Is there a material adverse effect? When companies and their officers may be liable for when things change

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By Norman Donato, Partner

A recent decision of the NSW Court of Appeal[i] is timely. It discusses a number of issues which are likely to be playing on minds of borrowers and lenders at the moment, as interest rates continue to their unprecedented and unexpected climb.  Many loans locked in at relatively low fixed rates are maturing, and borrowers will need to extend their loan or reduce their debt.

This article discusses the Court of Appeal’s view regarding the interpretation and application of a no material adverse effect representation; and whether officers of a company are personally liable for signing or issuing certificates to lenders containing misrepresentations.


The case involved an Australian publicly listed company which entered into multiple financing arrangements. As at mid-2015, approximately $1.125 billion of debt was due to mature between July and December 2017. The debt was about to become a current liability in the accounts for the financial year 2016.

During the 2015 financial year, falling iron ore prices had an adverse impact on the borrower’s business. The borrower’s Board initiated various measures to address the financial situation, including an attempted sale of its mining business and the recapitalisation and restructuring of its finance facilities.

Between December 2015 and February 2016, the borrower issued several drawdown and roll-over notices under the facilities.  Each notice included representations of ‘no material change” and ‘solvency’ representations. However, the proposed sale of the mining business did not materialise because the board did not accept any of the offers. The 2016 half yearly accounts included a Going Concern Note indicating material uncertainty as to whether the borrower would continue as a going concern.  The recapitalisation proposal also failed. The directors decided to place the company into voluntary administration in April 2016 and it then went into liquidation in June 2016.

Among other claims, the lenders sued the Borrower’s Chief Financial Officer and its Treasurer for losses and damages said to have been suffered by the lenders’ reliance on incorrect representations in the relevant drawdown and roll-over notices. The lenders argued that because of the misrepresentations, they lent money to the borrower they would not have otherwise have done.

The questions to be determined by the Court were whether the Material Adverse Effect Representation was incorrect, and if so, were the officers of the company who signed the notices personally liable for any loss or damage the lenders’ suffered because of the misrepresentation.

No Material Adverse Effect Representation

Specifically, the no material change representation stated in the relevant documents stated that:

“each Borrower Party … represents and warrants to the Lender in relation to itself, and the Parent represents and warrants in relation to each Guarantor that:

(l)         (no material change) in the case of the Parent only, there has been no change in the Group’s financial position since the end of the accounting period for its most recent Accounts delivered pursuant to clause 15.1 which constitutes a Material Adverse Effect.”

Material Adverse Effect was in turn defined as “any thing which has a material adverse effect on a member of the Relevant Group’s ability to perform the obligations under a Transaction Document.

In considering whether the position of the borrower was misrepresented to the lenders in the relevant notices the Court noted the following:

  1. there are two components to the MAE Representation: a change in the financial position of the company; and that such change would have a material adverse effect on the ability of the company to perform its obligations under the Transaction Documents;
  2. whether the change would have a MAE on the ability to perform the obligations, means whether there is a material increase in the risk of an inability to perform those obligations; and
  3. the inability to perform does not simply relate to financial obligations but extends to any other of the obligations under the Transactions Documents.

The Court first considered what was meant by ‘financial position’. The borrower argued that the ‘financial position’ in this context required a narrow meaning, being the financial position disclosed in the company’s balance sheet. The lenders on the other hand, argued for a broader interpretation, being that it meant the financial position of the borrower generally. The trial judge had chosen an intermediate interpretation. The interpretation favoured by the trial judge was that financial condition meant all the financial information contained in the accounts and said that a change in position is determined by reference to information that would have been contained in the accounts, had those accounts been prepared at the time of the representation.

Neither party on appeal, cavilled over the intermediate interpretation given by the trial judge.  Instead, each complained with the conclusions reached by the trial judge.

The Court of Appeal accepted the trial judge’s intermediate definition, saying that:

“The purpose of the provision is to protect a lender from a change that would have been disclosed to it if it had accounts at the date of the relevant drawdown notice (and the actual date of the drawdown).

The next step in the Court’s analysis was to consider whether there had been a relevant change in the financial position? The four changes examined were changes in the balance sheet; changes in profitability; changes in the gearing ratio and the interest cover ratio; and the qualification to the going concern disclosure.

In a complex and technical examination of the relevant issues, which is beyond the scope of this brief article, the Court considered:

  1. whether each constituted a change in the financial condition;
  2. if so, when did the change occur; and
  3. did that change increase the risk of the inability of the borrower to perform it obligations as they stand?

In summary, the Court held that:

  1. the failure to achieve a desired sale of part of the business was not a material change in the financial condition; and
  2. changes in the gearing ratio and the interest cover ratio did not constitute a change in financial position that had a material adverse effect before the relevant date; but
  3. there was a change in the financial position that constituted a material adverse change by reason of the board of the borrower considering the going concern note, and it became a change in financial condition when the board became aware of material uncertainties casting significant doubt on the ability of the entity to continue as a going concern.

In respect of the second point, the Court said:

“It does not follow from the fact that “headroom” or “margin” is reduced, that there is a significantly increased risk of breaching the ratio covenants.  In short, one can sail close to the wind without incurring significantly increased risk of transgressing.  Indeed, the point of such ratios is to establish parameters, the breach of which will evidence an increase in risk.  Caution should be applied in drawing a conclusion of a materially increased risk of a breach just from the circumstance that one is close to the line.”

Are Officers personally liable for misrepresentation when signing those certificates?

When acting for a borrower, a prudent approach is to request an amendment to the drawdown notices or certificates to expressly state that the officer signs the notice or certificate in his or her capacity as an officer of the company, not in his or her personal capacity. Lender’s and / or their lawyers often resist the amendment.

The Court of Appeal reminded us that,

“it is the person who makes the misrepresentation that engages in the contravening conduct.  No doubt the status of an individual as an employee does not divest that person of personal liability for contraventions committed while an employee.  But it does not follow that where a corporation engages in contravening conduct through an officer or employee, the conduct is necessarily to be attributed to the employee as well as the corporation.”

The fact that the person making the misrepresentation is an employee or officer of the company does not, of itself therefore immunise the employee or officer from personal liability. The issue is whether the conduct is more than merely ‘ministerial’ because if it is more than merely ministerial, the conduct may also be conduct of the individual personally.

The relevant question is to whom the conduct is in law attributable, and there have been a number of case where a misrepresentation was held to be attributable to the individual officer. [ii]  Telling factors in the relevant cases include whether the person was the directing mind of the company, gave the relevant instructions and consequently was “the human embodiment of the corporation”.

The Court said there is a distinction between where a person is merely ‘involved in the contravention’ as opposed to have engaged in it personally. It is not enough that a person directs or authorises the corporation’s representation (unless the relationship is one of principal and agent) to find that the person engaged personally in the conduct. For a person to be found to have engaged in the conduct personally, it is necessary that the conduct would reasonably be attributed to him by the representee.   In other words, would it be reasonable for the representee to attribute the representation as conveying  the person’s view or position on the matter.

In analysing the certificates the Court concluded that:

“Insofar as they were signed by an ‘Authorised Office”, it was manifestly in their capacity as an authorised officer or agent … as required by the facility agreements … and not in any personal capacity.  The readers of the drawdown notices would not have understood [the relevant officers]…  to have [had]any involvement in the making of the representation beyond their purely ministerial acts as organs of the Company .  Neither did anything beyond acting within the ordinary scope of their duties as officer or employees, such that their relevant acts were purely ministerial.  No reasonable reader of the notices would understand the representations to be made by … [them] personally.”

Take out points

Ultimately, the outcome of each case where a lender seeks to rely on a no MAE representation being false depends on its specific facts and circumstances.

The complexity of the analysis and discussion of no material adverse change representations highlights the importance for lenders to carefully and clearly draft and tailor such clauses to the particular circumstances. Only then can they exercise their rights under such clauses with a reasonable degree of certainty.  In drafting a no MAE representation it is important to consider:

  1. what specific changes should trigger the clause;
  2. when such changes are to have, or be deemed to have, occurred; and
  3. if seeking to rely on financial covenants, consider setting a specific trigger point.

Lenders are rarely confident to enforce breaches of no MAE representations. If anything, this case demonstrates why. The paradox is that no MAE representations are general in nature deliberately, to deal with unforeseen circumstances, however by being general, the lender’s ability to rely on them is more uncertain and/or unlikely.

Officers of a company should be cautious when signing any drawdown notice or certificate containing representations on behalf of a company or otherwise ensure that any D & O insurances covers such a claim. While it may unlikely that an officer that merely signs the notice or certificate will be personally liable if it contains a misrepresentation, they could be held liable personally in certain circumstances if the representee could reasonably believe that it was their personal view. Officers should request that the notices or certificates clearly state that it is issued on behalf of a company, and not personally by the officer or alternatively sign the notice or certificate under section 127 of the Corporations Act.

[1] Anchorage Capital Master Offshore Ltd v Sparkes [2023] NSWCA 88

[2] Australian Securities and Investment Commission v Narain (2008) 169 FCR 211 and CH Real Estate Pty Ltd v Jainran Pty Ltd; Boyana Pty Ltd v Jainran Pty Ltd [2010] NSWCA 37

For further information, please do not hesitate to contact us.

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