When Can A Lender Pull The Plug On A Credit Agreement? Material Adverse Change Clauses Explained

Picture this: a borrower is relying on a revolving credit facility to meet working capital needs. Suddenly, it is told by its lender that a “material adverse event” has occurred, and the facility is now being frozen or called. What does this mean, and what can the borrower do?

In a credit agreement, Material Adverse Change (MAC) clauses can be powerful and catch borrowers off-guard. They give lenders the contractual right to withdraw financing in response to a significant deterioration in the borrower’s condition, but it can be difficult to determine when that right can be exercised.

(Note: the terms “material adverse change” and “material adverse effect” (MAE) are often used interchangeably, though some agreements distinguish them such that MAE encompasses a broader range of conditions that prevent the party from performing their loan obligations.)

What is a MAC Clause, and What Does It Look Like?

A MAC clause is a contractual provision that allows one party, typically the lender, to take protective action. For example, declining to advance funds, accelerating the loan, or declaring a default if a “material adverse change” or “material adverse effect” occurs in respect of the borrower.

MAC clauses typically look like a broadly worded trigger referring to any change, event, or circumstance that has had, or could reasonably be expected to have, a material adverse effect on the borrower’s business, assets, financial condition, or prospects. It is often deliberately broad and protects lenders by capturing a range of situations that might not have been specifically contemplated at the time of the agreement.

Many sophisticated credit agreements often include negotiated exceptions to the MAC definition. These exceptions can include:

• Changes caused by worldwide emergencies;
• Changes arising from general economic or market conditions;
• Changes in applicable law;
• Changes affecting the borrower’s industry as a whole; or
• Effects of the transaction itself.

These carve-outs can significantly limit the circumstances in which a lender can invoke the clause to “pull the plug” on the agreement.

Ways that MAC Clauses Operate: Representation and Warranty vs. Condition Precedent

There are three main ways that MAC clauses function in a credit agreement:

1. As a representation and warranty: The borrower asserts that no MAC has occurred at each drawdown date. If the assertion is inaccurate, the borrower is in breach, which could constitute an event of default. This formulation places risk on the borrower, who will need to assess whether a MAC has occurred at each drawdown.
2. As a condition precedent to funding: The lender is only obligated to advance funds if no MAC has occurred. This formulation allows the lender to refuse a drawdown request without declaring a formal default, placing less pressure on the borrower.
3. As an event of default: When listed as an independent event of default, the lender can have discretion to determine whether a MAC occurred, and consequently whether the agreement is in default.

For a borrower, the consequences of a MAC can change depending on how it operates in a credit agreement. If a MAC operates as a condition precedent or an event of default, the lender can have the right to simply stop lending, whereas if a MAC operates as a condition precedent, the lender can have the right to demand immediate repayment and enforce its security — a significantly more severe consequence.

What Does “Material” Mean?

Some changes are clearly material to the agreement, and others are expressly described in the agreement itself. In cases where it is unclear, the lender needs to meet a high threshold of “materiality.” What that means exactly is largely unsettled in Canada, so courts often borrow definitions from the Securities Act, accounting, and international jurisdictions.¹ Generally, materiality can turn on whether the change or event would hurt the overall earnings potential of the designated party significantly, over a prolonged period.² Subject to the specifics of the arrangement and the change at issue, there are other factors that may affect materiality, such as whether the adversely impacted party was uniquely affected³ or whether the parties had knowledge of (and/or relied on) the MAC in question.⁴

Risk Management for Borrowers

To avoid getting blindsided by MAC clauses, borrowers can take measures before, during, and after the credit agreement is in place.

1. Negotiate the definition. Negotiate specific, clearly defined carve-outs for foreseeable risks. The narrower the MAC definition after carve-outs, the harder it is for a lender to invoke.
2. Insist on objective thresholds where possible. Tie MAC triggers to measurable financial metrics (e.g., a specified decline in revenue over a defined period) rather than leaving the determination entirely to the lender’s subjective judgment.
3. Monitor and communicate proactively. Maintain open lines of communication with the lender, especially during periods of financial stress. A borrower that proactively discloses adverse developments and suggests a credible remediation plan is in a stronger practical and legal position than one that allows the lender to discover bad news independently.
4. Get independent legal review of the credit agreement. MAC clauses are often buried between hundreds of clauses, and their implications might not be obvious without careful legal analysis. Borrowers should have their credit agreements reviewed by counsel before signing, with particular attention to the MAC definition, carve-outs, and the consequences of a MAC determination.

Footnotes

1. See Cineplex v. Cineworld, 2021 ONSC 8016 and Fairstone Financial Holdings Inc. v. Duo Bank of Canada, 2020 ONSC 7397 for their discussions on Akorn, Inc. v. Fresenius Kabi AG (October 1, 2018), Doc. 2018-0300-JTL (U.S. Del. Ch.).

2. Fairstone Financial Holdings Inc. v. Duo Bank of Canada, 2020 ONSC 7397 at para 64.

3. Fairstone Financial Holdings Inc. v. Duo Bank of Canada 2020 ONSC 7397 at para 77.

4. Inmet Mining Corp. v. Homestake Canada Inc. 2002 BCSC 61 at para 128.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.