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Do your company’s financing agreements contain provisions that require you to provide MAE disclosures to your lenders?
By Phil Stanton and Ed Chod
The recent rapid spread of COVID-19 and various social distancing, shelter-in-place and other measures adopted by state and local governments has had, and will likely continue to have, adverse impacts on a variety of industries. Financing agreements contain various provisions that will require borrowers to assess the impact of COVID-19 on their business and possibly provide disclosures or notices to lenders as to whether the business has suffered a “material adverse effect” or “material adverse change” (MAE).
Relevant contractual provisions
Definition. A typical definition in a loan agreement may read like this:
“Material Adverse Effect” means (a) a material adverse change in, or a material adverse effect upon, the operations, business, properties, liabilities (actual or contingent), condition (financial or otherwise) or prospects of Borrower; (b) a material impairment of the ability of any party to the Loan Documents to perform its obligations under any Loan Document to which it is a party; or (c) a material adverse effect upon the legality, validity, binding effect or enforceability against any party to the Loan Documents of any Loan Document to which it is a party.
Note that this is only an example — determining appropriate steps to take under an MAE clause will require careful reading of the specific language in the borrower’s agreement, including any exceptions that may be included.
Interpretation. MAE clauses have been rarely invoked by lenders and, as a result, there is little guidance on interpreting them. Borrowers will need to consider how COVID-19 has impacted their specific business and whether any notices or disclosures are required. For example, a brick-and-mortar retailer operating in jurisdictions where they have been ordered to cease operations has a higher probability of suffering an MAE in current circumstances than a manufacturer of medical equipment or supplies. Governing law clauses will be important in this determination. While many loan agreements are governed by New York law, many are governed by the laws of other states.
Application of MAE clause. MAE clauses affect the performance of and borrower’s obligations under a loan agreement in several ways.
- Signings. At signing, borrowers usually represent that they have not suffered an MAE. Borrowers in the midst of negotiations may need to negotiate an exclusion of COVID-19 from the MAE clause.
- Draw certificates. At each draw, the loan agreement may provide that the borrower brings down this representation and re-affirm it as of the date of the draw. Borrowers may need to provide a written disclosure of the COVID-19 situation as an MAE in the draw certificate.
- Periodic compliance certificates. Periodic compliance certificates may also require a re-affirmation of the MAE representation. Borrowers should consider if they need to disclose the COVID-19 situation as an MAE in their compliance certificate.
- Affirmative obligations. Borrowers may have an affirmative obligation to give notice to the lender of an occurrence of an MAE. This obligation may not be waived just because the MAE is a matter of common knowledge. As a result, borrowers need to determine if they have an obligation to affirmatively notify their lenders of an MAE, even if they are not making a draw or delivering a compliance certificate.
Considerations going forward
As the COVID-19 situation develops, borrowers with existing credit facilities need to review their credit agreements and understand their obligations with respect to MAEs.
Borrowers in the middle of negotiating credit agreements need to make sure that they address this issue in MAE provisions that will bind them going forward.
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