How does the COVID-19 pandemic affect borrowers and lenders and their financing arrangements?

A Material Adverse Effect (MAE) clause is included in most finance agreements. It is a catch-all concept to capture unpredictable and unforeseen events or circumstances that would otherwise be difficult to incorporate into the agreement specifically.

Broadly, a MAE clause covers a material adverse effect on the business operations of the borrower, the ability of the borrower to fulfil its obligations under the finance documents, the rights of the lenders under the finance documents as well as any adverse effects on the enforceability of security granted.

Force majeure and supervening impossibility of performance

Unlike many commercial contracts, facility agreements typically do not include a force majeure clause and therefore could not be raised by borrowers to stop making payment of money under a facility agreement. The common law ‘supervening impossibility of performance’ doctrine is also unlikely to be helpful to the borrower because the outbreak will usually not make payments of money impossible..

Therefore, it is important for lenders and borrowers to consider whether an MAE event has occurred.

Material Adverse Effect

MAE provisions appear as repeating representations and warranties or as events of default. Unless the relevant agreement gives either party the power to determine an MAE, it is ultimately a matter of contractual interpretation (including the context) as to whether an MAE has occurred. MAE provisions are often negotiated and therefore each MAE clause will need to be interpreted on its specific wording.

Case law relating to MAE provisions is limited. From a review of applicable cases under English law, US law and some of our own cases, the general position is as follows:

  1. the party seeking to rely on an MAE clause will bear the evidentiary burden of convincing a court that a MAE has occurred. This comes from public policy that favours the enforcement of signed agreements where the commercial risks are discernible by the parties, especially sophisticated parties.
  2. a court’s construction of a MAE clause would be based on the facts, and the specific wording of the clause. The application of the law of contractual interpretation will be applied to the finance documents as a whole.
  3. the materiality test must be satisfied. The change must be of sufficient magnitude and the effect must be of significant duration – a change must not merely be temporary or short-term.
  4. the meaning of ‘financial condition’ (of the borrower) will be interpreted narrowly and may be included in the definition of an MAE.
  5. there must be a causal link between the adversity and the change in the borrower’s financial position. For example, the borrower will need to show that the COVID-19 pandemic has caused a material unforeseeable and unforeseen change to its financial position.
  6. The future prospects of the borrower will be reviewed, if this is included in the definition of an MAE clause in the facility agreement.

Will the COVID-19 outbreak constitute a Material Adverse Effect in itself?

Circumstances not specific to a borrower (such as the general outbreak) will not in itself constitute a MAE but the detrimental effects of the outbreak on a borrower’s financial (or business) condition could, in theory, lead to a MAE. In the context of a facility agreement, a change would usually only be deemed material if it would affect the borrower’s ability to repay amounts due under the finance documents.

Is the duration of the pandemic significant enough to constitute an MAE?

To invoke an MAE clause, it would be important to demonstrate that any change to the borrower’s financial position caused by the pandemic is long-term or terminal as opposed to temporary or recoverable. The duration of the COVID-19 pandemic remains uncertain, however, the effects for many are not generally expected to be everlasting.

Practical considerations of an MAE:

  • From a reputational standpoint, lenders are being cautious to call a default. Mitigation protocols such as the nationwide lockdown have already caused substantial harm to businesses across industries. Lenders must consider ways to recover their capital while trying not to abandon business in these trying times.
  • Borrowers must consider the viability of their business amid the COVID-19 pandemic. Lenders are likely to be more inquiring and borrowers need to be able to demonstrate how any effects are being managed and mitigated.
  • Borrowers that don’t have sufficient financing may need to consider obtaining greater lines of credit, to tide them over.


As we have seen in previous macroeconomic downturns, lenders traditionally look for easily demonstrable facts, such as non-payment or the breach of a financial covenant, before seeking acceleration or enforcement by calling an MAE.

Furthermore, a court may find that invoking an MAE event of default triggered by the COVID-19 outbreak would, in the particular circumstances, be unreasonable or unfair. This would mean that the court would not allow the lender to exercise its contractual rights on this basis. Relying on other specific clauses that relate to default may be easier than trying to prove an MAE.

It is not certain whether the COVID-19 situation constitutes an MAE in each particular circumstance. Therefore borrowers and lenders should engage pro-actively to discuss the terms and conditions set out in their finance documents to ensure that their financing arrangements are not jeopardised as a result of the COVID-19 outbreak.