MAC clauses: Phantom menace

A recent case has highlighted that a downturn in a developer’s fortunes, even where caused by general economic conditions, could prove to be the tipping point for financing being pulled part way through a development. This is due to commonly incorporated, but rarely administered, Material Adverse Change (MAC) clauses.

MAC clauses are intended to deal with unforeseen changes in a party’s circumstances and are, by their nature, widely drafted. They are also often heavily negotiated.

They are included in a variety of commercial contracts, particularly finance documents. Although a lender providing development finance will carry out due diligence on the strength and stability of the developer at the outset, it also wants to ensure it can withdraw from providing finance if the developer’s financial position weakens.

Replace general MAC provisions with specific provisions clearly identifying what will be deemed a MAC

Importantly, the cause of the change in a developer’s position may be irrelevant. As suggested in the recent case of Grupo Hotelero Urvasco SA vs (1) Carey Value Added SL (formerly Losan Hotels World Value Added I SL) (2) London Value Added I Ltd, and Carey Value Added SL (formerly Losan Hotels World Value Added I SL) (2) Grupo Urvasco SA [2013], a change in financial position predicated by a general economic downturn could prove sufficient.

In this case, a Spanish hotel developer, Grupo Hotelero Urvasco SA (“GHU”), was in the process of developing a hotel and apartments on a prime central London site. GHU entered into agreements with a Spanish hotels fund, Carey Value Added S.L. (“Carey”). These included loan agreements (including to provide finance for the development) and a share purchase agreement under which Carey would acquire the property on completion, subject to a lease back and option to repurchase in favour of GHU.

The financial standing of GHU’s Spanish parent company was adversely affected by the downturn in Spain. GHU also breached a number of obligations under the loan agreements. Carey withdrew funding, causing the development to stall.

GHU sought declaratory relief against Carey’s right to rescind the share purchase agreement and claimed damages for failure to advance the loan. Carey counterclaimed for recovery of sums already advanced and claimed against a guarantor of the loan.

GHU was held to be in breach of the loan agreement due to financial and development defaults. The MAC provisions in the loan agreements were also considered at length in the judgment, as Carey relied upon them in defence of its refusal to advance funding. In assessing whether a MAC had occurred, it was held to be unnecessary to limit enquiries to a company’s financial information.

Therefore, while not ultimately decisive to the case, a MAC in the financial condition of GHU’s parent company was found to have occurred, principally due to the property bubble bursting
in 2008.

There are a number of ways in which developers can seek to protect themselves:

• If possible, replace general MAC provisions with specific provisions clearly identifying what will be deemed to be a MAC
• Require a lender’s exercise of a MAC clause to be subject to an objective test of reasonableness. Removing subjectivity may prevent a technical breach being used as justification for withdrawing funding
• Limit the parties subject to the MAC clause, restricting it to the developer rather than the developer’s wider group
• Ensure that obligations that the developer enters into under other agreements are “back to back” with the MAC obligations in any financing agreement. Such provisions would need to be carefully drafted in construction contracts to avoid falling foul of the Construction Act’s prohibition on pay-when-paid clauses.

Developers, and other parties affected by the potential withdrawal of financing on a project, should continue to be alive to the dangers of MAC clauses.

Luke Baines is a legal director at DLA Piper