The issue of whether the coronavirus pandemic triggers the MAE/MAC clauses found in commercial contracts is as important to our corporate and banking clients as the issue of force majeure. This is particularly true in merger and acquisition agreements, where the absence of a MAE/MAC is regularly a condition precedent to closing, and in credit agreements, where it often serves not only as a condition precedent to disbursements, but also as an event of default or event of acceleration, permitting the lender(s) to accelerate the maturity of the loan.[1]

If any development since the outbreak of World War II would by its mere visibility and anticipated impact on mankind appear to trigger those contract clauses, it is the current COVID-19 pandemic. Yes, more so than 9/11 or the worldwide financial sector collapse of 2008. But these clauses normally are not triggered simply because of a cataclysmic event, but only because of the consequences of that event on a designated party or project (if the situation involves a project).  In other words, a knee-jerk reaction to this horrible pandemic would not be appropriate; rather, the MAE/MAC clauses require analysis of the designated party’s (or project’s) specific, current and likely future situation as a result of the pandemic.

The starting point, of course, is the language used in the relevant contract, which is not uniform in commercial contracts. In fact, many subtly different variations of this clause are used, so parsing the language involved is always very important as a starting point.  As a threshold matter, the clauses break down into two broad categories: the MACs, which rely on a material adverse change in the designated party’s (or project’s) individual situation, and the MAEs, which rely on some event having an adverse effect on that situation. While an “effect” and a “change” will most often overlap, the two concepts are not synonymous, and one can  imagine a situation where an event would have a serious “effect” on a designated party’s situation, without in the short run causing a “change” in that situation, or conversely, where a “change” in the designated party’s situation could not easily be causally connected to the “effect” of some event.[2]  Aside from this threshold distinction, it is difficult to distinguish the language generally used in MAE versus MAC clauses.

It is common for these clauses to include a “material adverse change/effect” not only on the designated party’s own business and financial situation and on any project being financed, but also on important related parties. In credit agreements, it is also common to see a MAE/MAC clause include changes in the enforceability of the financing documents themselves, which, of course, seems odd in a provision intended to measure “adverse” change on the designated party: if anything, such a change would likely favor the designated party. In merger and acquisition agreements, one commonly finds references to dramatic changes in economic or social conditions – such as acts of God, weather events, natural disasters, terrorism, war or civil insurrection, general economic downturns, and matters generally affecting the designated party’s industry – as exceptions to the MAE/MAC clause.[3] Often there is then also an exception to the exception, which allows the MAE/MAC clause to be triggered if there has been a disproportionate impact on the designated party. As with many other provisions in both credit and acquisition agreements, in its simplest form what is occurring is an allocation of risk among the parties: if such and such happens, which party bears the burden?

In both credit and merger and acquisition agreements, the breach of certain specific representations and warranties, covenants, conditions precedent, and events of default, arguably could also permit an acting party to act under the MAE/MAC clauses. In these situations, it would seem much better for the acting party to base its action on the breached covenant, representation, condition precedent or event of default, rather than on MAE/MAC clause. The latter brings into play the often tricky issue of “materiality,” discussed below. It is best for an enforcing party to avoid this issue altogether.[4]

At times a MAE/MAC clause specifies that the determination of “materiality” must be made “reasonably” by the acting party.  Of course, if the acting party is  a lender  secured by personal property, or its actions otherwise trigger the Uniform Commercial Code, it will be required to act “reasonably” in enforcing its rights, whether or not the MAE/MAC clause so specifies.[5] In addition, state laws as well will often require the acting party to act reasonably, and what lender wants to appear before a judge (much less, jury) after having acted “unreasonably”? Moreover, from the existing case law, discussed below, the issue whether the acting party acted “reasonably” often seems to get mixed into the process of a judge deciding whether the “materiality” threshold has been crossed, whether or not it is openly discussed as a legal requirement. Acting parties which have not arrived “reasonably” (which in this context essentially means thoughtfully and carefully) at the conclusion that a MAE/MAC has occurred, can expect a tough time convincing a judge. The same is true for “foreseeability” – though neither the law nor any language in an agreement may refer to the foreseeability of a claimed MAE/MAC, the courts seem to consider that factor as well in making their own assessment. Consequently, an acting party will have a tougher time convincing a judge that a circumstance that could have been foreseen at closing constitutes a MAE/MAC.

 MAE/MAC clauses generally do not attempt a definition of “material,” leaving it to the pertinent tribunal to ultimately make that determination if the issue is contested.  Instead, it is common for a MAE/MAC clause to somewhat redundantly (and circularly) define a MAE/MAC as an effect/change which “materially” adversely affects the designated party, or project, without any effort to explain further. In law, “material” is generally defined in terms such as important, relevant  or significant.  Those adjectives certainly apply to MAEs/MACs, but they are far from encapsulating what the courts look for.

The leading recent cases have considered “materiality” in the context of a merger and acquisition contract, and not in the context of a credit agreement.[6] This is not surprising, since commercial lenders often have to weigh concerns that are normally not as pertinent to a merging corporation, so they naturally  would be more reluctant to rely on this clause for any action they take. Reputation is one such concern, as are “lender liability” laws of various kinds which may apply under state law. For example, as already noted, if the credit is secured by personal property, the Uniform Commercial Code’s requirement that a party act “reasonably” applies. More directly relevant, so does the provision of Article 9 requiring that every aspect of a disposition of collateral after a default, be “reasonable,” or the creditor may incur liability. [7]As a result, creditors are understandably loath to act based on a determination of “materiality” which may later be second-guessed by a court, and much prefer to rely on a covenant or representation default whose breach objectively is clear and indisputable.

In terms of determining “materiality”, as already noted the process is highly individualized to the designated party, and not to a broader community.  Consequently, this clause cannot be satisfied by reference to an economy, community or industry, even if it has been devastated by some natural disaster. The acting party must determine the situation of the designated party itself. For example, the COVID-19 pandemic, devastating though it is, would not in and of itself justify action under a MAE/MAC clause.

Time is also a critical consideration in a court’s determination of “materiality”.[8]  A short-term difficulty – or “blip” - which the designated party may be able to overcome over a reasonable period of time, does not make a good basis to declare and act on a MAE/MAC.  The question becomes, how long is appropriate? The merger cases, which use periods at times measured in years to project what the designated party might have been able to achieve, are probably not good precedents for credit agreements.  Loans are not as absolute, all-encompassing, permanent transactions as mergers and acquisitions, so logically the time standard applied should be less, and should certainly consider the remaining duration of the loan.  Nevertheless, the truth remains that courts look at the amount of time the acting party considered and allowed for the designated party to dig itself out of the hole it was in. What time is appropriate? One would expect the answer should depend on considerations such as: What was the event or circumstance that caused the MAE/MAC? Was it self-inflicted? How much damage has the designated party suffered? How has the designated party reacted?  How good are the designated party’s plans to recover? And, how much money does the acting party have at risk?  In short, allow or factor in a reasonable time under the circumstances for the designated party to recover.

The remaining issue is the amount of loss suffered necessary to make an event “material.” Obviously, this question is interrelated with the prior ones, in particular with the time dimension. The courts have made it clear that in this instance, “material” means very significant in proportion to the designated party’s resources, performance or prospects.  They look for a significant impact on the designated party’s earnings, and/or some significant deterioration in the designated party’s prospects. Another possible consideration is whether the designated party has been notably more adversely affected by the event than its competitors.

Now the determinations of “materiality” referred to, again, were reached in the context of all-encompassing and permanent merger transactions. Consequently, in the context of a less important and shorter transaction such  as a loan, perhaps the court would not apply as high a standard. Nevertheless, an acting party should not rely on this possibility unless declaring a MAE/MAC is of great importance, and there are no other contract clauses on which to base its actions.  Consequently, it would seem ill-advised to determine that anything other than a very large loss (proportional to the designated party’s over-all resources, of course) was sufficient to declare a MAE/MAC.

To summarize, here is what one might advise an enforcing party thinking of declaring a MAE/MAC:

1. If possible, justify your action based on another provision in your contract, and not the MAE/MAC clause;
2. Short of global thermonuclear war, don’t rely on any generalized disaster, including COVID-19, for your declaration. Instead, focus on the impact of the event on the designated party or project, and the damage or loss it has suffered or can be reasonably expected to suffer;
3. Make sure you act reasonably and can strongly defend each of your decisions and actions in court. Among other things, this means assembling thoughtfully the data on which you rely for the declaration, and being able to document that it was intelligently considered by multiple persons (perhaps by a Board committee delegated to do so);
4. If the event on which you rely was reasonably foreseeable at the closing of your transaction, you will have a tougher time convincing the court a MAE/MAC has occurred;
5. Do not act based on a MAC/MAE unless you can defend that the loss or damage to the designated party will last for a significant period of time, measured in light of the particular transaction in which you are involved; and
6. The loss or damage to the designated party must be very significant in proportion to its assets.

Of course, if you are the designated party, you will conversely be looking for the absence of one or more of these factors in the acting party’s determination that the MAE/MAC clause has been triggered as a basis to challenge its enforcement actions in court.