Interpretation of material adverse change clause in loan agreement

Published Date
Jun 11, 2013
Material Adverse Change clauses are common in credit agreements, but are rarely interpreted by the courts. In Grupo Hotelero Urvasco SA v Carey Value Added SL (formerly Losan Hotels World Value Added I SL) & anr [2013] EWHC 1039 (Comm) Blair J considers what can be taken into account when considering a borrower's "financial condition", how to assess the "materiality" of any change in financial condition and to what extent a lender's knowledge of pre-existing financial circumstances at the time of granting credit can be considered when assessing whether a material change has occurred.

This was a factually complex case involving the financing of a hotel and apartment development in London. The developers (a group of Spanish companies and an English-incorporated SPV) had two banking facilities, one provided by the group's primary lender Banco Bilbao Vizcya Argentaria SA (the BBVA Credit Agreement) and a later facility that had been provided by a Spanish fund called Carey Value Added SL (Carey) when the developer was experiencing financial difficulties and sought further funding (Loan Agreement). One of the group companies had provided a guarantee. In 2008 Carey ceased to make advances under the Loan Agreement. The case is of interest for a number of reasons but this case note is limited to a consideration of the court's interpretation of the relevant (and "plain vanilla") material adverse change (MAC) clause.

The MAC clause under the Loan Agreement stated:
"There has been no material adverse change in its financial condition (consolidated if applicable) since the date of this Loan Agreement [21 December 2007]."
This representation was automatically repeated on drawdown. The Loan Agreement also provided that an event of default under the BBVA Credit Agreement constituted a default under the Loan Agreement. The Loan Agreement contained a similar MAC provision relating to the guarantor. A misrepresentation about the financial condition would have been a default under the BBVA Credit Agreement if made at a relevant point in time prescribed by the BBVA Credit Agreement.
The developers/borrowers made a drawdown request under the Loan Agreement on 6 June 2008 but Carey failed to make the advance, claiming that by 6 June 2008 there had been a substantial deterioration in the financial condition and prospects of the developer companies. Carey later terminated the Loan Agreement for non-payment of interest. At trial, Carey argued that there had been a material adverse change in the financial condition of the borrowers and guarantor by 6 June 2008. The court found that there had in fact been a material adverse change in the guarantor's financial condition but that the guarantor had not repeated its representation about its financial condition on 6 June 2008 as the time at which the representation was deemed to be repeated was set out in the BBVA Credit Agreement and was "the first day of each Interest Period", which was not 6 June 2008.

Although Carey's case on the MAC default failed on the representation point, the court considered the proper interpretation of the MAC clause.

There were three contractual interpretation issues as set out below. It should be noted that although the Loan Agreement was governed by Spanish law, this did not give any rise to any material differences in how the MAC clause should be interpreted.

Financial condition
Carey argued that the reference to the "financial condition" of the borrowers should be broadly construed to include "all aspects of the company's finances including balance sheet items (assets and liabilities), profit and loss account items and cash-flow or liquidity items, and the impact on these of the state of the markets in which the company was operating".

The borrowers argued that this was too broad and the consideration of a company's financial condition should begin with an assessment of its position as shown in financial statements at the relevant date. It did not encompass the prospects of a company or external economic or market changes.

The court preferred the borrowers' approach and held that their emphasis on the company's financial information was correct. The court contrasted the MAC clause in the Loan Agreement, which referred to "financial condition", to an event of default clause in the BBVA Credit Agreement which referred to both the "financial condition" and "business" of an obligor. The inclusion of events which had a material adverse effect on the company's business covered a broader scope than the MAC which was limited to the company's financial condition. The borrowers' interpretation was also supported by reference to the words in parenthesis "(consolidated if applicable)" which the court accepted was probably a reference to the consolidated accounts. The court considered that if the broad interpretation contended for by Carey applied, the factual enquiry would have become "broad ranging and imprecise". Although the borrowers' financial statements were the starting point for any factual enquiry, it was not necessarily limited to this information. In this case, the fact that the borrowers had ceased to pay bank debts (itself in anticipation of a rescheduling of its debt) was a relevant issue.

The borrowers argued that materiality should be assessed by reference to changes in the balance sheet position which are relevant to the borrowers' ability to meet their obligations regarding the payment of principal and interest.
Carey submitted it was wrong to limit the enquiry to matters which went to the ability of the borrowers to meet future obligations, pointing out that one of the parties to the Loan Agreement (the SPV) had no payment obligations. However, the court rejected this argument. The court quoted from academic commentary with approval, referring to:

  1. the Encyclopaedia of Banking, where it states: "if the change would have caused the bank not to lend at all or to lend on significantly more onerous terms, eg as to margin, maturity or security";1 and
  2. Zakrzewski, Law and Financial Markets Review, which considers a change to be material that: "substantially affects the borrowers' ability to repay, or, more generally, significantly increases the risks assumed by the lender".2

The court emphasised the importance of the word "significant", noting that a lender would otherwise be able to call a default or suspend lending when it was not fully justified, thus propelling the borrowers into insolvency.

Pre-existing circumstances
The borrowers argued that it was axiomatic that where a state of affairs was subsisting at the time that the Loan Agreement was entered into, it could not constitute a material adverse change if it also subsisted at the time of drawdown. This was a reference to the fact that the Loan Agreement had been sought at a time when the developers were in financial difficulties and had sought additional finance to close a funding gap. The borrowers argued that if the lenders were aware of the state of affairs, they should be taken to have entered into the Loan Agreement notwithstanding their existence.

Carey disagreed that pre-existing circumstances should be taken into account and argued that this would make the interpretation of the clause dependent on the subjective state of mind of the lender.
The court agreed with the borrowers. Blair J referred with approval to U.S. case authority considering a MAC clause in the context of a takeover agreement where the court held that the purpose of the MAC clause was to protect "the acquirer from the occurrence of unknown events that substantially threatened the overall earnings potential of the target in a durationally significant manner". Blair J considered that the law had been correctly stated in an article by Professor Rawlings when he stated that: "the lender cannot trigger the clause on the basis of circumstances of which it was aware at the date of the contract since it will be assumed that the parties intended to enter into the agreement in spite of those conditions, although it will be possible to invoke the clause where conditions worsen in a way that make them materially different in nature".3 The judge also emphasised that in order to be material, any change could not be temporary.

Although Carey failed to establish an event of default on the basis of a misrepresentation in relation to the MAC clause, the court held that there had been other defaults and Carey therefore ultimately succeeded on its claim to recover the sums it had already advanced to the borrowers and on its claim under the guarantee that had been provided by one of the group companies.
Cases that consider the interpretation of MAC clauses are rare and this case therefore provides useful guidance, including by referring with approval to the academic commentary on MAC clauses referred to above.


  1. Encyclopaedia of Banking Law F[1862].
  2. Zakrzewski, Material adverse change and material adverse effect provisions: construction and application, (2011) Law and Financial Markets Review, 344.
  3. See Rawlings, Avoiding the Obligation to Lend, 2012 J.B.L. 89.

Further information

This case summary is part of the Allen & Overy Litigation Review, a monthly update on interesting new cases and legislation in commercial dispute resolution. For more information please contact Sarah Garvey, or tel +44 (0)20 3088 3710.

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