In these circumstances, many businesses are looking to their contractual remedies and are taking legal advice as to whether obligations which have now become onerous might be capable of being terminated or suspended based on force-majeure clauses or ordinary principles of contract law such as frustration of contract.
From a debt finance perspective, the closest corollary we have to a force-majeure provision is the "material adverse change" clause. So, to what extent might a "mac" clause be capable of being relied upon by a lender to exercise its typical remedies under a loan agreement as a result of a material adverse change brought about by the pandemic?
Material adverse change in Finance Documents - recap
It is not typical at all to see a force-majeure provision in a loan agreement. This is largely because contractual remedies arising under a loan agreement are different from those in ordinary commercial contracts. Whereas termination rights are key in commercial contracts, in a loan agreement the main default remedies are acceleration of the debt due or the imposition of a draw-stop on any available facility. One would therefore have to draft a force-majeure clause as an event of default and this simply isn't seen in most finance documents - it's just not market.
However, "mac" clauses are very much de rigeur in debt markets and, in a typical loan agreement (including all loan agreements in LMA form (other than the LMA investment grade templates in certain specific instances)), one will come across "mac" provisions in the following circumstances:
1.First, as a specific event of default triggered, typically, if a Material Adverse Effect (as defined) occurs.
2. Second, as a representation and warranty made by the borrower in connection with its last set of audited accounts - e.g. "there has been no material adverse change in the financial condition of the borrower since the date of the most recent audited financial accounts delivered to the lender".
3. Third, as a qualifier to certain covenants and representations & warranties given by borrowers - e.g. "the borrower is not in breach of any [material contract] where such breach would be reasonably likely to give rise to a Material Adverse Effect".
In the context of examples 1 and 3 above, a fairly typical definition of Material Adverse Effect would be:
"Material Adverse Effect" means [in the reasonable opinion of the Majority Lenders] a material adverse effect on:
(a) [the business, operations, property, condition (financial or otherwise) or prospects of the Group taken as a whole; or
(b) [the ability of an Obligor to perform [its obligations under the Finance Documents]/[its payment obligations under the Finance Documents and/or its obligations under clause [ ] (Financial covenants)]]/[the ability of the Obligors (taken as a whole) to perform [their obligations under the Finance Documents]/[their payment obligations under the Finance Documents and/or their obligations under clause [ ] (Financial covenants)]]; or
(c) the validity or enforceability of, or the effectiveness or ranking of any Security granted or purporting to be granted pursuant to any of, the Finance Documents or the rights or remedies of any Finance Party under any of the Finance Documents.]
The consequences of a breach of covenant or a misrepresentation arising under a "mac" provision will be that there will be an event of default (usually after the expiry of a short grace period for remedy). If there is a "mac" event of default clause and it is triggered, then clearly there is an immediate event of default. In both circumstances, the lender is likely to have one or more of the following remedies:
1. First, the right to accelerate repayment of the loans so they must be repaid immediately on demand and not on the contractually scheduled repayment dates.
2.Second, the right to impose a draw-stop on the facilities so the borrower may make no further drawdowns thereunder.
3. Third, the right to charge default interest (although this right often applies only in respect of unpaid sums rather than the mere occurrence of an event of default - i.e. the lender accelerates repayment and there is then a failure to pay on the sums demanded).
Could the pandemic give rise to a "material adverse change"?
There is no doubt that the pandemic and the subsequent government actions have had a material detriment on many businesses across the world. In a UK context, the pandemic is accelerating and thereby placing an enormous strain on the NHS. The UK Government has therefore imposed a "lockdown" under which many businesses have been forced to close their doors to further trade, and gatherings of two or more persons have been banned altogether (unless comprised of a family unit that lives in the same house). Indeed, each individual is expected to self-isolate if he or she is experiencing symptoms, and to practice social distancing if he or she is not with strict rules as to when a person may leave his or her house. It doesn't take too much imagination to picture the scale of damage this will do to many businesses, regardless of the emergency economic stimuli packages which the UK Government has rolled-out.
Those businesses under the most strain may subsequently find themselves under pressure from their lenders, particularly if there have been previous defaults and rollovers unrelated to the pandemic. Might it be possible for a lender to seek to enforce its rights under a loan agreement based on a typical "mac" clause and before any other default has occurred such as a non-payment or a breach of financial covenant?
The answer to that question is "it depends". To my mind, the following should be taken into account:
1. Is the "mac" clause in question specifically triggered by pestilence, pandemic or subsequent government action? In other words, are there specific provisions stating clearly that the occurrence of such events will be regarded as being a "material adverse change"? If so then it's likely that a lender could rely on that specific drafting to enforce. However, a "mac" clause that contained such wording would be highly unusual in our experience. Such drafting would be more typical of a force-majeure clause.
2. Typical rules pertaining to "mac" clauses. The following general principles (amongst others) arose out of the case law on "mac" clauses following the 2007 to 2009 financial crisis and its aftermath:
a. The event relied upon must be specific to the borrower in question and, in the absence of specific drafting (see point 1 above), a lender will not be entitled to rely on adverse events suffered by a wider market or an economy or country as a whole.
b. The event relied upon must not be transitory and must give rise to a permanent or long-term detriment.
These general principles would appear to point towards a conclusion that the pandemic cannot be relied upon to trigger a "mac" clause since (a) the pandemic is an event affecting the country and the economy as a whole and is not specific to any one borrower; and (b) the pandemic is, we all hope, a transitory event. However, I think a lot will also turn on whether the "mac" clause is drafted in objective or subjective terms.
3. Is the "mac" clause drafted in objective terms? In other words, is any discretion given to the lender to make the "mac" determination along the lines of "an event or circumstance occurs which, in the [reasonable] opinion of the lender, has a material adverse change upon….." If the emboldened and italicised text (or similar wording) is not contained in the "mac" clause then it is drafted objectively. In these circumstances, the lender must establish the "mac" as an objectively verifiable fact and the burden of proof is quite onerous. There is no question in these circumstances that the general rules pertaining to "mac" clauses as stated above apply and, accordingly, it is probable that the pandemic, in and of itself, could not be relied upon to trigger a "mac" clause.
4. Is the "mac" clause drafted in subjective terms? In other words, does the "mac" clause contain language conferring discretion upon the lender to make the "mac" determination along the lines of the language in emboldened and italicised text in para 3 above? If so, then the fact of the matter is that the "mac" clause confers a large degree of autonomy upon the lender, which becomes almost the judge and jury in its own cause. It is true that the addition of the word "reasonable" would add some protection here and would introduce an element of objectivity to the analysis which could therefore be the subject of judicial analysis. However, in my opinion, the word "reasonable" does not add a great deal more in protection to the standard of reasonableness that would apply absent the "reasonableness" qualification in an entirely objective clause. This standard is sometimes referred to as "Wednesbury" or "Socimer" reasonableness (after the leading case law on the matter) and it essentially means that, as a matter of law, the holder of a contractual discretion must not act capriciously and must not reach a determination which is so unreasonable that no reasonable person could possibly have reached the same determination. Given the current circumstances, it is at least arguable that "Wednesbury" / "Socimer" reasonableness protections would not be triggered if a lender determined that a "mac" had occurred based on the prevailing situation as regards the pandemic.
I have long taken the view that borrowers should not accept anything other than entirely objective language in "mac" clauses and the current circumstances do nothing to dissuade me from this opinion. It seems reasonably probable from the case law that, in the case of an entirely objective "mac" clause, that clause could not be triggered by a lender solely as a result of the pandemic. The position becomes less clear where subjectivity has been drafted into the "mac" clause; the protection afforded to lenders by subjective language cannot be overstated.
Having said that, it remains the case that "mac" clauses are often invoked as a last resort by lenders relying on poorly drafted loan documentation which has not been triggered by other more obvious events of default such as breach of a financial covenant. In that context and given the prevailing market conditions as a result of the pandemic, it is surely only a matter of time before covenants based on EBITDA or cash-flow metrics (such as leverage, interest cover or cash-flow cover covenants) or covenants based on balance sheet or asset values (such as net asset value or loan to value covenants) will be triggered. Accordingly, many lenders may bide their time rather than taking unnecessary and possibly precipitous action based on nebulous "mac" defaults.