COVID-19: What should mid-market borrowers consider to withstand the crisis
The outbreak of coronavirus is causing serious disruption to businesses globally. While most resulting circumstances are out with our control, there are some important issues for borrowers with mid-market lending arrangements to consider that can help protect their position in these times of uncertainty.
Directors will need to consider their duties to promote, in good faith, the best interests of the company and its shareholders. What does this look like in the current uncertain climate, and how can ‘best interests’ be achieved?
Lending Documentation Review
Review the terms of relevant credit agreements, security and guarantee documents:
- What issues arise? What needs to be done? What cannot be done?
- Which members of the group are involved? What are the cross-default provisions?
- What are the lender’s rights and obligations? When can these be enforced and can the lender actually do its bit?
Security and Guarantee Documents
Consider the relevant documents:
- Are any relevant guarantees performance or demand and, if so, on what terms?
- Which assets are secured? Are any needing released/sold to provide for liquidity?
Particular loan agreement issues should be looked at independently but initial considerations will include:
- Repayment - consider debt servicing and repayment obligations – are the relevant payments systems still operational and does the business have the staff to ensure compliance? Will current and anticipated cash-flow/income allow for all relevant payments to be made in full? Consider relevant provisions of attendant interest-rate hedging documents – do any adverse issues arise?
- Event of Default – consider if any relevant events of default could be triggered as a result of the COVID-19 outbreak, allowing a lender to refuse to permit further utilisations of a revolving or working capital facility and, in extreme situations, accelerate the repayment of debt and take enforcement action. What are the obligations to notify a lender of any actual or potential breach?
- Financial Covenants - these monitor the ability of a borrower to service its loan. Will COVID-19 reduce revenue to an extent that the ability to comply is restricted (possibly leading to a block on distributions or, more seriously, an event of default). Are there any equity cure mechanics whereby, if a financial covenant is in danger of being breached, further equity can be used to prepay a portion of the loan in order to cure the breach?
- Financial reporting – can audited annual and unaudited quarterly information be provided as required?
- Material Adverse Effect – this is a factual and subjective assessment by a lender to establish whether any anticipated financial difficulties of the borrower would trigger a material adverse change in the business’ financial condition, thus possibly leading to an event of default.
- Further drawdown/Permitted Borrowings – does the business require to drawdown additional or supplemental capital in terms of existing arrangements or from third party sources? What provisions exist that allow or prohibit such drawing by any lender (senior, junior or mezzanine)?
- Lender consent - can the business make any use of proposed Government packages or assistance and, if so, is any consent needed from any lender and on what terms?
- Representations - certain representations could be triggered as a result of the COVID-19 outbreak:
- Disputes – borrowers may be subject to litigation proceedings as a result of a failure to perform under an agreement e.g. force majeure or frustration claims.
- Cross default - in project or development credit arrangements, what impact may there be on borrowing arrangements by any breach of any underlying material contract, and vice versa?
- Insurance – consideration of whether insurance may cover losses incurred in relation to COVID-19 – business interruption, loss of rent or losses related to travel restrictions etc.
Actual or Potential Issues
If the business (or any relevant group company) is in danger of defaulting in any of its obligations to the lender (actual breach or potential breach), consider whether to: (i) seek an extension or waiver in respect of any such breach; (ii) fundamentally restructure the finance documents entirely (especially around financial covenants); (iii) obtain additional or alternative financing; or (iv) a combination of all three options (depending on whether COVID-19 is likely to result in minor, short term or major long-term loan agreement compliance difficulties).
The costs and benefits of all options need to be considered and, while a short-term extension or waiver might be all that is required, undertaking a more substantive restructure (or alternative financing option entirely), while a more complex (and longer) proposition, it may be the best option for some borrowers depending on the nature and severity of COVID-19 on their business.
In these uncertain times it pays to have as much clarity as possible over your lending arrangements and so checking the points above and being fully informed of your position can provide reassurance and allow you to take any necessary steps to protect your business.
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