Evaluating Material Adverse Change (MAC) Clauses in the Loan Default Context (Part 1 of 2)
Guest Writer - Christopher T. Nixon, Winstead PC
In an earlier posting we briefly covered the importance distinction between a “monetary” default and a non-monetary default. One non-monetary clause getting increased attention in the “material adverse change” clause. This is the first of a two-part series on this topic.
Commercial lenders often include Material Adverse Change (MAC) clauses in their loan documents, especially in transactions involving the release of funds over time, such as credit facilities, revolving lines of credit or cash advances on asset-based transactions or in real estate transactions, earn-outs or some other form of future funding. A MAC clause is typically broad and provides that the occurrence of a "material adverse change" constitutes an event of default by the borrower under the loan documents. A “material adverse change” is then defined to include changes in business, operations or the financial condition of the borrower.
Lenders typically are cautious in declaring that a borrower default under commercial loan documents has occurred as a result of a “material adverse change." The more broad the MAC clause, the more uncertainty the lender has in evaluating whether the MAC clause is applicable to the alleged "material adverse change."
Case law may also deter lenders from declaring a borrower default based solely on a broad MAC clause. Courts have not yet developed a standard test in evaluating MAC clauses. Courts will carefully review the language of the MAC clause and the extrinsic evidence, if necessary, to determine whether the MAC clause is applicable.
In the event the lender declares that a borrower default under the loan documents has occurred as a result of a “material adverse change,” a lender should be prepared for the borrower to contest such default declaration in the event the answer to any of the following questions is “Yes”:
1. Is it unclear whether the change at issue is “material” and “adverse?”
While determining whether a particular change is "adverse" is somewhat straightforward, determining whether the change is "material" is typically a challenge in the context of a broad MAC clause.
Lenders intentionally do not define the term "material" in the MAC clause. Lenders want the MAC clause to cover all unknown and unforeseen adverse changes.
Materiality is a fact-based determination and highly dependent on the circumstances of each case. There is no baseline percentage or threshold amount that is deemed to be "material," absent specific language in the document. Given the fact-sensitive nature of the issue and the broad language of a typical MAC clause, courts typically consider a broad MAC clause to be ambiguous and require extrinsic evidence to determine the parties' intent as to what types of changes the clause was intended to cover. Any litigation on the issue will likely require a full-blown trial because summary judgment cannot be obtained under these circumstances.
Each party should carefully review the loan documents to determine whether any specific objective thresholds are included in the loan documents with respect to whether a particular change is "material" under the MAC clause.
Each party should also determine whether the loan documents contain any specific exclusions to the MAC clause. In the event specific changes are expressly excluded from the MAC clause, and the particular change deemed by the lender to be “materially adverse” is not an express exclusion, a court may view such non-excluded change to be subject to the MAC clause.
Each party should review its file with respect to prior loan document negotiations. If the borrower requested that the particular change deemed by the lender as being “materially adverse” be excluded from the MAC clause (and such requested exclusion was ultimately not accepted by the lender), the exclusion may be used by the lender as evidence of the parties’ intent that the MAC clause cover the requested exclusion.
In my next posting, I’ll explore several other aspects of dealing with a MAC clause.
Please post a comment with any questions, comments or you own experience – real or hypothetical!
