Oil price collapse + Corona = MAC? The”force majeure” of loan agreements

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The world is fighting a pandemia and combined with the oil price plummeting the consequences are severe - for our health and for the economy. Do these types of unforeseen, wide reaching and serious events have any impact for financing agreements?
Thursday, March 12, 2020
  1. Do loan agreements have «force majeure» clauses?

Loan agreements normally do not contain «force majeure» clauses, but have a similar mechanism by  Material Adverse Change («MAC») clauses. Agreements typically have provisions addressing situations where an event or circumstance may have significant negative consequences (“Material Adverse Effect”)

  1. MAC/MAE – what situations are covered?

Agreements based on the Loan Market Association templates normally have a definition of Material Adverse Effect. Both material negative effects on the business and operations as such («Business MAC») and on the ability of the borrower (or the group of obligors) to pay («Payment MAC») is often included. In secured financings, the definition will typically also comprise circumstances that have a material adverse effect on the validity, priority or enforceability of security. 

  1. Do all loan agreements have a MAC, and how does it work?

These provisions are often individually negotiated in each loan agreement, and will normally occur either as a condition (for instance for drawing of the loan) or as a qualification of obligations. Many loan agreements have qualified a number of representations and warranties, undertakings or covenants so that only a breach which has, or is likely to have, a Material Adverse Effect, will be a breach of the relevant provision.  

In the LMA leveraged facilities template it is set out as a separate Event of Default if a situation or circumstance occurs which the lenders (or a qualified quorum) reasonably considers has, or which may reasonably have, a Material Adverse Effect. In the LMA Investment grade template this provision is set out as optional.  

MAC clauses can also be linked to financial reporting, for instance that the borrower has to represent (and often in repeating intervals) that there has been no material adverse change to the borrowers assets, business or financial condition since the delivery of the original financial statements provided upon the entering into of the loan agreement. These types of provisions are also individually negotiated. Note that this type of MAC is backward looking and can thus be relevant also for a period after a «crisis» has occurred.

  1. What about non-negotiated standard terms, or less complex agreements?

Banks operating in the Norwegian market regularly lend on standard terms that also contain clauses similar to MAC clauses. It is often listed as a material breach of the agreement if it, due to a material deterioration of the borrower’s ability to pay or of its business prospects can, in the opinion of the lender, be expected that a material breach of the credit will occur.

In less complex loan agreements without specific provisions on this one will have to consider whether there is a material breach or anticipated material breach that a lender may evoke on the basis on general principles of contract law in light of the actual circumstances in matter.

  1. Which other finance documents may contain a MAC clause?

MAC clauses are frequently found also in offer letters, term sheets and mandate agreements, where arrangers, underwriters or agents for larger loan facilities that are to be syndicated reserve themselves against significant negative changes not only to the borrower’s financial situation, but to the market as such (“Market MAC”). Such provision would typically address material adverse changes to the international debt, bank, capital, equity and syndicated loans market or in the global or financial situation. Again, the specific wording will vary, and the threshold for when such provision may be evoked will depend not only on the exact wording, but also the specifics of the actual situation in matter.

  1. Kan MAC be a drawstop?

For revolving facilities or delay draw term loans the absence of a MAC can be a condition for drawing. A lender might then, if a MAC (as described in the relevant agreement) has occurred in the relevant  interim, claim to be in a position where it is not obliged to disburse the loan.

  1. Is MAC a real threath or a papir tiger?

A MAC clause is intended to be «security valve» for situations that are of so fundamental significance to the credit and the position of the lender, and which are so extraordinary or unpredictable that they have not been specifically regulated by other provisions of the loan agreement.

If a lender is to evoke a MAC clause, the onus is on the lender to substantiate that the extraordinary circumstances that has occured actually has, or on the balance of probability will have, such material and adverse consequences (as specified in more detail in the relevant agreement). The lender has to prove both the occurence of the relevant circumstances, and the effect of these. At the time of evoking the clause this could be a forecast, which in hindsight – for instance at the time of a legal hearing about the same matter, may appear different due to the developments in the interim.

The risk of liability for erroneous judgements, which may have decisive importance to a borrower’s business, is not insignificant, and there is limited Norwegian case law on the use of MAC-clauses.  Even though Norwegian courts will, in interpreting agreements between professional parties, give significant weight to the wording of the relevant provisions, the courts will take into account the specific circumstances of each case, where also general principles of loyalty between contractual parties and principles of fairness may be applied.

  1. Some examples of other relevant clauses

Extraordinary circumstances like the ones we now have encountered can for many businesses lead to extraordinary costs and losses. For loan agreement with financial covenants based on adjusted EBITDA, one relevant question may be whether such costs and losses may be added back in the calculation of EBIDTA.

For project financings or financings of substantial assets where the debt service is related to material contracts of the business, the loan agreements will in many cases contain a clause whereby the termination of such contracts shall be considered an Event of Default (alternatively if termination has or is likely to have a Material Adverse Effect). Often will what constitutes «termination» be further defined or specified in the agreement. However, where the grounds for termination itself is disputed between the parties of the underlying contract, one question will be whether – and from what point of time – there is a breach of the loan agreement.  Where termination is subject to litigation or arbitration, this may not be determined before the case is finally decided by a non-appealable judgement.  In the meantime it can be relevant for the parties to the loan agreement to enter into a dialogue to clarify the situation and obtain necessary waivers or declare necessary reservation of rights.  

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