is possible that the impact of the pandemic on a party’s financial position, or the impact of government actions (for instance a party not being able to lawfully carry out its business due to the business closure requirements) could technically lead to a MAC.
Note that the party seeking to rely on the MAC clause will have a heavy burden to prove to a court that there is sufficient evidence that a MAC has occurred. This will be the case even if there is a subjective element to the drafting of the MAC clause, i.e. whether there is a MAC in a party’s opinion; that party will still need to show, as a matter of fact, that there has been a MAC.
2. Can changes in market conditions be a Material Adverse Change?
Since each clause is interpreted on its own language, if the drafting does not include prospects or external/market conditions, a party will not be able to rely on these if it is seeking to enforce the MAC clause.
3. What counts as “material”?
As the name suggests, to rely on a MAC clause, the event must be material. This means that it must be substantial and significant and it must be for a significant period of time. If it is only temporary or a blip, it will not be sufficient to constitute a MAC. Parties may face a challenge in demonstrating that with the Coronavirus outbreak, the change is long term as opposed to temporary and recoverable; whilst the period of impact is unknown, we don’t expect it to last forever. Again, the wording of the clause itself is critical; for example, in a Facility Agreement a change is likely to only be considered material if it affects the borrower’s ability to repay monies.
4. What is the effect of a Material Adverse Change?
Typically, MAC clauses operate to alter the situation between the parties in the event that something significant happens to affect the circumstances or one or other party. For example, in a corporate transaction a MAC event may give the buyer the ability to walk away from a deal, and in a finance context may give a lender the ability to prevent further drawdown of funds. As a general rule, MAC clauses are seen as a catch-all concept, a backstop which allows the lender or the buyer (as the case may be) to bring the parties back to the table during a downturn, rather than being used as a cause of action on their own. In addition, there is very limited case law around MAC clauses, showing that whilst they are often included in financing and corporate agreements, they are rarely litigated. In particular, there is no case law around MAC clauses during a pandemic (e.g. the last SARS outbreak).
5. What if the other party disagrees that there is a Material Adverse Change?
It is worth noting that if a party relies on a MAC clause (for example if a lender refuses to advance further sums that they are obliged to advance, assuming the borrowing party is compliant in all other areas), and it is later proven that there had not been a MAC event, the party relying on the clause would be in breach of contract, and the other party would have a claim for damages, which could involve significant compensation.
However, it is important to bear in mind the risk of adverse publicity during this time, as the general consensus amongst businesses seems to be a desire to be supportive through the Coronavirus outbreak. Overall, the risk of enforcing a MAC clause in these circumstances is high for the party seeking to rely on it, and generally not something we are currently expecting to see being used widely, particularly in the case of finance agreements. If you have concerns, then early conversations with the other party may be worth having, to understand their thoughts and position with regard to the operation of the contract. It is also worth noting that, given the fast-paced nature of the pandemic and how quickly things progress, the position may change rapidly, and we would recommend monitoring the situation over the next through weeks and months.
If you would like to talk through the consequences for your business, please email us and one of our team will get in touch.
The content of this page is a summary of the law in force at the date of publication and is not exhaustive, nor does it contain definitive advice. Specialist legal advice should be sought in relation to any queries that may arise.
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