The most common loan default is for non-payment. But there are many other events that can trigger a default. Indeed loan documents, including guaranties, typically contain a multitude of default-related provisions. One provision that we often see, but rarely apply, looks something like this:
Insecurity. Lender determines in good faith that a material adverse change has occurred in Guarantor’s financial condition from the conditions set forth in the most recent financial statement before the date of the Guaranty or that the prospect for payment or performance of the Debt is impaired for any reason.
Greenwood Place v. The Huntington National Bank, 2011 U.S. Dist. LEXIS 78736 (S.D. Ind. 2011) (rt click/save target as for .pdf) addresses a similar material adverse change (“MAC”) clause.
Summary judgment. In Greenwood Place, Southern District of Indiana Judge Tanya Walton Pratt issued a ruling on a motion for summary judgment filed by a lender against two borrowers based on the theory that there had been a “material adverse change in the financial condition of” the guarantor of the loans. The opinion did not quote the entire clause, but it was clear that the subject loan agreement provided that “any material adverse change in the financial condition of” the guarantor constituted an event of default. (Note that an alleged default occurred even though the loan payments were current.)
The change. Since the execution of the loan agreement, the guarantor’s cash had been almost completely depleted, his net worth had decreased by 60%, his equity in real estate had diminished by 80%, and he had unpaid judgments against him for several million dollars. According to the Court, “to be sure, [guarantor] has experienced an adverse change in his financial condition.” But, “whether this change has been material . . . is a more difficult question.”
The Court’s struggle. The Court conceded that “at first blush, it would appear that this change has been material as that word is used in common parlance.” Nevertheless, the Court noted that the loan documents did not define “any material adverse change.” Evidence from six witnesses suggested different definitions. Although the lender urged the Court to accept a “know it when you see it” interpretation, the Court was “uncomfortable” with applying such an approach at the summary judgment stage. “Materiality,” noted the Court, is an “inherently amorphous concept.” The guarantor still had a sizeable net worth that, based on certain assumptions, could be enough to absorb any liability stemming out of the underlying loans. “This cushion creates questions as to whether the adverse change in [guarantor’s] financial condition is, in fact, material.”
Ambiguous. The Court denied the lender’s motion for summary judgment:
Given the “sliding scale” nature of materiality, coupled with the lack of a definition or objective standard found in the [loan agreement], the Court cannot help but find that the term is ambiguous because reasonable people could come to different conclusions about its meaning. . . . [T]herefore, “an examination of relevant extrinsic evidence is appropriate in order to ascertain the parties’ intent.”
Essentially, the Court held that the issue of materiality was a question of fact for trial.
What we learned. The Court’s analysis of the relevant financial conditions provides a road map for prosecutors (or defenders) of similar defaults. The Court’s opinion does not question the fundamental validity or enforceability of MAC provisions. The opinion does, however, raise the question of whether such a provision can form the basis for a pre-trial disposition of the case: “when it comes to materiality, it’s all relative.” The implication is that every case (financial condition) is different, and facts may need to be weighed. On the other hand, Greenwood Place does not go so far as to proclaim that summary judgment should be denied in every case. The opinion merely demonstrates how difficult summary judgment might be to achieve.