(Bloomberg) -- U.S. and European leveraged loan investors who committed to financing companies and are now looking for ways to get out of those agreements amid the pandemic may have limited options, according to credit research firm Covenant Review.
Some lenders who have yet to fund deals have the option of pulling out of their obligations by invoking a rarely used clause known as the Material Adverse Change, or MAC. The problem is that it’s not clear what constitutes a material change.
“There’s a lot of uncertainty at this point in time as to whether the Covid-19 pandemic will have an impact which is sufficiently long that lenders can invoke the MAC clause,” Jane Gray, an analyst at Covenant Review said in a telephone interview.
An investor has to prove that the virus has had such a significant impact on the business that it will hamper its ability to repay the loan, or that it would have affected the lender’s decision to lend at all. Failure to demonstrate the material change could result in potential liability and reputational risk for lenders, Gray noted.
Read more: Leverage Loans in Europe Endured Worst Week on Record
What’s more, the weakening of investor protections in recent years has resulted in many large deals in Europe missing a MAC clause altogether, Gray said. For those that do have it, deals will have to be examined on a case by case basis.
In the U.S., lenders’ options are even narrower. Bill Brady, a lawyer in Paul Hastings LLP’s special situations group and the head of its alternative lender and private debt group, said that over the past five or six years, the language has become scarce in U.S. financing documents.
“As the market has been hot, most deals that get done don’t have a general MAC clause,” Brady said. Where the relevant language does still show up, he said, it’s just one in a list of statements an issuer attests to in order to receive additional financing.
“Most will require the issuer make a statement that no MAC has taken place, or would reasonably be expected to take place, as a condition to funding,” Brady said.
In the go-go years of easy credit that preceded the current market freeze, lenders extended financing on ever looser terms. In doing so, they lost the kind of negotiating leverage they had long used to rein in or influence companies’ practices during a downturn.
The ability to call on the terms of a covenant to begin talks with a borrower “gets lenders a head start if they want to take action or get the company around a table and find a solution,” Brady said.
Gray echoed the significance of the weakening of covenant protections in recent years, saying that the very focus on MACs reflects the erosion of lender protections elsewhere.
“The fact that lenders are looking at the MAC clause also indicates to us how weak documents have become,” Gray said. “They’re having to rely on clauses that traditionally you wouldn’t rely on because they’re so uncertain.”
(Updates to include commentary on U.S. markets throughout)
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