Does The MAC Have Your Back? The Use Of Material Adverse Change Clauses In Canadian Loan Agreements

Material adverse change ("MAC") clauses are routinely inserted into loan agreements by lenders. However, the practical effects of enforcing a MAC clause in the context of a loan financing remain uncertain. In this bulletin, we summarize the current case law with respect to MAC clauses, borrowing from developments in the United States and the United Kingdom, and provide some practice pointers for drafting MAC clauses in loan agreements.

1. What is a MAC Clause?

   In loan agreements, a standard MAC clause describes an event, whether general or particular, that prevents the borrower from being able to meet its obligations. In a typical loan agreement, a MAC can be stated as (i) a condition precedent to closing, or (ii) an event of default, in each case, the MAC being determined at the lender's discretion, and/or (iii) a representation of the borrower, which is determined by the borrower. Declaring a MAC gives the lender certain rights, which can include demanding repayment of the loan. As a result, MAC clauses have the potential to offer significant protection to lenders and are carefully negotiated during the drafting phase of most loan agreements. While lenders tend to prefer broadly-worded MAC clauses, borrowers try to negotiate narrowly-worded MAC clauses with many exclusions. Case law with respect to MAC clauses, however, is sparse and sometimes conflicting, which raises concerns for lenders about their ability to rely on MAC clauses to protect their interests. As discussed below, the way a MAC clause is phrased can have a profound effect on a court's interpretation of whether a MAC has actually occurred.

2. Canadian Case Law

   The British Columbia Supreme Court's decision in Doman Forest Products Ltd. v. GMAC Commercial Credit Corp. ("Doman Forest")1 is the only Canadian case that has interpreted a MAC clause in the financing context. In this case, a MAC, in relation to an event of default, was defined as:

   [A] material adverse effect, as determined by Lender in its sole discretion, on, as the case may be, (a) the condition (financial or otherwise), operations, assets, business or prospects of [Doman Industries Limited] on a consolidated basis, (b) Borrower's ability to pay the Obligations in accordance with the terms thereof, (c) the Collateral, the Liens on the Collateral or the priority of any such Liens, or (d) the practical realization of the benefits of Lender's rights and remedies under this Agreement and/or the Ancillary Agreements.2

   The court considered whether the borrower's serious financial setbacks, which worsened after the US government imposed a softwood lumber duty, constituted a MAC, despite the cyclical nature of the borrower's business. In finding that it was open for the lender to declare a MAC, the court provided certain guiding principles for analyzing and drafting MAC clauses.

   First, the court stated that because the MAC clause left the determination of a MAC to the lender, in its sole discretion, the standard of materiality is that of the particular lender in its discretion rather than "the objective standard of a reasonable lender in [the same] circumstances."3 However, the court did note that the lender's discretion has to be "exercised reasonably and be based on bona fide considerations."4 Second, the court held that prior knowledge of the borrower's financial problems (which were known to the lender before execution of the loan agreement and supported through the financial covenant to provide future financial statements) does not preclude a MAC because what matters is whether the financial problems accumulate over time, until they become "material".5 The court noted that the definition of material adverse effect was broadly defined to include the financial condition of the...