COVID-19 and the "Material Adverse Change" Clause

Posted on by Neil E. McCullagh in Corporate and Business, Creditors' Rights, Bankruptcy and Insolvency

Due to the COVID-19 pandemic, our firm has received a number of inquiries about "force majeure" and "material adverse change" contract clauses. Some of my colleagues have already written about "force majeure" clauses (article available here). Generally speaking, a material adverse change ("MAC") clause allows one of the parties to a loan agreement or other contract to not perform its obligations, or to declare the other party in default, if a change in circumstances undermines the value of the agreement. For example, a loan agreement often gives the lender the option to stop funding the loan and/or to declare a default in the event of a material adverse change in the financial condition of the borrower, another obligor on the loan (e.g., a guarantor), or a project financed by the loan.

The usefulness of a MAC clause to a lender seems obvious in light of the COVID-19 pandemic. Nonetheless, the reported case law on MAC clauses in the lending context, while limited, cautions against a lender invoking a MAC clause without first carefully considering the loan agreement, the circumstances surrounding its creation, the rationale for invoking the clause, and the supporting evidence. In this article, we review some of that case law and suggest several principles that can be derived from it.

Principle #1 – Read the loan documents carefully, and connect the purported material adverse change to an obligation of the borrower.

Weisfelner v. Blavatnik (In re Lyondell Chem. Co.), a 2017 bankruptcy-court case out of New York, arises out of the 2008 financial crisis. In that case, the court ruled that the lender had breached a credit agreement that had been created before the crisis by refusing to fund a $750MM unsecured loan to a borrower who had subsequently been devastated by the crisis, as well as two hurricanes. At the time the borrower requested the $750MM draw, the lender knew the borrower was on the verge of filing bankruptcy, and in fact the borrower filed bankruptcy only eight days later. In court, the lender argued that the impending bankruptcy had triggered the MAC clause in the credit agreement, which covered "a material adverse effect on the business, operations, assets, liabilities (actual or contingent) or financial condition of the company." The court rejected the lender's position, however, because the agreement did not require the borrower to be solvent when it requested a loan draw, but only when the agreement had closed. The court wrote that it considered "the entirety of the agreement to discern the parties' intent, rather than reading the MAC clause in isolation" and that because the parties had the opportunity to include an ongoing-solvency requirement but did not, the lender "cannot now stretch the MAC clause to include it."

The takeaway is clear: a lender who wants to invoke a MAC clause should (a) read its loan agreement carefully, and (b) define the material change in relation to one or more obligations of the borrower under the agreement. The lender in In re Lyondell Chem. Co. may have believed that it was obvious that it should not be required to make a $750MM unsecured loan to a company whose fortunes had turned so badly and who was on the verge of bankruptcy, but in hindsight it should have, if possible, tied the purported material adverse change to one of the borrower's obligations.

Principle #2 – "I know it when I see it" is not a sound basis for deciding what's "material".

In Greenwood Place v. Huntington Nat'l Bank, et al., a 2011 case out of Indiana, the lender invoked a MAC clause in a loan agreement with a real estate developer after a personal guarantor's financial condition deteriorated. The MAC clause provided that "any material adverse change in the financial condition of Guarantor" was an event of default. The guarantor subsequently experienced a decline in cash from $7MM to $3,000, a net-worth decline of 60%, a decline in real estate equity of 80%, plus "$17 million in unpaid judgments against him with over $5 million more forthcoming." In court, the lender asked for summary judgment on the issue of whether the borrower was in default based on the MAC clause. The court stated that "[a]t first blush, it would appear that [the change in the guarantor's financial condition] ... has been material as that word is used in common parlance" but that "upon closer examination, the analysis is perhaps not so cut-and-dried." The court noted that the loan agreement was "replete with sophisticated metrics and carefully defined terms", so it was "somewhat perplexing why the parties left such a potentially game-changing term so vague." A number of the lender's officers and employees testified that what was "material" was a subjective determination and that "you know it when you see it." The court rejected that approach, however, and noted that even with the decline in the guarantor's finances, "he should still have room to absorb any guaranty liability stemming from the" lender's loans and that this fact "creates questions as to whether the adverse changes in [guarantor's] ... financial condition is, in fact, material." The court accordingly denied the lender's request for summary judgment.

River Terrace Assoc., LLC v. Bank of N.Y., a 2005 case out of New York arising from the 9/11 terror attacks, provides a contrast as to how to establish materiality. In that case, the borrower, who was building an apartment building in lower Manhattan, sued the lender, claiming that the lender's suggestion that a MAC "may have occurred" due to the attacks amounted to a repudiation of the $83MM credit agreement they'd entered into shortly before the attacks. The borrower sued for a refund of the fees it had paid as part of the agreement. The agreement defined a MAC as a "a material adverse change . . . in the Premises or the business, operations, financial condition, prospects, liabilities or capitalization of the Borrower." However, several appraisals shortly after the attacks indicated that rents in lower Manhattan had declined by at least 20%, leading the lender to conclude in an internal memo that the project could no longer support an $83MM loan. The court denied the borrower's motion for summary judgment, writing that "[g]iven that there were several appraisals indicating that the value of ... [the borrower's] project had decreased materially in the wake of 9/11, whether ... [the lender's] conduct amounts to a repudiation is all the more questionable." In other words, the court did not decide whether a MAC had occurred, but it thought the appraisals made the borrower's position that there had been no MAC "questionable".

The takeaway from these two cases is that the lender should, as much as possible, define "material" according to objective criteria that are relevant to the lender's position. The guarantor in Greenwood Place had suffered huge financial losses from his own perspective, but those losses weren't necessarily "material" because the lender had not shown that they undermined the availability of the guaranty in ensuring repayment of the loan. By contrast, the lender in River Terrace Assoc. had obtained appraisals and performed an analysis indicating that 9/11 had changed the borrower's project such that it could no longer support a loan in the agreed amount, thereby insulating the lender (at least temporarily) from the borrower's claim for damages.

Principle #3 – Interpret the MAC clause in light of the context and circumstances surrounding the creation of the loan agreement.

Capitol Justice LLC v. Wachovia Bank, N.A., a 2009 case out of Washington D.C., also arises from the 2008 financial crisis, and also involves a borrower suing a lender who invoked a MAC clause. The lender invoked the MAC clause in a loan commitment because the financial crisis undermined its ability to sell the prospective loan into a securitization. The MAC clause provided that the lender had the option to terminate the commitment "in the event of any material adverse change in the financial, banking or capital market conditions that could impair the sale of the Loan by Lender as contemplated in the Term Sheet." The borrower then sued the lender for damages, and the lender asked the court for summary judgment that it had not breached the commitment. The court initially ruled that the lender carried the burden of proving that a material adverse change had occurred (in this regard, the court followed the rule laid down in a reported case involving a MAC clause in the context of a failed corporate merger). Then the court found the MAC clause to be ambiguous "when viewing the contract in the context and circumstances surrounding the agreement." On the one hand, as the lender argued, a MAC might be any meaningful change in market conditions that could impair a sale of the loan. On the other hand, however, a MAC might include only an unforeseeable change. The court thought the latter interpretation was reasonable because (a) case law arising in the context of failed corporate mergers suggests that MAC clauses are used "to protect against unknown, not known, events", and the lender was aware when it signed the commitment that there was turbulence in the market into which it planned to sell the loan, and (b) the lender had assured the borrower it would invoke the MAC clause only in the event of a "9/11 type event". Therefore, the court denied the lender's motion for summary judgment.

Capitol Justice points to the importance of considering the issue of foreseeability in deciding whether to invoke a MAC clause. In the context of COVID-19, this means considering what, if anything, the loan documents, the related negotiations of the documents, and the reasonable commercial expectations indicate regarding which party assumed the risk of large, unforeseeable changes in the economic climate.


In three of the four cases discussed above, the lender either had judgment taken against it or failed to obtain summary judgment in its favor, notwithstanding that, viewed from afar, the facts seemed to favor the lenders. After all, in two of the three cases the 2008 financial crisis had intervened, and in the third case the guarantor's finances had suffered massive declines. These cases therefore suggest that courts are generally wary of MAC clauses and will place the burden on the lender to provide substantial evidence to support invoking the clause. Careful analysis and planning, therefore, is warranted when considering whether to invoke a MAC clause, even when extraordinary circumstances such as COVID-19 suggest that a material adverse change clearly exists.

About the Author

Neil E. McCullagh is an attorney who works with banks on a wide variety of issues, including lending, insolvency, workouts, creditors' rights, bankruptcy, and collections.

Spotts Fain publications are provided as an educational service and are not meant to be and should not be construed as legal advice. Readers with particular needs on specific issues should retain the services of competent counsel.