March 26, 2020

Invoking MAC Clauses During the Pandemic

By: Robert M. Berman and Craig A. Enck

Although Material Adverse Change (“MAC”) clauses are quite prevalent in loan and financing documents, there is very little case law in Maryland dealing with the successful or unsuccessful enforcement of these clauses. With the current COVID-19 pandemic, we will likely see more lenders invoking a MAC clause to deny funding or to declare an event of default, and accordingly, more case law will evolve. Time will tell whether the coronavirus will create economic conditions to such a degree that MAC clauses will be successfully invoked. 

Generally speaking, a MAC clause is included as a condition precedent to an advance of funds under a line of credit or takes the shape of an event of default.

In essence, a MAC clause contains language relating to “any event, condition or change in the Borrower which could reasonably be expected to materially and adversely impair, diminish or affect the financial condition, assets or operations of the Borrower”. 

The occurrence of the aforementioned would either allow the Lender not to make an advance under the line of credit or call an event of default under the credit facility.

Lenders who rely on the enforcement of the MAC clause for the above reasons will face an onerous burden of proof.  The words “material” and “reasonably” alone are ambiguous enough by nature to elicit differing opinions. 

In the 2009 case from the district court of the District of Columbia, Capital Justice LLC v. Wachovia Bank, N.A., 706 F. Supp. 2d 23, the Lender relied on a MAC clause to terminate a credit facility to the Borrower when the commercial mortgage-backed securities market continued to decline, leading to diminished market liquidity. As a result, the Lender claimed it would be “unable to effect the securitization of the loan.” 

The Court looked at whether the MAC clause should only relate to unforeseeable events or events which are both foreseeable and unforeseeable.  The Court held that both views were plausible and remanded the case for additional fact findings to decide whether a MAC clause relates to any meaningful or significant change or whether a MAC clause relates solely to an unforeseen adverse change.

Alternatively, as described in the 2016 case from the district court of Illinois, Luxco, Inc. v. Jim Bean Brands, Co., 2016 WL 3136917, 6, N.D.Ill, Jim Bean Brands reformulated certain product lines, which Luxco alleged breached the express warranty that “no material adverse effect” had occurred. Relying on the Delaware Chancery Court, the court explained, “where a Material Adverse Effect condition is as broadly written as the one in the Merger Agreement, that provision is best read as a backstop protecting the acquirer from the occurrence of unknown events that substantially threaten the overall earnings potential of the target in a durationally-significant manner. A short-term hiccup in earnings should not suffice; rather the Material Adverse Effect should be material when viewed from the longer-term perspective of a reasonable acquirer.”

While the Luxco case was not born out of the turbulence of an economic downturn akin to the 2008 financial crisis or the current COVID-19 pandemic, its interpretation of what constitutes a material adverse change (or material adverse effect) may still be instructive.

Lenders generally prefer broad, open-ended MAC clauses to provide them with flexibility while Borrowers want more objective standards and will try to define what is “material” and what is “adverse”. 

From a practical point of view, a Lender should exercise caution in relying solely on a MAC clause to either deny an advance of loan proceeds or to call an event of default.  The Borrower will likely contest the Lender’s decision and the ambiguity of the language will be in dispute. 

In any event, if a MAC clause is triggered, it is likely that another event of default has occurred or will occur in the near term; i.e., a payment default, a breach of a financial covenant, etc. 

During the current uncertain economic conditions, given the intentionally broad language of a MAC clause, Lenders should still exercise caution in relying solely upon a MAC clause to halt advances under a line of credit or to claim an event of default.