Material adverse change provisions in credit agreements are under much heightened scrutiny in the current circumstances.

By James Chesterman and Helena Potts

In the current environment, both corporates and their lenders are trying to assess a fast-moving situation. Businesses are suspending operations, countries are limiting travel and non-essential activities, events are being cancelled and consumers are in actual or semi-lockdown.

At present, credit arrangements are an important source of cash for companies, and continuation of trade is a function of continued access of those credit lines. An absence of liquidity may force a board of directors to consider whether a company can continue to trade as a going concern in many jurisdictions. In many cases, this consideration involves an assessment of access to available lines of liquidity and credit, as well as a company’s ability to continue to meet its ongoing payment obligations.

Relevant issues arising currently include

  • Material adverse change (MAC) provision
  • Cross default and cross-acceleration
  • Litigation tripwires
  • Using covenant-lite structures to obtain liquidity
  • How directors’ duties can affect company strategy in financial difficulty
  • Impact of Market Abuse Regulation and other securities laws
  • Issues under certain funds commitments
  • State aid

The current focus on the occurrence of a potential MAC provision or material adverse effect under contract is reminiscent of the Lehman Brothers insolvency and the onset of the 2008 financial crisis. In credit agreements, this may manifest as an independent event of default, a requirement for other events to be triggered (such as cessation of business), a breach of representation relating to absence of MAC, or a separate drawing condition.

The application of a MAC provision is entirely a matter of specific construction of the provisions under the relevant governing law, and no conclusions can be reached without a review of the specific documentation concerned. However, some points of general application from an English law perspective include:

  • There is little case law on what constitutes a MAC on business or financial condition. However, generally, if there has been a change that means, given the current facts, a lender would not have lent at all, or would have lent only on much more onerous terms, that may be sufficient. The test is a high bar, however, current circumstances could overcome that issue depending on the actual specifics of the borrower’s situation (although arguments as to how temporary the current situation is could be made as well).
  • Provisions may have a trigger with multiple “prongs”. For example, a material adverse effect on payment obligations or on a company’s ability to comply with financial covenants may be included, as well as a more general MAC.
  • Does the default require a MAC to have occurred, that a MAC will occur, or, instead, will be reasonably likely to occur?
  • Event of default provisions often require an “event or circumstance” to have happened, so identifying whether there is such an event or circumstance in the specific situation is important. In this instance, the COVID-19 outbreak may be certainly considered to be a continuing circumstance whereas, for example, a closure of a business line may be an event.
  • Whether the agent and the banks need to act reasonably (either expressly or impliedly).
  • It is worth noting MACs can be included as repeating representations with respect to historic accounts.
  • Whether for recent and new financings the current circumstances are pre-existing.

By way of cross-border comparison, New York law credit agreement have MAC events of default significantly less frequently than European credit agreements, but a no representation may often be required for lending new money.

Making a correct determination of MAC is clearly important for financing parties as withholding facility utilisations without contractual justification could lead to claims for damages owing to breach of contracts, particularly if withholding a new drawing leads to the collapse of the company concerned. Whether trigger events based on material adverse effect have occurred is frequently a matter of some debate, in which a borrower, agent and lenders may have different views. This may lead to court applications for declaratory relief and challenges from some borrowers if material adverse effect is used as a basis for withholding utilisations.