With COVID-19 having a significant economic impact on businesses, we consider the key issues for corporate borrowers under their loan facilities.
We focus on agreements governed by English law, and on loan facilities. However, the issues discussed will often have wider application, extending to other types of financing such as bonds and structured financial products.
We also consider the availability of loan schemes announced by the Government as part of its package of measures to support businesses during the pandemic.
Can a borrower assert 'force majeure' to claim relief from its obligations under loan agreements?
This is unlikely. A contract governed by English law would have to include a specific contractual right to invoke force majeure, because the concept has no legal meaning outside that which is drafted in the contract. Loan agreements and similar finance documents do not typically include a force majeure clause. This is in contrast to some other types of commercial agreement (such as an acquisition agreement) which may include a force majeure clause, but in these cases, the clause would have to be read carefully to make sure that the current pandemic falls with its terms.
In the absence of an express force majeure clause, the English common law doctrine of frustration may apply, but it is difficult to invoke. Generally speaking, the doctrine covers situations where the performance of contractual obligations has become impossible, or the contract could only be performed in a significantly different manner to that envisaged when it was entered into. The fact that a borrower is struggling to service and repay its loans under current trading conditions is probably insufficient to establish a claim of frustration.
It follows from the above that general law is unlikely to assist a borrower which is struggling to meet its obligations under a loan agreement (assuming that it does not invoke formal insolvency procedures). It is therefore critical to consider the loan agreement itself to determine the potential impact of COVID-19. One caveat to this – in a rapidly developing situation, we cannot rule out the possibility of further government intervention affecting lenders'/borrowers' rights under existing facilities, even if such a radical intervention preventing lenders accelerating loans may be unlikely. We will continue to monitor the situation.
What impact will the COVID-19 outbreak have on the loan agreement?
The pandemic in itself is highly unlikely to constitute a breach by the borrower of its obligations under the loan agreement. However, there are a number of areas where the knock-on impact on the borrower may lead to a breach of the terms of the loan agreement. The main areas are noted below, but this is not an exhaustive list – loan agreements are individually drafted and they have to be considered on a case by case basis to see where potential breaches may arise.
- Payment default: A failure to make a payment on its due date will in most cases be an event of default. Loan agreements often include a payment grace period of a few days to cover technical issues with payment systems, but this will not help a borrower that has missed a payment solely because of a cashflow issue. Borrowers should plan ahead and be aware of any scheduled payment dates and if necessary negotiate with lenders to defer scheduled payments. Capitalisation of outstanding interest may be another possibility to discuss with lenders.
- Financial covenants: A borrower in financial difficulties may breach these provisions. Particularly relevant may be financial covenants tested on a look-forward basis, including interest cover, debt service cover and cashflow. The calculation period may also be important – a long calculation period may help to smooth out short term difficulties for a borrower otherwise in good health.
If a breach of financial covenants is likely to occur, the agreement should be checked to see if any cure rights are included. For example, there may be an 'equity cure' provision where a sponsor/shareholder of the borrower can inject additional capital (by way of equity or subordinated debt) so the financial covenant is deemed not to have been breached.
- Material adverse change: Many loan agreements include an event of default where the lender believes that there has been a 'material adverse change' (MAC) in circumstances, or that a change in circumstances has caused, or is reasonably likely to cause, a 'material adverse effect' (MAE). The concept may also be framed as a repeating representation.
Any such provisions will have to be considered carefully on a case by case basis. However, they often refer to events or circumstances that, in the lender's opinion, could affect the 'business, operations, property, condition or prospects of the borrower' or 'the ability of the borrower to perform its obligations.' Accordingly, the pandemic by itself should not cause a MAC/MAE breach, but the impact of the pandemic on the borrower and its operations could be a MAC/MAE. The drafting of the provision will be important. For example, reference to a MAC/MAE occurring in 'the lender's sole opinion' (or words to that effect) will make it easier for the lender to invoke the provision than if it had referred to 'the lender's reasonable opinion', where there is more room for the parties to argue whether or not a MAC/MAE has occurred.
Historically, lenders have been reluctant to call an event of default based solely on a MAC/MAE provision. A lender may also be wary of incurring reputational damage if it is perceived as too hasty or too harsh in invoking MAC/MAE, particularly during a global pandemic. Moreover, these provisions have been construed fairly narrowly by the courts. Nevertheless, there were a few cases where lenders invoked MAC/MAE provisions following the global financial crisis. Under the current crisis, it is possible that a lender may feel justified invoking MAC/MAE in the light of borrower difficulties caused by the pandemic. However, a lender would need to demonstrate that the pandemic will have a material adverse effect on the borrower's business for a sustained period of time. In such instances the lender will have to look at whether the borrower has sufficient capital reserves to manage the impact of the pandemic.
- Negotiation with creditors: Amongst other insolvency related events, there is often an event of default if a borrower commences negotiations with creditors (other than the lender under the loan agreement at hand) with a view to rescheduling indebtedness. This may catch borrowers seeking rent reductions or payment holidays with landlords, or seeking to negotiate debt rescheduling with other lenders or trade creditors. A borrower should check the existence and scope of any such provisions before approaching its creditors for any debt rescheduling.
- Cessation of business: Another common event of default is when a borrower suspends or ceases to carry on (or threatens to suspend or carry on) all or a material part of its business. As COVID-19 is causing some businesses to suspend part of their operations or close offices (due to self-isolation of employees) it is possible that this event of default may be triggered.
- Expropriation: An expropriation provision may be widely drafted to include business curtailment resulting from any restriction or other action by a governmental, regulatory or other authority. Arguably, restrictions imposed in the light of COVID-19 could cause a breach of an expropriation provision.
- Information: Undertakings by the borrower to provide information to the lender should be checked. In addition to the provision of ongoing information relating to the borrower's financial condition, there may be obligations to keep the lender informed of other matters, such as potential breaches under its material contracts and any 'key persons' within management ceasing to perform their duties due to ill health. If a borrower does not comply with its information undertakings, it is likely to trigger an event of default under the loan agreement.
- Property development covenants: if a loan facility is for property development, there will be a number of development specific provisions that could be breached, including failure to meet certain milestone deadlines, failure to fund cost overruns and abandonment of the development project. The latter could catch a temporary abandonment. Whether a project has been abandoned may be arguable. However, a lender may seek to assert that a cessation of work on the site (due to workers self-isolating at home) falls within the concept of abandonment.
Another area of potential difficulty may be provisions relating to valuation or re-valuation of property. It may be practically difficult in the current circumstances to have a professional valuer visit a site within the timeframe envisaged by the loan agreement.
Some other considerations
- Group members: The discussion above has focussed on the 'borrower'. However, provisions in loan agreements may be more widely drafted to catch circumstances affecting other members of the borrower's group, or even third party security providers. The provisions will have to be considered carefully to determine which entities are relevant to potential breaches.
- Other documents: The discussion above has also focussed on the 'loan agreement'. However, relevant provisions may appear in security or other related finance documents. The entire suite of documents should be considered.
- Cross-default: Many loan agreements include a cross-default provision. Therefore a breach of another loan entered into by the borrower (or even, depending on the way the cross-default is drafted, a breach of some other commercial agreement) may cause a breach of the loan agreement with the cross default provision, even if the borrower has not directly breached any other provisions within that loan agreement. A borrower with multiple facilities with different borrowers may see a 'domino effect' where the breach of one facility cross-defaults the others.
- Roll-overs: Revolving credit facilities (RCFs) often have a 'drawstop' of the borrowing of new monies if an event of default has occurred, or a 'potential event of default' has occurred. However, a 'rollover' of a loan that has already been borrowed may be allowed unless an actual event of default is continuing. It depends upon how the utilisation mechanics are drafted - RCFs should be considered on a case by case basis. A lender may also be wary of incurring reputational damage if it exercises a drawstop as it could have a material effect on the cashflow of the borrower and consequently the borrower's ability to repay the RCF in full.
- Market disruption clauses: A market disruption clause in a loan agreement allows the lender, in certain circumstances, to calculate interest on a different basis to that on which it is normally calculated. These may be triggered when a lender's cost of funding exceeds the interbank lending rate benchmark and would allow the lender to increase the interest rate charged to the borrower to reflect the actual costs of funds to the lender. These have rarely been used by lenders to date in response to loan market instability but if, as a result of the pandemic, lenders consider it necessary to increase the interest rate charged to the borrowers, then borrowers need to consider (i) the impact this will have on their cashflow and their ability to service increased interest payments, (ii) the impact this will have on their financial covenants and whether these will be adversely affected by the increased interest rates, and (iii) any impact this has on any existing interest rate hedging.
- Margin ratchets: Margin ratchets may be triggered in the event that financial performance worsens due to the current economic difficulties or on an event or potential event of default. As above, borrowers will need to consider what impact this will have on their cashflow and their ability to service increased interest payments.
- On-demand facilities: If a loan is repayable 'on-demand' by a lender, then the lender will usually have complete discretion whether or not to call in the loan. However, the lender may be wary of incurring reputational damage if it is perceived as too hasty or too harsh calling in loans during a pandemic. Although, ultimately, a borrower will not be able to stop a lender calling in an 'on-demand' loan, an open dialogue between borrower and lender may help to reduce the risk.
- Commercial tenants: The Government has announced, as part of its package of measures to protect businesses during the pandemic, that commercial tenants who are unable to pay their rent because of COVID-19 will be protected from eviction. However, a borrower which is a commercial tenant may have provisions in its loan agreement whereby non-payment of rent is a breach. Also, a borrower which is a landlord may be subject to an undertaking in its loan agreement to diligently collect rent from its tenants. The Government measure may prevent eviction, but it appears unlikely on current information that it would by itself prevent breaches of any rent related provisions in loan agreements. Much may turn on the drafting of these provisions. We continue to monitor this situation.
Of course, many lenders will be keen to assist their borrowers in the current economic difficulties, rather than seeking to find defaults. Nevertheless, borrowers are well advised to look at their finance arrangements carefully and start discussions with lenders sooner rather than later to avoid, waive or cure potential breaches. Many lenders are contacting their borrowers with this in mind, but in other cases the borrower will have to make the initial approach.
Options to discuss with a lender may include waivers of breaches, agreeing repayment holidays, interest capitalisation, 'standstills' on lenders' enforcement rights and whether new lines of credit can be included to help with cashflow difficulties.
In circumstances where a borrower is currently in the process of negotiating new loan documentation, the impact of COVID-19 should be considered – it would be preferable to amend the draft provisions before completion to deal with any potential COVID-19 impact, rather than having to seek waivers post completion.
Borrowers may need to assess their ability to draw new loans under existing facilities (as a potential event of default may cause a drawstop) or to refinance existing loans. If a borrower approaches a new lender for an additional loan (even under a government backed loan scheme), this may cause difficulties under its existing finance arrangements. For example, there may be restrictions on incurring 'other indebtedness', or a 'negative pledge' restricting the grant of security to other parties. Accordingly, it may be advisable for a borrower to first approach its existing lender for any additional loan.
Government backed loan schemes
The government has produced a package of measures to support businesses affected by the disruption caused by COVID-19. Full details can be found via the government webpage available here. We briefly summarise below the key features of the two debt finance schemes within this package.
The Coronavirus Business Interruption Loan Scheme (CBILS) for SMEs
- CBILS provides facilities of up to £5m for smaller businesses. To be eligible, (i) the business must be UK-based in its business activity, with annual turnover of no more than £45m, and (ii) it must have a borrowing proposal which, were it not for the current pandemic, would be considered viable by the lender, and for which the lender believes the provision of finance will enable the business to trade out of any short-to-medium term difficulty.
- The following trades and organisations are not eligible to apply: Banks, Building Societies, Insurers and Reinsurers (but not insurance brokers); the public sector including state funded primary and secondary schools; employer, professional, religious or political membership organisations or trade unions.
- CBILS is being delivered through commercial lenders, backed by the British Business Bank. There are currently 40 accredited lenders. Accredited lenders are listed on the website of the British Business Bank, available here. The website encourages a potential borrower to approach its existing lender before approaching any new lender. CBILS decision making is fully delegated to the accredited lenders.
- CBILS supports a range of business finance facilities from accredited lenders, including term loans, overdrafts, asset finance and invoice finance. However, not every lender can provide every type of finance. Finance terms are up to six years for term loans and asset finance facilities. For overdrafts and invoice finance facilities, terms will be up to three years.
- CIBLS provides the lender with a government-backed, partial guarantee (80%) against the outstanding facility balance, subject to an overall cap per lender. It is important to note that the guarantee is in favour of the lender. The borrower remains liable for the debt.
- There is no fee for a borrower to access CBILS. Also, the Government will make a Business Interruption Payment to cover the first 12 months of interest payments and any lender-levied fees. However, fishery, aquaculture and agriculture businesses may not qualify for the full interest and fee payment.
- At the discretion of the lender, the scheme may be used for unsecured lending for facilities of £250,000 and under. For facilities above £250,000, the lender must establish a lack or absence of security prior to businesses using CBILS.
- If an accredited lender can offer finance on normal commercial terms without the need to make use of CBILS, it will do so.
Full details are available on the website of the British Business Bank, available here.
The COVID-19 Corporate Financing Facility (CCFF) for larger companies
- CCFF is also known as the joint HM Treasury and Bank of England Lending Facility. Under the CCFF, the Bank of England (BoE) will buy short term debt in the form of commercial paper of up to one year maturity from larger companies. It will do so in the primary market via dealers and from eligible counterparties in the secondary market.
- The BoE will purchase the commercial paper from eligible issuers, where the paper meets the following requirements: (i) it is sterling-denominated, (ii) it has a maturity of between one week and 12 months, (iii) where available, it has a credit rating of A-3/P-3/F-3 from at least one of the credit rating agencies as at 1 March 2020, and (iv) it is issued directly into Euroclear and/or Clearstream.
- BoE guidance states that commercial paper with any non-standard features, such as extendibility or subordination, will not be accepted under the CCFF. Also, commercial paper issued by banks, building societies, insurance companies and other financial sector entities regulated by the BoE or the Financial Conduct Authority will not be eligible. In addition, commercial paper will not be eligible if issued by leveraged investment vehicles or from companies within groups which are predominantly active in businesses subject to financial sector regulation.
- It is also a requirement of the CCFF that a potential issuer makes a material contribution to economic activity in the United Kingdom. BoE guidance states that, in practice, firms that meet this requirement would normally be: UK incorporated companies, including those with foreign-incorporated parents and with a genuine business in the UK; companies with significant employment in the UK; and firms with their headquarters in the UK. Another consideration is whether the company generates significant revenues in the UK, serves a large number of customers in the UK or has a number of operating sites in the UK.
- A potential issuer should approach its existing bank to access the CCFF. If that bank does not issue commercial paper, UK Finance (a trade association for the UK banking and financial services sector) has provided a list of banks that are able to assist, available here.
- If a potential issuer does not already have a credit rating, then it may still be able to access the Facility. Bank of England Guidance states that one solution is for the issuer or its bank to contact one of the major credit rating agencies to seek an assessment of credit quality in a form that can be shared with BoE and HM Treasury, noting that the assessment relates to participation in the CCFF. BoE has held discussions with the rating agencies in relation to the form of credit assessments that would be suitable evidence of credit status for the CCFF.
Full details of the CCFF can be found on the Bank of England's website, available here.
Should you have any queries relating to finance documents arising from COVID-19, please feel free to get in touch with Chris Lenton (Partner) or Matthew Weedon (Consultant) who are both based in our London office, Adrian Low (Partner) who is based in our Dubai office, or your regular Clyde & Co contacts.
Our Coronavirus Information Hub
For more information on how we can help with reviewing your insurance and on your responsibilities towards employees and the public, we suggest that you refer to our Coronavirus Information Hub.
In the meantime, please do not hesitate to contact us if your business is impacted (or is likely to be impacted) by COVID-19.