Material adverse change

By Diccon Loxton
Banking Corporate Governance Financing Litigation

In brief

In a recent decision, the New South Wales Supreme Court held that a sufficiently significant failure to meet budget expectations could constitute a 'material adverse change', and upheld the lender's right to serve a default notice and accelerate repayment on this basis. Partner Diccon Loxton and Lawyer Alicia Lyons examine the case and its ramifications.

How does it affect you?

  • The case – Minumbra Lancewood Pty Ltd v AM Lancewood Investment Nominees Pty Limited1 – indicates, once again, a willingness in courts to uphold acceleration of repayment on the basis of a 'material adverse change' (MAC) provision, albeit one drafted in a lender-friendly way.
  • It gives good insights into the principles that will be applied and points to the importance of the drafting.


Two companies established a 50/50 unit trust as a joint venture to acquire and operate an accommodation village for miners. The trustee of the unit trust as borrower entered into a loan agreement with the holder of 50 per cent of the units in the unit trust as lender.

The term of the loan was 30 months. It allowed for the capitalisation of interest if the borrower could not pay.

After about 13 months, the profitability of the village had significantly decreased and was far below the budget agreed at the time of entry into the joint venture. The borrower could not repay principal or interest. The evidence was that the condition was unlikely to improve.

The lender issued a default notice and demanded immediate repayment on the sole basis that there had been a MAC, which constituted an event of default. The MAC Event of Default (paragraph (i)), was worded as follows:

Material adverse change: any situation occurs which in the opinion of the Lender gives it grounds to believe that a material and adverse change in the business or financial condition of the Borrower has occurred or that the ability of the Borrower to perform its obligations under this Agreement has been or will be materially and adversely affected or that any other Event of Default is likely to occur.

Other clauses of the loan agreement:

  • provided that any discretion given to the lender was 'unfettered and absolute' (clause 1.5);
  • required the borrower and lender to discuss a plan to repay the loan in good faith if the freehold title to the village was not acquired by 28 months after the first drawdown (clause 7.1); and
  • required the lender, before serving a default notice, to reasonably consider and discuss with the borrower alternative possible courses of action for the loan to be repaid (clause 9.1(b)).

The borrower claimed that no Event of Default had occurred under paragraph (i) because:

1. the failure to meet budget expectations could not constitute a 'situation';

2. the lender had an obligation to form the requisite opinions in good faith and had not;

3. there must be a reasonable basis for the requisite opinions and there was not;

4. the change did not affect the borrower's ability to perform its obligations; and

5. there was no material adverse change.

The decision

The lender won.

The burden was on the lender to prove that there was an event of default and it succeeded. In respect of the various arguments set out above, the Court held as follows.

(1) 'Situation':
  • The disparity between the budget and the financial performance of the borrower was sufficiently great to be a 'situation' for the purposes of paragraph (i).
(2) Requirement of good faith for opinions:
  • The lender had to form the opinions set out in paragraph (i) honestly and not capriciously, and did so. The clause did not import an additional obligation to act in 'good faith' in the sense of having regard to the interests of the borrower, nor did the remaining documents or the joint venture relationship. The lender was entitled to exercise its rights under the loan agreement in accordance with the ordinary meaning of its terms, considering its interests as lender and not tempering its actions because it had a 50 per cent interest in the borrower.
  • In any case, the lender had acted in good faith.
  • The obligation to 'discuss and consider' alternative possible courses of action did not mean the lender was not entitled to act in its own interests in deciding to serve a notice of default if discussions with the borrower did not bear fruit.
  • The fact that the loan agreement contemplated that interest may not be paid every month did not make the obligation to pay interest discretionary or constitute acceptance of the probability that the nature of the borrower's business would inherently undermine its capacity to pay interest.
  • Evidence of the borrower's subsequent financial performance could not assist in establishing the bona fides of the lender at an earlier time, and may be of limited relevance in determining the reasonableness of the lender's conduct, but the accuracy of the lender's forecasts was relevant to the issues raised by the borrower in this case.
(3) Reasonableness of opinion:
  • There was a reasonable basis for the opinions formed by the lender.
  • The language did not require that the opinion be objectively valid. As drafted, the clause only required an opinion that there were 'grounds to believe' a material and adverse change had occurred, not an opinion that such a change had occurred. An opinion formed honestly and not capriciously was effective unless no reasonable person in the position of the lender could have formed that opinion.
  • The subject matter of the decision was difficult to describe, nebulous and fluid, so the decision was not easily open to challenge.
  • Justice Robb did not put significant weight on clause 1.5 (that the lender's discretion was unfettered) because the lender did not rely on it. He said it provided some support for his conclusion that the opinion required by paragraph (i) was not required to be supported by facts that objectively prove its validity. Clause 1.5 would not have preserved an opinion that was not honestly held but may have preserved an opinion that no reasonable person would form, provided there was no obvious error.
(4) Ability of borrower to perform obligations:
  • To activate paragraph (i), the change need not materially and adversely affect the borrower's ability to repay the loan or to perform its other obligations under the loan agreement. Changes that undermine the lender's original decision to lend or would cause the lender to proceed upon significantly different terms (as to such matters as margin, maturity or security) are also sufficient.
  • The exercise of construing the relevant MAC provision is likely to be complicated and case specific. Guidance may be drawn from earlier cases, but their utility is limited. Justice Robb declined to follow an English case2 in which Justice Blair held that, to be material, the adverse change in financial condition must significantly affect the borrower's ability to perform its obligations, in particular, its ability to repay the loan. In this case, the language used in the documents and overall context of the term were different.
  • The court also held that there were two limbs of paragraph (i) and only the second limb required a change in the borrower's ability to repay. That requirement was not to be read into the first limb.
(5) Material and adverse change:
  • In the present case, an Event of Default did not arise unless the adverse change was 'significant' in that it had 'a substantial adverse effect'.
  • Whether the failure of a business to meet budget expectations is a relevant change for the purposes of paragraph (i) is a matter of degree, and depends upon the magnitude of the shortfall and the underlying reasons for its occurrence. Here, the magnitude was great and the reasons were not ephemeral, so the failure to meet budget expectations was sufficient.
  • The Court rejected arguments that the asserted 'change' was merely the inherent volatility of the market; that the failure to pay interest could never constitute a paragraph (i) 'change' because unpaid interest was automatically capitalised under the loan agreement; and that the borrower's failure to generate sufficient revenue could never constitute a paragraph (i) 'change' due to the obligation to consult on alternative payment schemes in clause 7.1. These arguments misstated the expectations the parties had at the time of entering into the joint venture, as set out in the budget, and ignored the reality that the borrower could not pay, not only interest, but principal repayments during the 30-month term, and had no expectation of being able to do so thereafter.


One should be wary of generalising about MAC provisions. They vary with the drafting and the circumstances, and the inherent vagueness means there is some degree of uncertainty as to when they can be enforced.

Nevertheless, in many of the cases where lenders have been sufficiently bold to enforce them and they have gone to court, the courts have enforced them. Things have been sufficiently dire for the borrowers.

This case shows the advantages from a lender's point of view (and the dangers for borrowers) in drafting MAC provisions so that:

  • they rely on the opinion of the lender; and
  • they are triggered by circumstances other than a material adverse effect on the ability to perform obligations.

Where the MAC does depend on the opinion of the lender, the courts will give latitude to the lender.

In this case, it appears that, even without those features, the court would have been prepared to have found there was an MAC.

This case does depart from an English authority, where the court did tie materiality to the ability of the borrower to perform is obligations under the loan agreement.


  1. Minumbra Lancewood Pty Ltd v AM Lancewood Investment Nominees Pty Limited [2013] NSWSC 1929 (Eq).
  2. Group Hotelero Urvasco S.A. v Carey Value Added S.L. [2013] EWHC 1039.