April 2, 2020 - On March 30th, the LSTA hosted part two of COVID-19 and Credit Agreements: What You Need to Know webinar series, which addressed the myriad of questions submitted by LSTA members to our panel of experts, Michael Chernick and Josh Thompson of Shearman & Sterling, Samantha Good of Kirkland & Ellis, Justin Forlenza of Covenant Review, and Jason Kyrwood of Davis Polk. The majority of the questions related to the MAC clause and financial covenants in credit agreements.
At the outset, members were reminded that the MAC clause, which can be prospective (focusing on the prospects of the borrower’s business) or retrospective, is a critical clause that must always be reviewed carefully in the context of the specific credit agreement. Few credit agreements in our broadly syndicated loan market have a MAC event of default as a standalone default. Generally the concept arises in deals where the borrower is seeking to borrow under a revolving credit facility and thus must bring down certain representations, including that no “Material Adverse Effect” has occurred. Those seeking to invoke the MAC clause because of the pandemic have a challenging path ahead of them. First, paying particular attention to the language of their credit agreement, they must consider whether a specific credit’s precipitous drop will have durational significance. If a temporary spike down is followed by an immediate recovery, it may be hard to demonstrate that there was durational significance.
Moreover, the mere belief that a company will not be able to pay its debts as and when they fall due is not in itself sufficient to declare a Material Adverse Effect. Access to funds is not relevant to whether the company has experienced an MAE. Indeed, if a debt fund’s limited partners have not themselves honored a capital call, this will not relieve the fund from its own obligation to fund under a credit agreement.
The mere ministerial role of agents was also highlighted. In this context, parties were reminded that agents need not share their MAC analyses (or their credit analyses) with other lenders. Upon receipt of a borrowing notice, agents are obligated only to pass it on to the lenders, who must then check for themselves that it is in the proper form and, likewise, make their own credit analysis. Lenders who remain concerned that a MAC may have occurred will not be forced to fund but should bear in mind that the borrower is ordinarily likely to be in a better position to evaluate its own financial health and give the representation based on its information. As a defaulting lender, a lender who fails to fund will typically not be eligible for fees or to vote under the applicable credit agreement. Furthermore, if a lender fails to make an advance that the borrower believes should be made, that lender could be sued by the borrower for breach of contract, and the borrower also would have the right to replace it pursuant to the “yank-a-bank” provision.
There are many expenses a borrower could incur during this outbreak that it would otherwise not have faced. For a borrower, these COVID-19 “non-recurring, one-time, or unusual charges” could include increased cleaning costs, costs incurred from temporarily shutting facilities (and in due course, reopening those facilities), expenses relating to retaining workers who are not being used, and increased production costs where suppliers need to be changed.
Looking ahead, and considering what we can expect in credit agreements later in the year, parties may revisit certain provisions which, for example, permitted leakage of value and perhaps revisit those, but a wholesale reset of terms is probably unlikely.