Jaime Rachel Koff
Senior Partner
Riemer & Braunstein LLP

One of the more ubiquitous terms in a credit agreement is “material adverse effect” (MAE). Like its twin, “material adverse change” (a term that is interchangeable with MAE), the phrase is used in numerous contexts in financing documents, from a standalone event of default to a borrowing condition and everything in between. Today, MAE is a fundamental modifier of countless representations, warranties and covenants. When a borrower is in a downturn scenario, a sound understanding of the term’s origin, evolution and current usage can prove invaluable.

MAE has three components: “material” (basically, something that is a ‘big deal’), “adverse” (something that is bad, whether for the borrower, the lender or both) and “effect” (something new that has happened). Put simply, a MAE is something

Lon M. Singer
Senior Partner
Riemer & Braunstein LLP

negative that has happened and which has a major impact.

Evolution of the Term

When asset-based lending first came into existence, it was considered a platform of last resort in which lenders had all the leverage. In that long-gone environment, a MAE was generally a free-standing event of default in every credit agreement. In other words, lenders had the power to stop the music — accelerate and exercise rights and remedies — if a MAE occurred.

That time has long since passed, and asset-based lending is a different animal. Once the exclusive domain of lower middle-market commercial finance companies, ABL is now a key financing product for many money centers and major banks, and it serves some of the largest companies in the United States. Alongside this metamorphosis, the ABL market also has changed. Sponsors draft their own credit agreements and lenders compete furiously for the privilege of deploying their capital. In other words, the standing of borrowers today means that a separate MAE event of default is no longer considered a standard market provision.

Even when the market allowed a free-standing MAE event of default, it was a dangerous default upon which to rely as a lender. Lenders were forced to make subjective determinations that MAEs had occurred. Since the implications were profound (a lender could literally put the borrower out of business), there was a uniform reluctance to invoke the MAE default, at least as a sole or exclusive event of default. With a subjective default, a court could decide the lender was overreaching and the alleged circumstances did not in fact exist. Accordingly, lender liability and reputational risks were substantial and, as a consequence, the MAE default tended to be invoked, if at all, only in conjunction with one or more other objective defaults, such as the breach of a financial covenant or a negative covenant (for example, the making of a prohibited payment). Once its utility as an event of default devolved to the status of “piling on,” it is easy to see why MAE fell out of favor as an independent event of default.

Significance of the Term Today

But if a MAE is no longer an event of default, how does the concept exist and work now? As noted earlier, it is one of the most important modifiers of representations, warranties and covenants —including covenant exceptions — throughout most credit agreements.

For example, a borrower is generally asked to represent that it has complied with all applicable laws. Even lawyers must admit that the number of federal, state, local and municipal laws and regulations is overwhelming. Accordingly, to focus the parties on the jurisprudence of more critical importance in a particular transaction, the representation is often modified by the phrase “except where noncompliance could not reasonably be expected to have a material adverse effect.”

Similarly, other representations and a variety of important covenants (including negative covenants and the exceptions to them) may be modified by a similar phrase that can appear in dozens of places throughout a credit agreement. Further, many credit agreements retain a borrowing condition (whether as a condition precedent to the initial closing, to any subsequent borrowing or to the effectiveness of an amendment) that since a particular date in time, there has been no MAE. Similar text may be included in a standalone representation. In a revolving credit facility, these representations are typically renewed each time a borrowing request is made. If the representation is not true, it results in a misrepresentation that constitutes an event of default. However, the same issues that led to the falling away of MAE as a standalone event of default are still present — lenders are skittish about calling an event of default solely in reliance on a MAE, whether as a default in its own right or as the linchpin in an alleged misrepresentation.

Notwithstanding all of the foregoing, given its continued presence as a modifier of representations and covenants, the MAE construct retains tremendous vitality and its implications are far-reaching. For that reason, it is important to examine how it may be defined — and where nuances in the several components of the definition should be considered with care — and customized and negotiated for each transaction.

A Look at the MAE Definition

The range and variety of definitions of a MAE in the market are vast. Breaking down some of the components of the definition and the concept generally, the touchstones are on the condition of the borrower and the likelihood that the lender will be repaid in full.1

Almost all MAE formulations are keyed first and foremost to some major deterioration in the “operations, business, properties, liabilities or condition” of the borrower or its assets. More attenuated — and subjective — is the concept of “prospects” that is sometimes, but less often, included in this laundry list.

Every lender receives projections that are often heavily qualified and may be presented in multiple formats, each with varying utility. However, what happens if something makes those projections look like they obviously will not play out according to plan? The “prospects” component of this definition addresses that change. Nevertheless, determining what a borrower’s prospects look like is a highly subjective matter. Borrowers and their counsel certainly want to avoid a situation where they have authorized a lender to deem the facility in default merely because the lender decides it is starting to feel a little “uncomfortable” about the credit.

The result is “prospects” might sometimes still be included in definitional formulations in lower middle-market transactions, but the larger and more up-market credits generally omit this part of the formulation.

Other considerations that may be the subject of negotiation with respect to the MAE definition include the following:

  • Is the focus limited to the borrower or does it include every loan party? If all parties are included, is it enough that the MAE affects any one of them, or must a lender make the MAE determination with respect to the obligor group “taken as a whole?” The breadth of these alternatives is negotiated between counsel to the lender and the borrower, the former hoping to cast as wide a net as possible, while the latter hopes to limit the provision to the fewest entities and then only to the extent the whole obligor group is impaired.
  • Does the impact on rights and remedies and the likelihood of repayment in full extend to defects in perfection or other factors relating to the value to the lender of collateral security? If so, must the impairment relate to the collateral generally, a material portion of the collateral or something else? In secured, asset-based lending, collateral is everything. From a lender’s perspective, a better formulation of MAE includes impairment of the collateral and any defect in perfection, regardless of its cause.
  • Is the formulation limited to individual events, or may a confluence of events in the aggregate give rise to a MAE? Obviously, if a few smaller things can add up to a MAE, the definition has more bite from the lender’s standpoint. The cumulative formulation, however, is more of an exception than a rule.

Developments in the COVID-19 Era

COVID-19 has driven home an important point about the way MAE provisions work in today’s documents, both in theory and in practice. If a loan agreement included a standalone MAE event of default, then, as a result of the COVID-19 pandemic, the threshold for such a default was about as unambiguously and defensibly crossed as ever. However, because the same scenario was likely equally true for substantially every credit in a lender’s portfolio, most lenders have continued not to invoke this default. Instead, lenders are contending with long relationship histories and the reputational risk of behaving more harshly than their competitors. Accordingly, with the national interest (as well as their own) in mind, lenders have proceeded in a very careful and measured fashion.

The practical result has been that lenders and their customers are coming back to the table. ABL financing has always been “high touch, relationship-centered” lending, which has certainly remained true as the pandemic has unfolded. Lenders and borrowers are meeting to consider strategies for modifying business operations, to evaluate additional sources of liquidity (both governmental and private), and to assess how they might adjust their documentation to account for a phenomenon whose impact (hopefully) will be short-lived but that affected virtually every industry in one way or another.

So where has that left the definition of MAE as time and COVID-19 go on? Both by way of amendment to existing credit facilities and in connection with the documentation of new financing arrangements, a “COVID-19 proviso” is now a somewhat standard feature of the MAE definition. It applies to address the MAE impact of COVID-19 only on the assets and business of the borrower, rather than on any of the legal issues, such as documentation, collateral, or rights and remedies. It essentially provides, in deciding whether there was a MAE, the lender must ignore effects that “substantially and directly” relate to the pandemic. But, as with all legal provisions, there is a range of approaches and some subtlety.2

There are several issues to consider when drafting and negotiating a “COVID-19 proviso.” First, is the COVID-19 pandemic truly the driver of the event? An interesting piece of this puzzle is consideration of whether a specific borrower has been hit worse by COVID-19 than its competitors, perhaps because management was weaker. This possibility is clearly a risk allocation exercise between the lender and its customer. If the COVID-19 pandemic has hit a particular borrower harder than its competitors, to the potential detriment of the lender, why should the borrower’s inferior business acumen entitle the borrower to preserve flexibility in its credit documents when other borrowers with stronger management teams are not in as dire straits? With this in mind, lenders may choose to differentiate between pervasive, generalized effects and those that rightly may be laid at the doorstep of a particular borrower.

Second, how long should the proviso apply? Most of these COVID-19 “free passes” only run through the end of a borrower’s fiscal year 2020, or, in more borrower-friendly versions, through June 30, 2021. Of course, as the pandemic drags on, it would not seem unreasonable that these dates may be extended; only time will tell how this will play out. In any event, the idea is that the proviso should apply only to impacts that happen through a specified date, after which it is expected that COVID-19 will no longer dominate society and the economy.

Third, should a broad exception (i.e., anything that happens as a result of the COVID-19 pandemic) be permitted, or should there be reliance on an enumerated list of effects as specified in writing? This feeds into the temporal issue discussed earlier. From a lender’s perspective, the more specific the proviso is, and the tighter the carve-out, the better it is. That way, if the borrower wants a pass, the event has to be identified in advance to the lender.

On a related note, some lenders do not approve of COVID-19 “exceptions” applying for all purposes wherever the concept of MAE is present. For example, more conservative lenders may want to limit the application to those provisions truly impacted by the COVID-19 pandemic, namely, standalone closing conditions and representations stating that as of a particular date, no MAE has occurred. In those lenders’ views, the fact that the pandemic is ongoing should not impact individual representations and covenants that may include MAE qualifications, such as a litigation representation (i.e., that no litigation has occurred that, if determined adversely, could reasonably be expected to have a MAE) or a covenant to comply with payment obligations in respect of taxes (i.e., that the borrower will make all such payments except where the failure to do so could reasonably be expected to have a MAE).

One thing to keep in mind is lenders may have internal requirements with respect to changes to their MAE definitions. Some lenders, particularly money-center banks, are protective of their standard MAE formulation to the point that any COVID-19 exceptions to the approved language must be authorized by internal legal departments before the changes may be implemented.


The concept of MAE in financing arrangements has evolved considerably from its beginnings as a standalone event of default. As lenders’ reluctance to rely on a MAE as a singular default has grown, its use in such context has fallen out of favor, but its appearance as a modifier of covenants, representations and warranties has increased. Accordingly, the concept of MAE remains as vital to documentation and negotiations as ever before. As the COVID-19 pandemic has raged on, the MAE definition has continued to adapt to address new concerns. Changes to the term may be material and sometimes even adverse (depending on one’s point of view), but so long as business teams and their counsel appreciate the issues, any concerns can hopefully be resolved in a mutually agreeable manner.

  1. An example definition of a “material adverse effect” is: (a) A material adverse change in, or a material adverse effect upon, the operations, business, properties, liabilities (actual or contingent), condition (financial or otherwise) or prospects of any loan party or the parent/lead borrower and its subsidiaries taken as a whole; (b) a material impairment of the ability of any loan party to perform its obligations under any loan document to which it is a party; or (c) a material impairment of the rights and remedies of the agent or any lender under any loan document or a material adverse effect on (i) the collateral; (ii) the validity, perfection or priority of any lien granted by any loan party in favor of any agent on any material portion of the collateral; or (iii) the legality, validity, binding effect or enforceability against any loan party of any loan document to which it is a party. In determining whether any individual event would result in a material adverse effect, notwithstanding that such event in and of itself does not have such effect, a material adverse effect shall be deemed to have occurred if the cumulative effect of such event and all other then-existing events would result in a material adverse effect.

  2. An example of a “COVID-19 proviso” is as follows: Provided, that, solely for purposes of the foregoing clause (a) (and notwithstanding anything to the contrary contained therein), any change in or effect upon the business, operations, assets, liabilities (actual or contingent) or financial condition of borrowers or any of their subsidiaries substantially and directly relating to the impacts of the COVID-19 pandemic occurring prior to the last day of the fiscal year ending Jan. 30, 2021 [and thereafter with respect to any future periods in which a calculation, a ratio or representation in such future periods contains such period (or a portion thereof)] shall not be considered to be a material adverse effect (except to the extent that borrowers or their subsidiaries may have been disproportionately affected thereby to a material extent, relative to their competitors generally).

Jaime Rachel Koff and Lon M. Singer are both senior partners in the commercial finance practice group of Riemer & Braunstein LLP.