Many entities that have debt agreements may be unaware of certain clauses contained within these agreements that allow a financial institution to accelerate payment terms of outstanding debt as a result of certain events. Often referred to as material adverse change clauses, or MAC clauses, these clauses may or may not be clearly defined within the debt agreement. Some types of MAC clause events may include the sale of a subsidiary, exiting of certain product lines, or simply the violation of a debt covenant. The purpose of these clauses is to protect the financial institution if certain events occur that are normally outside the control of the financial institution.
Violations of MAC clauses may provide the financial institution with the right to demand payment of outstanding financial obligations or restrict future borrowings under an existing line of credit. This may present significant cash flow problems. If an entity is unsure if any of their debt agreements contain MAC clauses they should discuss their debt agreements with their accountants, legal counsel and financial institution. Once an entity understands the potential triggering events of any MAC clauses contained in their debt agreements, management will be better able to identify potential issues during the normal course of business operations.
Additionally, the violation of a MAC clause may result in an entity being out of compliance on other debt agreements. For example, assume that an entity has two separate debt agreements with two unrelated financial institutions. Included within one of the agreements is a MAC clause that if an entity sells a subsidiary the debt will be called. The other debt agreement contains a debt covenant requiring a current ratio of 2:1. If the entity violates the MAC clause, and the entire balance of debt becomes due, the entity will most likely be out of compliance on their debt covenant. This may result in accelerated payments under both debt agreements. Depending on the complexity of the MAC clause, the most trivial actions of an entity could have a significant impact on the entity’s operations.
In order to avoid potential MAC clause violation, and the potential acceleration of debt payments, an entity should carefully consider their debt agreements to identify if there are any MAC clauses. Additionally, potential triggering events should be identified and appropriate procedures should be in place on how to handle these situations if they arise. These procedures may include having up front discussions with your accountants, attorneys and financial institutions prior to entering into significant transactions that may trigger the violation of a MAC clause. Further, for new debt agreements, an entity should ensure that there is a clear definition of what potential transactions would result in a material adverse change, as well as other potential implications on other debt holdings that the entity may have.
Aaron Kofira is a partner based out of our Rochester, NY office.