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Your banking and debt finance arrangements and Covid-19: key points for borrowers
Following the outbreak of the coronavirus disease (Covid-19) pandemic, many businesses are looking closely at their banking and debt finance arrangements.
As such, we set out below some key points for borrowers to think about in these difficult times:
- Review cashflow
- Preserve cash
- Review funding requirements
- Review existing facility agreements
- Review logistical arrangements
- Contact the lender
- Drawdown under existing facilities
- Force majeure, frustration and illegality
- Keep up to date
Due to deteriorating cashflows, some borrowers may need to approach their lenders to defer scheduled payments under the financing agreement or perhaps seek a broader rescheduling of debts. Borrowers should check that the necessary funds will be available for making interest and fee payments, and scheduled repayments of principal, over the next few months and that there is no risk of a payment default. Speak to your finance providers – often, they will be far more sympathetic if it is involved from the start. Any quid pro quo for such concessions however, for instance personal guarantees (see here), should be considered carefully.
Businesses can also consider taking out new finance. The UK government has announced the creation of several schemes, including:
- the Coronavirus Business Interruption Loan Scheme (CBILS): under this scheme, the UK government will lend up to £5 million in the form of term loans, overdrafts, invoice finance and asset finance to viable businesses that would otherwise be turned down. Further details can be found in our recent article here;
- the Coronavirus Large Business Interruption Loan Scheme (CLBILS): under this scheme the UK government will guarantee 80% of loans of up to £25 million to firms with an annual turnover of between £45 million and £500 million. Loans backed by a guarantee under CLBILS will be offered at commercial rates of interest; and
- the £1.25 billion UK government support package for innovative firms announced by HM Treasury on 20 April 2020. This package includes a £500 million investment “Future Fund” for high-growth companies (impacted by the crisis, made up of funding from the government and the private sector. The Future Fund has been designed to ensure high-growth companies across the UK receive the investment they need to continue during the crisis. Delivered in partnership with the British Business Bank and launching in May, the fund will provide UK-based companies with between £125,000 and £5 million from the government, with private investors at least matching the government commitment. These loans will automatically convert into equity on the company’s next qualifying funding round, or at the end of the loan if they are not repaid. To be eligible, a business must be an unlisted UK registered company that has previously raised at least £250,000 in equity investment from third party investors in the last five years.
Borrowers will need to consider all options to manage their cashflow. A borrower may be able to generate cash, for example, by:
(a) reducing or delaying expenditure
(b) minimising prepayments: a borrower could also save cash by not making any planned voluntary prepayments
(c) a sale of assets: any disposal of assets during the term of a loan will typically be subject to restrictions which the borrower will need to check carefully
(d) debt buy-backs: since the crisis has resulted in lower debt trading prices, a loan agreement could permit a borrower to cancel debt at less than par and thereby reduce interest costs.
If borrowers have on-going funding requirements and have committed facilities that are not fully drawn they will need to check whether all conditions precedent to utilisation can be met. If further additional amounts are required, they may need to seek new funding. This might include shareholder loans or funding under one of the government initiatives (see above). One important caveat is that borrowers will need to ensure that any new financing does not breach existing arrangements.
Borrowers should review their existing facility agreements to ensure they can continue to comply with their ongoing obligations and that an event of default will not arise, in particular:
(a) Covenants: Breaches of covenants usually allow lenders to declare a default under loan documents and demand early repayment of loans and/or act as a draw-stop, so that borrowers will not have access to their facilities. As a result, if you are facing a potential breach as a result of Covid-19, you must consider further steps on a timely basis to determine whether you can or should draw on existing available debt commitments or whether it would be prudent to proactively seek waivers in advance.
Key points to consider include:
- A drop in a borrower’s earnings due to Covid-19 will have an adverse impact on its cash flows and may drive companies to become more reliant on their revolving facilities for future liquidity needs. This increased usage by borrowers of their revolving facilities could trigger related maintenance test thresholds in loan financing documents.
- Borrowers will need to assess the impact of Covid-19 on their ability to comply with their financial covenants. Since many credit facilities, when testing financial covenants for compliance purposes, measure EBITDA over the last four fiscal quarter periods, the severe repercussions caused by Covid-19 could last well into 2021.
(b) Information undertakings: Borrowers should review their reporting and notification obligations to lenders and any deadlines by which they are obliged to deliver any such information and notices. Even where a grace period applies, a notice may still be required. Information undertakings usually include:
- financial information and auditors’ reports
- compliance certificates
- changes in credit rating, and
- matters relating to litigation and material contracts and/or developments expected to have a material adverse effect.
Information requirements may also include a catch-all for information requested by the lenders.
(c) Representations and warranties: Borrowers should review customary representations and warranties in their loan documents in the context of Covid-19, including the following:
- Material Adverse Effect: If not an event of default (see below), it is common for credit agreements to contain a representation and warranty that there have been no (or are not expected to be) circumstances having a material adverse effect on assets, business or financial condition of the group since a specified prior date (often the most recent financial statements). Borrowers are generally required to certify to their lenders that the representations and warranties in the loan documents are true and correct as one of the conditions to borrowing. The precise wording would need to be checked carefully.
- No default: This representation usually relates to defaults under the loan documents as well as defaults or termination events under other material agreements. This representation could be relevant where a company’s performance under third party contracts (including supply and commercial contracts) is materially adversely affected by the Covid-19 outbreak.
- Disputes: The representations relating to disputes may need to be reviewed. In particular, where businesses are subject to litigation as a result of the failure to perform under material contracts (for instance, litigation relating to assertion that Covid-19 constitutes a force majeure event under the relevant contract), these representations must be carefully analysed.
(d) Events of Default: In more normal times, if you fail to pay under a loan agreement you may expect to receive an enforcement/acceleration notice from the lender. These are, however, far from normal times. The UK’s court system has not shut down, but it has been scaled back with more reliance on video call technology. It will be a lot harder for creditors to bring/enforce proceedings during the crisis. It is also being reported that the Government is considering a moratorium on the issuing of petitions to assist struggling businesses in the face of the impact of Coronavirus. Those contemplating issuing a petition should do so promptly to avoid the risk of a moratorium being introduced. However, borrowers should consider the following customary events of default may be relevant in the context of the Covid-19 outbreak (however, the extent to which the impact of Covid-19 might give rise to an event of default will depends on the description of such events in the relevant loan documentation and any applicable grace periods):
- Payment Defaults and Cross-Defaults: A borrower’s failure to pay principal, interest and fees when due will generally trigger an immediate event of default (with respect to failures to pay principal) or have very short cure periods. Further, loan documents typically contain a cross-default in respect of events of default and/or failures to make payments under other indebtedness above a certain threshold.
- Material Adverse Effect: Although it is not market practice for widely syndicated loan facilities to contain a stand-alone “Material Adverse Effect” (or MAE) event of default, there still are many loan documents that contain such a provision. These should be carefully analysed to see if the relevant event does fall within the definition of Material Adverse Effect. In addition, even though there is no MAE event of default, the definition is sometimes included to qualify undertakings and representations under the loan agreement. That will mean that specified events (such as breach of laws, authorisations, taxation) must both be breached under the loan agreement and potentially cause an MAE. In most instances, the evidential burden on lenders to try and prove such an MAE, being focused on just the business and payment condition, will be challenging. It is more likely that where an MAE is occurring and the business is actually impacted, the issue will be so fundamental that another more obvious event of default will occur, such as non-payment or insolvency.
- Audit: Under certain loan facilities, if the auditors qualify their report with a “going concern” qualification it could constitute a covenant violation of the financial statement delivery covenant that may constitute an event of default. Typically, a “going concern” qualification would result from an auditor’s view that the company will not be able to satisfy all of its short-term (i.e. one year or less) obligations, including the potential acceleration of indebtedness and maturities of indebtedness without a likelihood of refinancing.
- Insolvency: Borrowers should also carefully review the applicable provisions for the “insolvency event of default” as there may be circumstances other than an actual insolvency proceeding that could cause there to be an event of default. For instance, certain credit facilities provide that if the borrower admits in writing its inability to pay its debts, such event would constitute an event of default. Another example is that in certain credit facilities “insolvency proceedings” may include negotiations with creditors.
Office closures and remote working may mean that relevant parties are unable to access information (for example, external auditors or accountants) so that the borrower might be less able to comply with information undertakings. Similarly, employee absence may delay the delivery of documents (for example, new utilisation or waiver requests). Appropriate contingency measures will need to be put in place.
Borrowers should make arrangements for key business decisions requiring board and/or shareholder consent to be made virtually. In the case of board meetings, most companies’ articles of association allow for virtual meetings and most boards will be familiar with the process of holding meetings by telephone or videoconference, but it is especially important in the current environment (where directors may be using new technology for the first time or stranded in different time zones) that the process set out in the articles for virtual meetings is followed.
Borrowers should make early contact with lenders, especially where waivers or amendments may be required. Borrowers should be proactive and keep open lines of communication at all times.
(a) Revolving facilities: Borrowers may be able to draw under existing revolving facilities in order to (i) have sufficient funds to meet payment obligations and/or (ii) borrow now when it is able to satisfy all relevant conditions to the drawdown rather than at a later date when there might be a potential or actual event of default that could act as a drawstop.
(b) Term facilities: If a borrower has committed to a transaction (for example, the acquisition of a property or a company) but there is a gap between exchange and completion, it will need to check that it is still able to fulfil the conditions precedent to drawdown of facilities required to complete that transaction. Other finance arrangements may provide that drawdowns under term facilities will occur throughout the life of the arrangement (for example, finance for developing a property). The borrower should check whether it will still be able to fulfil the conditions precedent to each further drawdown or whether it needs to approach the lender to seek to renegotiate these conditions precedent.
It is not common for facility agreements to contain force majeure clauses but they are sometimes a feature in some derivatives documents. However, force majeure clauses may be used in the documents relating to the transaction being financed (for example, in project finance or real estate development finance transactions). The specific details of any clause must be checked to see if the Covid-19 pandemic would trigger it.
Frustration and illegality may also be relevant in relation to the underlying transaction documents, although currently it would seem unlikely that a borrower could rely on these concepts in relation to its own obligations under a facility agreement.
This is a fast-moving situation and the government is introducing new measures at a blistering pace. Keep abreast of developments by regularly reading specialist news articles by business, accounting and legal experts. Fox Williams will be dispensing regular articles on all the latest Covid-19 developments here.
If you have any questions about these issues in relation to your own organisation, please contact a member of the team or speak with your usual Fox Williams contact.
Jonathan Segal, Partner
Articles and commentary by our legal experts on the impact of Covid-19 are all available here.