Lender’s “material adverse change” clause struck down

The “material adverse change” clause in a mortgage, designed to protect the lender when the mortgagor’s financial situation deteriorates, has turned around to bite the mortgage administrator in a recent California decision.  General Motors Acceptance Corp. was hit with a $40 million judgment (including $33 million in punitives) after it invoked the clause to claim breach of the agreement, even though the payments were not in default.

In the case, GMAC was acting as the administrator of about $1 billion in mortgages that were the securities backing a bond issue.  When the only tenant of a Silicon Valley building vacated after the dot-com bubble burst, GMAC — whose job was to represent the interests of the bond holders — refused to release the tenant’s early-termination fee to the mortgagors, the building’s owners, claiming that since the building was now empty the loan was at risk.

A state court trial judge ruled that the standard clause was so vague as to be meaningless, and therefore held that it simply could not be invoked in any situation where the mortgage payments were current.  He enjoined GMAC from invoking the clause under any of the mortgages included in the mortgage pool that includes the plaintiffs’ loan.  GMAC will appeal.