Effect of COVID-19 on material adverse change clauses

The global pandemic has created significant economic and social challenges for businesses. Given the degree of uncertainty caused by COVID-19, it is inevitable that there will be greater scrutiny of Material Adverse Change (MAC) clauses in the future.  

What is a MAC clause?

MAC clauses are commonly included in commercial contracts, particularly in M&A and financial transactions. They afford a party (usually an investor or lender) the opportunity to withdraw, terminate a transaction or exercise some other right, if a material change in circumstances occurs to negatively affect the operations or financial conditions of the target company or the borrower (as the case maybe). Importantly, the definition of a MAC is unique to each contract since it is negotiated by the parties to that agreement taking into consideration the specific circumstances of the transaction and each relevant party. It is not always the case that such provisions are confined to situations which can be measured or quantified to a certain threshold; for example, a negative effect on earnings (e.g. EBITDA and revenue) or net assets to a certain percentage of loss. Where clauses are drafted in such a way that is incalculable it can be particularly difficult to determine at what stage a MAC clause can be invoked.

Can MAC clauses be engaged by COVID-19?

Whether or not MAC clauses can be invoked due to COVID-19 is not a straightforward answer. As mentioned above MAC clauses are specific to each individual contract, dependent on the context in which it was drafted and the way it is subsequently interpreted. Moreover, it will be important to consider MAC clauses in the context of both existing contracts as well as new contracts which were drafted during COVID-19.

There is very limited case law to provide guidance on dealing with MAC clauses in response to pandemics such as COVID-19. Nonetheless, Grupo Hotelero Urvasco SA v Carey Value Added SL [2013] EWHC 1039 (Carey) provides some assistance outlining four general elements which should be considered and followed when invoking a MAC clause:

  1. Interpretation: Parties must give effect to what they have stipulated in their agreement, applying well settled rules as to the interpretation of contracts. Therefore, it is necessary to pay close attention to the precise words of the contract and analyse the matter in the light of the agreement, facts, and expert evidence.
  2. Materiality:To be material, the adverse change must be substantial in that it affects the borrower’s ability to perform the transaction.
  3. Awareness: Alender cannot engage a MAC clause if they knew of the circumstances at the time of making the agreement. In such a situation it is assumed that parties intended to enter the agreement regardless of those adverse conditions.
  4. Duration: Any material change must not merely be temporary. It cannot be a one-off loss of profits; it must cause long-term financial distress.

In applying these four elements to COVID-19, which has had a significant impact on economies, businesses, and individuals across the world, it is likely that in many cases a MAC clause could be enlivened. However, this will exclude contracts which were entered into during the pandemic, since parties were aware of its consequences; and contracts which specifically carve-out events, such as pandemics, precluding parties from being able to call on a MAC clause.

Is COVID-19 temporary within the meaning of Carey?

No-one truly knows the answer to this question, but experts say it is likely to linger for some time or that it is perhaps even the ‘new normal’. The effects of COVID-19 have been felt globally for months now, and it is hard to see the end in sight. It could be years until businesses are able to properly mitigate and manage the risks associated with COVID-19 (or similar pandemics). Therefore, it will be up to the party invoking the MAC clause to show that the consequences of COVID-19 will be lasting or perhaps terminal, opposed to transitory.

Engaging MAC clauses on new deals?

As previously mentioned, it will be much more difficult to invoke a MAC clause (due to COVID-19), on a contract entered during the pandemic. This is assuming the parties were both aware of COVID-19 at the time of making the agreement. Therefore, any party who seeks to assert that COVID-19 is a MAC should do so on deals that were pre-existing to the pandemic. Alternatively, those who seek to invoke a MAC clause on a new deal, after the proliferation of COVID-19, should do so on some other basis.

Should you invoke a MAC clause during COVID-19?

A party should not be too quick to invoke a MAC clause since if done wrongfully it can have serious consequences. Anyone who improperly utilises a MAC clause will face both disrepute and the risk of paying a substantial amount of compensation in damages to the non-invoking party. Moreover, regardless of COVID-19, it is important to consider provisions which may impact the ability for parties to utilise a MAC clause, including the effect of ipso facto provisions under the Corporations Act 2001 (Cth); or unfair contract terms under sections 23 and 24 of the Australian Consumer Law, being Schedule 2 to the Competition and Consumer Act 2010 (Cth).

Advice for drafting new contracts during COVID-19?

M&A MAC Clauses

  1. Buy side: Contracts should expressly state whether COVID-19 can invoke a MAC clause. The wording of the contract should clearly state when a MAC has occurred. For example, quantitative thresholds such as change in financial metrics e.g. EBITDA, fall in revenue or increases in debt.
  2. Sell side: A seller should seek to exclude COVID-19 events from the contract. Alternatively, they should circumvent the ability to invoke a MAC clause when the company is affected the same as its peers due to global or industry downfalls. Additionally, the MAC clause should not be worded in a way to rely on the buyer’s opinion; instead, it should be limited to the specified and pre-defined financial impact the MAC will have.

Finance MAC Clauses

  1. Borrowers: Those entering new loan contracts should be attentive as to how their MAC clauses are drafted. It may be important to clearly indicate that the current COVID-19 pandemic cannot enliven the MAC clause as this may cause technical defaults in the facility agreement.
  2. Lenders: Must be aware of how the agreement is drafted according to COVID-19 since it will be extremely difficult for lenders to invoke a MAC clause when they were aware of the pandemic prior to entering the contract.

Businesses should work closely with their legal and financial advisors when adopting negotiating or invoking MAC provisions given the specific circumstances of the parties involved.

Written by Savannah Brell. 


If you have any questions about this article please get in touch with the author or a member of our Banking & Finance team.


This information and the contents of this publication, current as at the date of publication, is general in nature to offer assistance to Cornwalls’ clients, prospective clients and stakeholders, and is for reference purposes only. It does not constitute legal or financial advice. If you are concerned about any topic covered, we recommend that you seek your own specific legal and financial advice before taking any action.