When a Spanish company entered into a lending agreement with another company, the ultimate purpose of which was to facilitate a property development in the Strand in London, the downturn in the economy and other factors caused the lender to ‘get cold feet’.

The original agreement was made in late 2007. By June 2008, market conditions had worsened and, wishing to withdraw, the lender relied on a ‘material adverse change’ (MAC) clause which allowed it to withhold funding if there had been an MAC in the borrower’s financial condition since the date of the loan agreement. The absence of an MAC had to be confirmed by the borrower each time a staged advance was made under the loan agreement.

The lender refused to make further advances with the result that work on the site ceased in September 2008 and it was subsequently sold to another company. The borrowing developer later began proceedings in the High Court, claiming loss of profits due to the lender’s action, which it claimed was in breach of the lending agreement.

The claim totalled approximately £70 million, with a counterclaim by the lender for £50 million. The case was complex and more than 200 bundles of documents were presented to the Court.

Among other evidence the lender had taken into account when it decided to cease lending were newspaper articles alleging that the developer was in financial difficulties. The Court heard that the decision to suspend loan advances was made without prior warning.

The Court had to consider the meaning of the MAC clause and stated that an MAC is a ‘significant deterioration in the financial condition of the borrower which threatens its ability to repay but which is short of an insolvency’. The lender argued that the term ‘financial condition’ is a ‘general phrase which has no inherent limitations. It is not, for example, limited to particular parts of company accounts, such as net current assets or profits. It allows the court to consider all aspects of the company’s finances including balance sheet items (assets and liabilities), profit and loss account items and cash flow or liquidity items, and the impact on these of the state of the markets in which the company was operating.’

The borrower, on the other hand, argued that ‘the purpose of a company’s accounts (and, in the case of the year end, the financial statements which include notes, an audit report and directors’ report) is to provide a picture of the financial state of the company. One would therefore ordinarily expect that any consideration of a company’s financial condition would begin with an assessment of its position as shown in financial statements as at the relevant date.’

The Court accepted that ‘to be material, the adverse change must be material in a substantial way to the borrower’s ability to perform the transaction in question’. It concluded that ‘the enquiry (to establish an MAC) is not necessarily limited to the financial information if there is other compelling evidence. The adverse change will be material if it significantly affects the borrower’s ability to repay the loan in question. However, a lender cannot trigger such a clause on the basis of circumstances of which it was aware at the time of the agreement. Finally, it is up to the lender to prove the breach.’

In a judgment that ran to 957 paragraphs, the Court decided that, on the particular facts of the case, the lender was justified in not making the further advances.

Had the MAC clause been drafted more tightly, specifying the criteria that would act as a trigger, it is possible that litigating at enormous expense might have been avoided.