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James McNeil | 26th March 2020

Effect of COVID-19 on lenders and borrowers


James McNeil | 26th March 2020

Effect of COVID-19 on lenders and borrowers

Lenders and borrowers issues and solutions around COVID-19

Despite the Government’s emergency budgets, the provision of other assistance to businesses and the Bank of England cutting interest rates to 0.1%, a number of business sectors (retail, aviation, travel, hospitality and tourism) have seen massively reduced cash flows due to the impact of the COVID-19 pandemic. There is no doubt that both lenders and borrowers should review the loans that they have in place as no business will have budgeted for such reduced cash flows or market disruption.

What should each party be looking at and what solutions are available?

  • Working capital/RCF facilities– revolving credit facility will often state that in the event of an event of default or a potential event of default a borrower is prevented from borrowing further advances. However, a lender should always think very carefully about invoking such a right as this will undoubtedly create a serious impact on the cash flow of the borrower! This may therefore actually mean that the borrower is less able to repay its outstanding debt.
  • Financial covenants – Financial covenants act as an early warning system by highlighting when a borrower is likely to be unable to meet its payment obligations. Although this is always the case, a borrower should now more than ever consider an early approach to its lender to seek amendments or waivers to these clauses.
  • Repayment – COVID-19 may well impact a businesses’ financial performance and therefore its ability to meet its repayment obligations under a loan agreement. Again, a borrower should always be aware of when it is due to make a repayment and if it has concerns, it should enter into early negotiations with its lender to defer scheduled payments, reduce the repayment amount or, in more extreme circumstances, look to restructure its entire debt.
  • Cessation of business – Most loan agreements contain an event of default which will be triggered if all or a material part of the borrower’s business is suspended or ceases to operate. In these circumstances, there is little that a borrower can do as it will probably be insolvent. Directors should at this point be taking specialist insolvency advice so as not to fall foul of their duties to creditors etc..
  • Negotiations with creditors in relation to actual or anticipated financial difficulty – Lenders and borrowers should consider the impact of entering into negotiations in relation to actual or anticipated financial difficulty of the borrower. This is because the events of default which relate to insolvency will often be triggered by a borrower starting informal negotiations with creditors due to its potential financial difficulties. This can cover the rescheduling of any indebtedness with any single creditor, including a company’s landlords and trade creditors, regardless of the value of those liabilities. The exact drafting of these clauses will need to be carefully examined.
  • Repeating representations – Borrowers will often be required by finance documents to make a number of representations to the lender. These representations allow a lender to check the on-going health of the business and are often repeated on the dates that a borrower has to pay interest. Lenders and borrowers should consider how the COVID-19 pandemic could affect such representations and whether the borrower can still make these representations.
  • Material adverse change (“MAC”) clauses – A MAC clause will normally give a lender the right to accelerate its loan facilities when a borrower’s position has substantially worsened. For this reason, these clauses tend to be strenuously negotiated. These clauses reference events where there has been a material adverse change to the business, operations, property, condition or prospects of the borrower or their ability to perform their obligations under finance documents or the effectiveness of guarantees or security. Analysis of the specific drafting of such clauses should be carried out before any party seeks to act on MAC provisions. Unless there has been a clear and “objective breach”, lenders tend not to rely solely on MAC provisions as they are difficult to prove and are subject to the normal rules surrounding contractual interpretation. In order to rely on a MAC provision, a lender would have to prove the effects of COVID-19 will have or have had a sustained adverse effect on the borrower’s business, that the current effects on a business are not temporary and that these effects will continue for a lengthy period of time. One way to deal with this would be explicitly exclude COVID-19 from the definition of MAC.
  • Market disruption provisions – Market disruption provisions will be be triggered when a lender’s cost of funding exceeds the interbank lending rate benchmark. With the LIBOR rate staging its biggest one-day drop in more than a decade, it is possible that these rates will start to be superseded by lenders’ cost of funding in the market. If such provisions are enforced, the interest on a loan will typically be calculated on the lender’s cost of funding (or average cost of funding across a group of lenders) plus a margin. However, due to the fact calculating cost of funds interest rates can be time-consuming and enforcing such rates may disturb the cash flow and financial covenants of a borrower, market disruption clauses have tended not to be used. A more practical solution would be to extend interest periods, thereby giving borrowers more time to make interest payments. This is obviously a short term solution.
  • Reputational risk – There is also an overriding issue which must be considered by both lender and borrower and that is the potential reputational impact on such a lender if it seeks to demand repayment of its loan due to the impact of the COVID-19 pandemic. This will need to be carefully examined especially due to current and anticipated political and financial support being provided by the government and the Bank of England.

If you would like to discuss any of the issues raised in this blog please contact James McNeil.

Our page entitled “Coronavirus – Legal advice and guidance” is continually being updated with tips and guidance as and when updates are received from the government and other regulatory bodies.

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