Skip to content.

Home

Allens Arthur Robinson

Focus: When is it safe to rely on a 'material adverse change' as a default?

7 June 2010

In brief: The circumstances in which a 'material adverse change' clause will trigger an event of default under security documents, and the lender's absolute discretion in determining such a change, has been analysed in a recent NSW Supreme Court decision. Partner Michael Quinlan (view CV) and Lawyer Clementine Davidson report.

How does it affect you?

  • The decision1 :
    • reinforces the absolute discretion that financial institutions have in respect of appropriately drafted 'material adverse change' clauses (which are almost universal in commercial facility and security documents), as long as the bank does not act in bad faith, or unconscionably, in calling on the default; and
    • highlights the difficulties a mortgagor or chargor may face in seeking to restrain the bank from enforcing terms of its loan documentation that were freely agreed between the parties. 

Background

In late 2006, Noble Growth Investment Limited applied to the Bank of Western Australia (the bank) for a loan to purchase the Fairmont Resort at Leura. The loan of $32,150,000 was advanced to Noble and secured by transaction documents, including a: 

  • facility agreement between the bank, with Noble as borrower and Brighten Pty Limited as guarantor;
  • first registered mortgage given by Brighten, as owner of the land upon which the Leura resort was situated; and
  • a registered equitable charge given by Brighten over all its assets.

The facility agreement provided for the bank to have absolute discretion to determine whether a material adverse change occurred, triggering the default event clause. It also provided that such a determination would be binding on the borrower and the guarantor, and that, on the occurrence of a default event, the bank might do anything it considered appropriate to recover the debt.

On 20 April 2009, Channel Nine's A Current Affair ran a report that criticised the standard and condition of the Leura resort. Another, equally critical, report was aired on the same program two days later (together, the ACA reports). The bank contended that the ACA reports constituted a material adverse change, resulting in a material diminution in the value of the resort and consequent downgrading of the resort's reputation.

Brighten commenced proceedings on 23 October 2009, seeking a declaration that events of default had not occurred, which would have the effect of restraining the bank from appointing a receiver.

On 11 December 2009, a court-appointed receiver, with limited powers, was appointed by agreement. The receiver soon furnished his report, and the parties were again before the court, on 25 February 2010, with Brighten seeking the extension of the existing interlocutory injunction. The bank opposed the application. 

Return to top

The decision

In dismissing Brighten's motion to continue the interlocutory injunctive regime, Justice Einstein examined the well-known principles informing the court's discretion to grant interlocutory relief – that is, the:

  • serious question to be tried; and
  • balance of convenience parameters.

His Honour determined that circumstances had arisen which, in the bank's opinion, had a material adverse effect on the business, assets and financial condition of Brighten and Noble, and on their ability to perform their obligations to the bank. The bank was entitled to reach this conclusion on the basis of its absolute discretion.

His Honour also raised the following key points:

  • Transaction documents: As the bank contended, the security and transactional documentation, as well as the terms and conditions, were completely standard and conventional. In other words, there was nothing unconscionable, unfair or unjust in any of the terms of the transaction documents. In respect of loan documentation, his Honour noted that 'lenders may wear both belt and braces'2 .
  • Good faith and unconscionable conduct: In these circumstances, there was no evidence to suggest the bank acted in bad faith or unconscionably.
  • The court-appointed receiver's report: The preparation of the receiver's report had been restricted by Brighten's general lack of cooperation in providing requested documentation. Interestingly, his Honour noted that Brighten's lack of cooperation was a factor that could be taken into account in determining the interlocutory hearing's outcome.

His Honour concluded that the bank's decision to exercise its discretion could only be impugned if it were exercised in bad faith, arbitrarily or capriciously. The test is not, however, one of fairness or reasonableness. His Honour held that the bank's rights in this case were to be viewed fairly and commercially, and that it was reasonably open to it to determine that there had been materially adverse changes. Brighten failed to show that they had a serious, not a speculative, case that the bank had acted outside its rights or for an ulterior purpose. Justice Einstein ruled that the balance of convenience was also not in favour of continuing the extant interlocutory orders until final hearing.

Return to top

Conclusion

Justice Einstein confirmed the bank would not be restrained from exercising its discretion under 'material adverse change' clauses, unless the mortgagor could establish unconscionable conduct by the bank.   

Footnotes
  1. Brighten Pty Limited v Bank of Western Australia Limited [2010] NSWSC 133. 
  2. Pan Foods v ANZ Banking Group [2000] HCA 20 per Gleeson CJ, McHugh and Hayne JJ.

For further information, please contact:

Return to top

Share with

What are these?

 

 

Recent Insolvency & Restructuring publications