Brexit and Material Adverse Change clauses

David Campbell, a partner in Allen & Overy’s banking department, considers whether the result in the EU referendum means that Material Adverse Change clauses (MACs) are triggered in credit agreements and mandate letters.

Does the result in the EU referendum mean that MACs will be triggered in credit agreements and mandate letters?

Quite a few clients have asked whether I think the EU referendum vote means that MACs are triggered in credit agreements and mandate letters. The short answer, for business MACs, is 'no'. For the longer answer, read on.

What is the difference between a 'business MAC' and a 'market MAC'?

A 'business MAC' refers to something which happens to the business or performance of the specific borrower (or group) which is party to the finance document. Underwriting commitments may also contain a 'market MAC', which is designed to be triggered by events which are not directly related to the borrower, but affect the debt market generally and, specifically, the ability of the underwriter to sell the underwritten loan to other lenders. It is quite possible that a market MAC (or market flex clause) in a mandate letter may be triggered by market volatility or loss of liquidity caused by the referendum vote—we will have to see how the markets develop over the next few days and weeks. Most questions I have received, though, are about business MACs, which is what the rest of this analysis is about.

What do 'business MACs' drive at?

MACs vary from those which could never realistically be used but are included in documents to tick a policy box, to those which are subjective (in the lenders' favour) and widely drafted. They are designed to deal with unforeseen circumstances so they are, by their nature, drafted relatively imprecisely—if you knew exactly the concern you were trying to address, you would draft a specific clause rather than a MAC. They are there to deal with lenders’ desire to cover the known unknowns.

I have a business MAC in my loan agreement or underwrite—is it triggered?

As always, the specific wording of a clause is important—but in general, to invoke a business MAC on the basis of the EU referendum result you would need to be comfortable that the vote itself (not its possible future consequences) has a material adverse effect on the borrower's business, financial condition, ability to service the debt, etc. It would be a very unusual borrower whose business is significantly impaired overnight simply by the passing of a vote. (Although it's fun to try to think of examples. How about a political party whose support is shown to have collapsed, and is then publicly abandoned by major donors? Or a borrower whose chief financial officer had been so sure of the referendum outcome that he'd been to the bookies on 22 June 2016 and staked a year's profits on a 'remain' vote? But if you're lending to borrowers like that, you have bigger problems than worrying about a MAC clause.)

Back to reality. Some business MACs include a future-looking element (such as a reference to the borrower’s 'prospects'), and in those cases one could more easily extrapolate for the future effects of the UK leaving the EU. But what does 'leaving' actually mean? Some versions of 'leave', such as adopting the Norwegian model, may not actually change the economic reality very much and UK businesses would still have access to the common market—we’ve already seen a slew of 'leave' politicians say that we need to maintain close ties with the common market. So until we know how the UK/EU separation will occur, it will be hard to take a view on a borrower’s prospects or rely on a MAC, even if that borrower’s business relies heavily on access to the single market or on EU-wide rights such as free movement of people.

It is also more difficult to invoke a MAC on the basis of circumstances which you knew about when the MAC was agreed to—in other words, if a loan agreement or underwriting mandate was signed when the referendum was already on the horizon. And, as always with MACs, making a wrong call could result in significant liability, not to mention damage to reputation—so someone would need to be very sure of their ground, or desperate, to drawstop or accelerate a financing on the basis of a MAC alone. Act with caution and seek legal advice.

Only a handful of finance document MACs were called during the financial crisis in 2007–2008, and I'm not sure any of them actually led to enforcement or acceleration. I would be surprised if many (any) MACs are declared because of the referendum vote. The best general advice for now—as in all moments of crisis—is to keep calm, don't panic, and don't do anything hastily which will be repented at leisure.

David is a partner in Allen & Overy's banking department and has a wide range of expertise which includes investment grade and leveraged finance, restructurings and distressed refinancings, trade finance, and acquisition finance for public and private bids in the UK, US, Europe and Australia.  He has acted for most major banks and his corporate relationships include several FTSE-100 and FTSE-250 companies. He has a particular focus on the Nordic region works with several major Swedish, Norwegian and Danish banks and corporates.

Allen & Overy has a significant amount of resources on Brexit—see www.allenovery.com/brexit—including a paper published on 24 July 2016 about the immediate implications of the vote (here). At times like this, clients are our priority. We are ready to help, and our experts are ready to advise across the full range of sectors and practice areas.

We work on more UK and EU loan and capital market transactions than any other firm, so we have an unrivalled overview of the debt market, and whatever develops in the coming weeks and months you can be sure we'll be seeing it. You can reach our Brexit team on A&OBrexitqueries@allenovery.com or, of course, contact me or anyone else at the firm. And of course we are very interested to hear what you're seeing in your world as a result of the vote, and what Brexit means for your business.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

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