Relying on a default of 'material adverse change'

In the recent decision of Einstein J of the New South Wales Supreme Court in Brighten Pty Limited & Ors v Bank of Western Australia Limited & Anor [2010] NSWSC 133, the Court considered the circumstances in which a ‘material adverse change’ would trigger a default entitling the secured lender to appoint a receiver.

Background

In late 2006, Bank of Western Australia Limited (Bank) provided a loan facility of $32,150,000 to Noble Growth Investment Limited (Noble) to enable the purchase of the Fairmont Resort in Leura, New South Wales (Leura Resort).  Among other things, the loan was secured by a mortgage given by Brighten Pty Limited (Brighten) as owner of the land upon which the Leura Resort was situated, and by a charge over its assets and undertaking.

Not unusually, the loan and security documents contained default provisions providing for the Bank to determine in its absolute discretion if there had been a ‘material adverse change’ in the business, property or financial condition of the loan parties or the Leura Resort.

In April 2009, Channel 9 aired two reports on its A Current Affair programme (ACA reports), highly critical of the standard and condition of the Leura Resort’s accommodation and facilities.  

The Bank formed the view that the ACA reports had a major impact on the business, assets and financial condition of the Leura Resort.  The Bank contended that the ACA reports, coupled with the consequent downgrading of the Leura Resort’s rating and reputation, constituted a ‘material adverse change’ for the purposes of the loan and security documents from the position at the inception of the loan.  As a result, the loan was in default and the Bank was entitled to appoint a receiver.

Brighten responded by commencing proceedings seeking a declaration that no default had occurred, which if successful, would have the effect of restraining the Bank from appointing a receiver.

In December 2009, the Court appointed a receiver. The appointment was by agreement and gave the receiver limited powers.  The receiver’s report was furnished to the court in February 2010 following which Brighten sought an extension of the existing interlocutory injunction.  Among other things, the receiver’s report concluded that there were serious public health and safety issues associated with the air conditioning systems and fire safety measures at the Leura Resort.  Whilst the plaintiffs submitted they had dealt with these matters, there was a clear inference that the plaintiffs had 'woefully and over a considerable period of time neglected to operate the resort in a competent fashion'.

The decision

Einstein J dismissed the application finding, among other things:

• The plaintiffs failed to show they had a 'serious, not a speculative case' which had a real possibility of success.  His Honour also determined that the balance of convenience did not favour a continuation of the interlocutory orders;
  
  
• That on the evidence, circumstances had arisen which in the opinion of the Bank 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 make that decision in its absolute discretion; 
  
  
• The Bank’s decision to exercise its discretion could only be impugned if it was exercised in bad faith, arbitrarily or capriciously.  The test was not one of fairness or reasonableness.  In the circumstances of this case, there was no evidence to suggest the Bank had acted unconscionably or in bad faith;
  
  
• The transaction documents between the Bank and the plaintiffs, including the terms and conditions of those documents, were 'completely standard and conventional' and that ‘material adverse effect change’ provisions are almost universal in commercial mortgage transactions. In other words, there was nothing 'unconventional, unconscionable, unfair or unjust' in any of the terms in the security documents.  His Honour noted that 'lenders may wear both belt and braces' in respect of their loan documentation; and
  
  
• The plaintiff’s lack of co-operation in relation to the preparation of the court appointed receiver’s report could be taken into account in determining the outcome of the plaintiff’s application.

Lavan Legal comment

This decision highlights the absolute discretion that lenders have, in the absence of the lender having acted in bad faith or unconscionably, in relation to suitably drafted ‘material adverse change’ clauses in loan and security documents. 

However, we recommend that to the extent possible, lenders also identify and rely on other defaults which may have also been triggered such as, for example, monetary defaults, a diminution in the value of security, breach of any applicable loan to value or other ratios and so forth, as those types of default events may be more readily identifiable and objective.   

For borrowers, the decision also serves to highlight the dangers of adverse media reports, which could lead to a lender determining that a default under relevant borrowing arrangements has occurred.

For further information please contact:
Kylie O'Keeffe on 08 9288 6852 or email kylie.okeeffe@lavanlegal.com.au.