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Will the vote for Brexit trigger material adverse change clauses?

Adam Sanitt
Kenneth Gray

Many finance documents contain material adverse change clauses (“MAC clauses”) that relieve a party of its obligations on the occurrence of an unforeseen event. These vary widely and are often heavily negotiated, so whether a MAC clause has been triggered by the UK’s vote for Brexit will depend on the terms of that particular clause, in particular

  • Which entity must have suffered the material adverse change? For example, the borrower, the borrower’s group of companies or any individual member of that group.
  • What must the change relate to? For example, the borrower’s financial condition only, or its prospects, or the economic outlook.
  • By comparison to what time is the change measured? For example, the date the contract was entered into.

Complacency that MAC clauses could never be triggered is not justified. Indeed, especially for certain forward-looking MAC clauses, lenders might seek to use them to prevent further borrowing (a ‘draw stop’) rather than as an event of default leading to acceleration of the loan.

There is little judicial guidance on the use of MAC clauses – as their interpretation may be uncertain, the circumstances in which they may apply rare and their consequences severe, they are not often used. But recent guidance was given by Blair J in Grupo Hotelero Urvasco v Carey Value Added [2013] EWHC 1039. He set out the following principles:

  1. ‘financial condition’ of a company alone does not encompass external economic or market conditions, but primarily its accounts and other financial information.
  2. whether a change is material depends primarily on whether it will affect the relevant party’s ability to meet its obligations under the agreement.
  3. the change must be something that the triggering party was not aware of at the time the contract was entered into.
  4. the change must not be merely temporary.

These are generally seen as strict criteria, hence the assumption in most circumstances that a MAC clause will not be triggered – or at least not until after there have been breaches of other provisions, such as financial covenants. But note, firstly, that criteria 3 and 4 are all met by the vote for Brexit. Assuming that the contract was entered into before 23 June, the vote was a binary, one-off event that could not have been predicted and caused a specific, permanent change. Those changes are continuing as, of course, the full consequences are not yet known.

This leaves criteria 1 and 2 as the critical factors. These are the factors that also depend heavily on the exact drafting of the MAC clause. Where it is phrased primarily by reference to the party itself – its financial condition, its business, and so on – then these criteria are unlikely to be fulfilled simply by the vote itself. The general economic and financial consequences will be too inchoate to constitute an event that prevents a company from fulfilling a specific obligation. But where a MAC clause is phrased by reference to the prospects of a company, then it is conceivable that it might be triggered by the vote for Brexit. This could apply to companies that rely on EU ‘passporting’ or other EU-wide regimes or that are deeply embedded in cross-border supply chains. The change may also materialise at a later date – when the terms of a Brexit are known (if for example, tariffs are imposed on the borrower’s exports to its principal market).

Given the harsh consequences of accelerating a loan and given also that those MAC clauses that might be triggered are more forward-looking, banks may be tempted to use MAC clauses simply to limit further lending. Where the prospects of a business have been materially adversely affected by the vote for Brexit, a lender might wish to limit its ongoing exposure to that business, and triggering the MAC clause might be its only avenue to achieve this aim.

Finally, the argument that a MAC clause is not relevant because by the time it applies other covenants will have been breached may be comforting, but carries little weight. A MAC clause is a general, ‘catch all’ provision that is necessary precisely because there may be circumstances that justify overturning the commercial bargain between the parties other than those they have specifically provided for. And the vote for Brexit is exactly the kind of unique, serious event that falls outside the contractual allocation of risk and therefore has to be dealt with by general, back-up provisions.

Overall, while the general market view is fairly sanguine about MAC clauses and the Brexit vote, there are a few particular MAC clauses involving some vulnerable businesses that may be at risk of triggering. Companies should include this as part of their mapping of Brexit risks and opportunities.

The United Kingdom has voted to leave the European Union.

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