With the significant impact on the economy and businesses across the world, corporate borrowers may want to consider the terms of their loan facilities and the effect that COVD-19 is having on them. It seems prudent that borrowers check their agreements and contact their professional advisers as well as their lenders to discuss the position if they have any concerns.
The pandemic will not in itself constitute a breach by any borrower of their obligations under a loan agreement, however, there are a number of areas where the effect on business may lead to a breach of the terms of the loan agreement. We cover some of these areas below:
- Payment Default: Failure to make a payment when due will, in the majority of cases, constitute an event of default. It is worth checking the term of any agreement as there may be a grace period to cover any technical issues (where a payment system has failed or is delayed). However, if a payment is missed due to a cashflow problem, this will constitute an event of default.
- Financial Covenants: Any borrower who faces financial difficulties may be in breach of their covenants, particularly where based on EBITDA, net income and other income measures given that borrowers are facing lower revenues as a direct result of the pandemic. Borrowers who anticipate that they may breach their financial covenants as a direct result of COVID-19 should approach their lender – lenders may be willing to waive or defer testing periods based on performance to date. Borrowers and respective lenders should check their finance agreements as it may be that they include cure rights which allow a shareholder to inject capital so the relevant covenant is not deemed to have been breached. The drafting should be checked carefully as cure rights may be allowed only by way of equity or fully subordinated debt.
- Information Undertakings: Borrowers are required to deliver financial statements to their agent or lender within certain time periods. This may be challenging under the current conditions and borrowers may anticipate delays in producing these. Companies House have helpfully extended the deadline for filing accounts (further detail on that here ). Lenders may also agree to extend deadlines for delivering financial statements to them under their loan agreements.
- Material Adverse Change: Most loan agreements will contain representations and warranties given by the borrower to the lender, one of which will be concerning “material adverse change/effect”. This will often also be an event of default. Whilst this depends on a plethora of factors, borrowers may be looking to rely on their credit lines to continue operating and will need to evidence to their lender that no material adverse effect has occurred. Lenders will likely be looking to satisfy themselves of this in relation to existing committed funds.
- Market Disruption: Market disruption clauses appear in loan agreements where lenders want to retain the ability to calculate interest on a different basis to the normal calculation. This is often triggered where the lender’s cost of providing funding exceeds the interbank lending rate benchmark and therefore the lender would have the ability to increase the rate charged to reflect the actual cost to them. This is rarely used by lenders in response to market instability but if, as a direct result of the pandemic, lender consider this necessary, then borrowers would have to consider how this may affect their cashflow, their ability to pay the increased interest payments and whether this may have a knock on effect on other areas of their facility agreement (i.e. satisfying financial covenant tests)
- Cessation of Business: loan agreements may contain an event of default where a borrower suspends or ceases to carry on (or threatens to suspend or carry on) all or a material part of its business. The impact of COVID-19 means that some businesses are having to suspend part of their operations or close their offices so it is possible that events of default may be triggered as a result. Lenders may want to consider whether they can waive any breach of this event of default for a temporary period.
- Negotiation with Creditors: there is often an event of default if a borrower commences negotiations with creditors, other than the lender, where such negotiation is to reschedule their indebtedness. This may be particularly relevant for borrowers who are seeking rent reductions or payment holidays with their landlords, (even under the recent government schemes) or are negotiating with other lenders or trade creditors and borrowers should therefore check the terms of their finance agreements and discuss with their lender before commencing any such discussions.
- Group Members: provisions in loan agreements are often more widely drafted and can apply to the borrower’s group as well as any third party security providers. Borrowers and lenders will have to review on a case by case basis to determine which entities are relevant for any potential breaches, particularly where lenders are willing to waive breach of any provision for a period.
- Cross-Default: Borrowers may find that their loan agreements include a cross-default provision. This means that any breach of another loan agreement, entered into by the borrower (or commercial agreement in some cases) may automatically trigger a breach of the loan agreement under the cross default provision. Any borrower with multiple facilities (even where there are different lenders) may be caught by this and should check the terms of their loan agreements carefully.
- Revolving Credit Facilities: Revolving credit facilities (RCFs) will often have a restriction on any new borrowing under them if an event of default (or a potential event of default) has occurred. However, lenders will often allow a rollover of a loan that has already been borrowed under the RCF where there is no event of default continuing. Generally this will be dependent on the drafting of the RCF and it should be reviewed carefully by borrowers and lenders together. It is likely that lenders would not want to exercise any such drawstop unless absolutely necessary, given this could have reputational damage for them.
Considerations for Borrowers and Lenders
- On-demand facilities: where a loan is repayable “on-demand” by a lender, the lender can demand repayment at any time. It is unlikely lenders will call in an on-demand loan simply as a result of the pandemic but a borrower would not be able to stop them doing so.
Borrowers should check their finance agreements to ensure that they are continuing to comply with their obligations. Although there is unlikely to be any specific requirement to inform lenders in advance, borrowers should consider it prudent to approach their lenders if they can foresee any cashflow issues. Loan Agreements typically contain a requirement for a borrower to notify a lender of any defaults or events of default that have occurred. Borrowers should therefore continue to assess on an ongoing basis whether a notification requirement has been triggered as a result of the pandemic.
Lenders may want to assist their borrowers through this difficult time and they may be willing to waive any potential breaches, agree repayment or interest payment holidays or amend testing periods to avoid potential breaches.
Where borrowers are considering approaching a lender for additional finance, even under any of the available government backed loan schemes, they will need to consider any effect this may have on their existing loan agreements as they may contain restrictions on incurring other “financial indebtedness” without prior consent. Lenders may be willing to grant a waiver for any such debt during this time and may be happy to consent or amend their facility accordingly. Borrowers may also find that their existing security contains a negative pledge which will restrict them giving security to another party. We suggest that borrowers remain prudent in considering their existing arrangements before taking any additional finance and consult their professional advisers where they have any queries/concerns.
Government loan schemes
The government has produced a number of initiatives to support businesses through this difficult time. Full details can be found on the government website. You will also find an overview of the Coronavirus Business Interruption Loan Scheme for SME’s here
and the COVID-19 Corporate Financing Facility for larger companies here
Please note that the above note highlights some, but not all, of the problematic areas for borrowers at this time and the areas that lenders may be willing to provide assistance with. The above is not legal advice as the position may differ depending on individual circumstances.
If you have any queries relating to your finance documents or you are a lender wanting to assist a borrower through these difficult times, please get in touch with Gwen Godfrey
, Michael Wrigley
or Katie Layton
by phone or by email, or with your usual contact at DMH Stallard LLP.