banking
Material adverse change clauses
Banking and finance partner James McNeil compares the use of material adverse change clauses in business sale agreements and loan agreements
What is a MAC?
A material adverse change clause (MAC) is used to allocate risk between parties under an agreement.
A MAC is so-called because it is triggered when the circumstances of one party (typically the seller in respect of a business sale or a borrower under a loan agreement) deviate in a materially adverse way. A purchaser or lender can therefore be insulated, to an extent, against external risk factors such as economic decline, increased regulatory burdens and changes in the law.
Trigger events
A typical MAC might be triggered by any fact, matter, event, circumstance, condition or change which materially and adversely affects the business, operations, performance, assets, condition and/or prospects of the other party.
The wording is deliberately vague. The intention is for the MAC to catch any changes in circumstances which could prejudice the buyer/lender’s position under the relevant agreement. For example, under a business sale and purchase agreement (SPA), unexpectedly deteriorating market conditions may decrease the value of the target business below the previously agreed sale price. Whilst under a loan agreement, a deterioration of the borrower’s business might cause the borrower to become an unacceptable lending risk as it increases the risk of other defaults occurring.
Negotiation of terms
In both a business sale and a lending context, the inclusion and terms of a MAC will be subject to negotiation and the terms ultimately agreed to will depend on the relative bargaining strengths of the parties. In a lending scenario, a borrower may be faced with a ‘take it or leave it’ situation where the lender refuses to deviate from its standard or market standard terms. In the SPA context, MACs are typically requested by American purchasers although its popularity with English purchasers has been generally increasing in recent years.
Different usage
Material adverse change clauses are almost exclusively included in SPAs to give the buyer legal grounds to halt the purchase if the target business’ conditions materially deteriorate between exchange and completion of the business purchase.
In contrast, loan agreements tend to utilise MACs in three distinct ways:
1 A MAC representation – the borrower represents and warrants that it has suffered no material adverse change since a specified date. The lender will often require that the borrower repeats the representation each time it applies to make a draw down or at the end of each interest period. If the borrower can no longer make the representation, then the lender is not obliged to lend and it can also call an event of default.
2 MAC event of default – this is the typical ‘sweep-up’ MAC which catches events not otherwise expressly drafted for. If triggered, the lender can terminate lending, accelerate the loan and enforce any security which it holds. The evidential burden of enforcing a MAC event of default (discussed below) typically means that a lender is often reluctant
to enforce by reason of a breach of this clause alone.
3 Representations and covenants by reference to a MAC – borrower representations and covenants can be softened by using a MAC qualification. For example, a borrower would only be in default of the loan agreement if a breach materially and adversely affected its ability to perform its obligations under the loan agreement.
Enforcing a MAC
MACs have wide-reaching implications for sellers and borrowers and this is particularly the case where the prejudiced party does not have the bargaining power to resist or qualify a MAC’s inclusion.
The courts have therefore taken a very strict approach to construing MACs. Although there is very little English case law on MACs, the consensus is that the party attempting to rely on the MAC will have a high evidential burden to show that the MAC has been triggered. This may not be the case where it can be shown that agreement containing the MAC clause was entered between parties who were aware of the commercial risks and accounted for them in the deal’s price.
The commercial reality
The legal difficulty and associated expense of bringing (and defending) a MAC court case means that parties often instead renegotiate following a trigger event. However, a defaulting party will usually be disadvantaged going into negotiations, particularly in a commercial lending scenario.
The wording and fundamental principles behind MACs in SPAs and loan agreements are therefore very similar. The main difference is the more varied use of MACs in loan agreements.
James McNeil 023 8048 2108
james.mcneil@
parissmith.co.uk
THE BUSINESS MAGAZINE – SOLENT & SOUTH COAST – OCTOBER 2016
businessmag.co.uk
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