COVID-19: Issues Under Loan Agreements
As the economic impact of COVID-19 (Coronavirus) continues to manifest itself, businesses are faced with a variety of challenges, not least in relation to meeting their obligations under loan agreements. Inevitably, this is creating issues for borrowers with their lenders, the most relevant of which we consider below.
The majority of business sectors (eg travel, restaurants, leisure and any non-essential activities) have already seen a significant reduction in turnover versus expectations. This may lead to a breach of financial covenants. Where a lender and borrower intend to continue the lending arrangement, the three main options for consideration are typically:
- an “equity cure”, where the sponsor/shareholder of the borrower injects enough new capital into the borrower (by way of equity or subordinated debt) so that the financial covenant is deemed not to have been breached. There will usually be a limit on the number of cures that can be applied in a given period, assuming it is provided for at all in the loan agreement. If not, it would require lender consent as a means of remediation;
- a once-off waiver of the particular breach. Lenders should be careful to ensure that they formally reserve all rights in relation to similar future breaches and other breaches; or
- amending the financial covenants to either (i) reflect revised realistic expectations in relation to covenant levels, or (ii) amend the definitions within the financial covenants to provide carve-outs for specific events.
Lenders will also have to make a commercial assessment of the issue, including how material the breach is and whether it seems likely to be repeated at the next covenant test date.
Request for further Facilities
Ironically, a borrower with a decreasing ability to meet financial covenants and payment obligations is more likely to request an increase in loan facilities to help it to manage cashflow. This poses a difficult commercial question to the lender, which will need to consider both the macro-economic outlook and the particular borrower’s position and handling of its challenges.
Some of the key questions a lender may consider when faced with a request for additional facilities at a time such as this include:
- what is driving the request for the additional facilities? Is the request stemming wholly as a result of COVID-19 related matters or are there other underlying strains on the business?
- what other measures is the borrower implementing, other than seeking additional debt, to protect its business?
- what is the nature of the debt request (overdraft, RCF or term loan) and what conditions need to apply to the additional debt? How long will the debt be made available for, how is it to be priced to reflect the additional risk the lender is assuming, how will it be repaid, when will it be repaid, can the business support the additional debt burden, should additional collateral be sought and what other documentary implications could flow from the debt increase?
- are there alternative options available to the borrower, particularly where the borrower has a sponsor with means? What level of risk share should apply to any solution the lender facilitates?
- can the borrower prepare any realistic short term projections to support its ability to service and repay the debt and can those projections be diligenced or supported independently?
- can the borrower offer additional collateral or external support for the increased debt?
- should reporting obligations increase for the foreseeable future?
From a documentary perspective, the provision of new loan facilities:
- may require amendments to the loan agreement(s), which can be effected in a number of different ways (eg amendment and restatement agreement, amendment agreement or amendment letter), depending on the scale of amendments required;
- would usually entail an analysis of existing security arrangements to assess the extent to which the new debt will be secured by existing guarantees and security. Where non-Irish law guarantees and/or security are involved, advice from local counsel (eg on any pre-approval steps or registrations) would ordinarily also be required;
- will require, where new collateral is being offered, new security documentation and/or guarantee documentation; and
- would usually require evidence of appropriate corporate approvals and potentially, in cross-border / syndicated transactions, legal opinions.
In the circumstances, depending on a lender’s tolerance for risk, it might make a concession to the borrower and adopt a light touch approach to the documentary formalities (eg dispensing with legal opinions or relying on obligors’ agent language to reduce costs and to accelerate the amendment process). It may also be feasible to provide additional credit in a documentary light manner through the increase of an internal overdraft limit or similar.
Where inter-creditor arrangements are in place, lenders will also need to consider how the new debt should rank for priority purposes and whether this needs to be reflected in the inter-creditor documentation.
Undrawn Commitments and Draw-stops
Where a borrower is in difficulty, the lender should consider whether its loan agreement includes any undrawn commitments and whether the lender would prefer to stop the borrower drawing them. If so, the loan agreement will generally include a contractual draw-stop, triggered by specified circumstances (eg the inaccuracy of repeating representations or the occurrence of a “Default”). A lender which does not intend to allow a borrower to increase its liability under the loan agreement should carefully (i) review its terms to establish a contractual basis for exercising a draw-stop, and (ii) consider the knock-on effect a draw-stop will produce for the borrower’s business. To the extent a draw-stop could result in an event of default, the lender should actively engage with its borrower to assess how best to manage the situation.
Missed / Reduced Repayments
The most immediately concerning breach for a lender will be where a scheduled payment or repayment is either missed or not made in full. A lender will need to consider whether to formally waive the default (reserving all other rights and addressing how the missed payment will be made up), to exercise forbearance, amend documentation to vary repayment obligations or to call an “Event of Default”. Calling an Event of Default should be carefully considered as it may trigger cross-default provisions in other agreements in addition to having capital maintenance implications for the lender. As mentioned elsewhere in this note, open and regular communication between lenders and borrowers will be essential. Lenders should encourage borrowers to prepare revised financial projections and to produce detailed workings establishing the measures the borrower is implementing in its business to ensure that any missed payment is an isolated incident. To the extent this information and analysis is not forthcoming, or to the extent that the information or analysis suggests that the business will continue to underperform for the foreseeable future, the lender should actively explore all options available to it with its borrower and its advisers, including restructuring options, equity or subordinated debt contributions, debt rescheduling and potentially even enforcement.
Enforcement / Acceleration
Sometimes a lender finds itself without any viable option other than to enforce its contractual rights. If taking this step, a lender will need to engage with its legal advisors to ensure it has a clear contractual basis for enforcement, it complies with all notice and other formalities, and it has a clear plan on how to efficiently and effectively enforce against any secured assets and guarantors.
Communication / Information
Finally, in times of uncertainty, communication is key. Ideally, a borrower will pro-actively engage with its lender to ensure that its financing arrangements continue to operate as smoothly as possible. However, the focus of many borrowers will inevitably be on immediate day-to-day challenges in their business. Loan agreements typically provide lenders with a broad range of information rights (breach of which could constitute an event of default), which a lender might usefully highlight to a borrower whose attention it is otherwise struggling to get. While borrowers may struggle to accurately project their business’ financial performance in the short term, lenders and borrowers should openly and actively engage with each other. Borrowers will need to be open with their lenders and lenders need to be prepared to offer creative solutions to take account of COVID-19 disruptions that pose material but possibly only short term issues of financial instability.
This document has been prepared by McCann FitzGerald LLP for general guidance only and should not be regarded as a substitute for professional advice. Such advice should always be taken before acting on any of the matters discussed.