The COVID-19 pandemic has resulted in wide-scale disruption for businesses, and has created significant challenges on their ability to manage cash flow and to service their financing needs through the crisis and beyond.

The Government has rightly focussed on a rescue package of measures to ensure businesses survive the uncertain months ahead. We have examined in another Business Law Update some potential sources of debt financing for businesses, including the recently announced Government Coronavirus Business Interruption Loan schemes.

Whether or not further finance is required, any business should review its existing debt finance documents, with a view to managing its relationship with lenders and planning for any potential breaches or commercial pressure points as the crisis continues.

What if you want to borrow more under an existing debt facility?

Businesses looking to draw further funds under existing facilities will need to be mindful that, prior to draw-down, a borrower will usually be required to confirm that no ‘Default’ is continuing and that certain representations are correct in all material respects.

To the extent that a business is unable to make these confirmations, due to current conditions, this could prevent a further draw-down being made.

So, while further finance may technically be available under an existing facility, a business may not actually be able to access such monies and should look carefully at the requirements for accessing the funds before relying on an existing loan.

What should you review in your existing debt facility arrangements?

Businesses who do not require further financing at this time should still keep their existing facility documents under review as there may be triggers in those documents which need to be carefully managed over the uncertain period ahead.

Specific provisions that may need to be kept under review include:

• Financial covenants: financial covenants effectively act as an early warning sign for lenders and are tested periodically during the life of a loan (commonly at the end of a quarter). On each test date the financial covenants will help the lender assess the borrower’s financial position to ensure the borrower is able to make the scheduled repayments. Many financial covenants are based on EBITDA, net income or other measurements of earnings and so, as a borrower’s income generating ability is affected by the current crisis, breaches of these financial covenants become increasingly likely. This is important as a breach of a financial covenant could result in an ‘Event of Default’ which could in turn lead to the acceleration of the facility and the reclassification of the debt from a long term liability to a short term liability. So, to the extent that a borrower foresees a potential breach of a financial covenant, it is worth them being proactive and approaching their lender early to discuss the breach and obtain a waiver for any such breach.
• Repeating representations: certain representations in the facility document may also be periodically tested by way of a deemed repetition of those representations. Whether these representations are capable of being repeated hinges on the wording of those representations and, like a breach of a financial covenant, a misrepresentation could result in an ‘Event of Default’ and the acceleration of the facility.
• Events of Default:
  • Insolvency Events of Default: finance documents often include specific insolvency-related ‘Events of Default’ which trigger a repayment obligation if the borrower or any member of the borrower’s group experiences financial difficulties. The current crisis may feasibly result in these insolvency provisions being triggered for many businesses, for example as a result of cash flow issues where the borrower is unable to pay its debts as they fall due, the borrower commencing negotiations with its creditors, or the borrower suspending a part of its business.
  • Material Adverse Change: finance documents often have some form of a general ‘Event of Default’ to cover unforeseen events which materially and adversely affect the borrower and/or its group. This is a much-negotiated provision in any finance document and so whether the impact of the COVID-19 pandemic could be a material adverse change will depend on the wording of the clause and the impact that the crisis has had on the borrower specifically.   
  • Cross Default: finance documents also frequently contain an ‘Event of Default’ which is triggered if the borrower or any member of the borrower’s group defaults on any of its other borrowings. Lenders will include this provision to ensure that they do not get ‘left behind’ when other lenders may be entitled to demand repayment of their facilities from the borrower group. It is therefore important for borrowers to note where cross default provisions appear in their finance documents, and the terms on which such a provision would be triggered, to ensure that a default under one document does not cascade into defaults and repayment obligations under multiple documents. It is also important for borrowers to be aware of the terms of their facilities to ensure that they raise and address any issues with the appropriate lender before a default, which could trigger a cross default.
• Notification requirements: another key point to note in finance documents is that there is often a general undertaking for the borrower to promptly notify the lender of any ‘Default’ or ‘Event of Default’ under the facility. Over the next few months all borrowers will therefore need to continually assess their position to determine whether it is required to notify the lender of an issue.

This information is part of a series of Harbottle & Lewis Business Law Updates, focusing on legal and business operational issues arising in the current COVID-19 crisis. 

If you have any queries on their content, please contact businesslawupdate@harbottle.com.