Borrowers in financial difficulties
In the current Covid-19 pandemic, many borrowers are facing considerable financial challenges, not least of which are cash flow difficulties, leading to a potential or actual event of default and enforcement action under their loan and security documents.
Borrowers should consider the below factors:
Finance agreement terms – check what their financing documents actually say as there may well be some saving provisions or qualifications which could pull the borrower out of an otherwise default situation.
Grace periods – some financing documents contain grace periods, i.e. an amount of agreed time in which the borrower can either remedy the breach or put together a proposal designed to remedy the breach in respect of which the financier has rights of approval. The existence and duration of a grace period will depend on the nature of the breach alleged. For example, a fundamental breach such as failure to pay will hardly ever enjoy a grace period, albeit there would be some allowance for disruption in payment systems. However, if there is a breach of financial covenants, there may be an equity cure provision to allow a borrower to remedy the default via support from a parent company or elsewhere in the group (such as fresh equity, prepaying the debt to an extent to bring the financial covenants back in line, providing additional collateral, etc).
Cross default – if a breach has occurred, a borrower should consider the impact on other financing agreements given cross default provisions and how other creditors may be affected.
Default interest – financing agreements typically provide that events of default (or certain events of default) trigger an entitlement by the lender to charge default interest, namely interest at the standard contractual rate plus an additional default rate. A borrower needs to factor in this exposure if it knows that an event of default will occur. Where it anticipates that a 'technical' event of default will occur but hopes that the facility will continue, it may be possible to agree in advance with its lender that the default interest will be waived, or at least organise for the event of default itself to be waived sooner rather than later, so that the default interest period is as short as possible.
Intercreditor terms – as part of considering its wider suite of options, a lender will be reviewing any intercreditor terms to see if there are any restrictions around its options, priority of payment and enforcement rights. A borrower should do likewise, again to help see the breach through the eyes of the lender and any particular drivers it may have.
Notice – check if notice has been properly served in compliance with the financing agreements. If not, that notice is defective. In reality, notice defects can be easily corrected such that notice is served in compliance with the terms of the financing agreement. Therefore this should not be relied upon for anything else save to buy time, but that itself can be important in a default scenario.
Commercial and other practical concerns:
Involve professional advisers – it is a statement of the obvious but any borrower in potential distress should be speaking with its accountants (for example to assess cash flow forecasts; work out which debts can be deferred; which staff could be furloughed etc) and its lawyers (both from a banking and litigation perspective) to ensure that its prospects of successfully getting beyond the breach are maximised and to enable it to put its case as best it can before a lender.
A lender may agree to suspend and defer repayments of interest or principal to a later date. We understand that the Prudential Regulation Authority has written to lenders encouraging them to waive financial covenant breaches if they have arisen as a result of Covid-19 and we understand anecdotally that some lenders have granted12 month covenant waivers.
CBILS and CCFF – if the lender is accredited by the British Business Bank, it may agree to make available a loan backed by HM Government guarantee under the Coronavirus Business Interruption Loan Scheme or the Coronavirus Large Business Interruption Loan Scheme. Additionally, for an investment grade borrower, it may be able to issue commercial paper under the Covid Corporate Financing Facility.
Collaboration – in our experience, lenders, for a variety of sensible commercial reasons, rarely look to enforce "out of the blue". There tends to be quite a degree of pre-enforcement discussion. Our advice would always be to keep those discussions as collaborative and as reasonably open as possible so as to keep the option of a negotiated settlement on the table. Inevitably, as soon as the tone becomes contentious or litigious, that negotiated settlement becomes harder to achieve.
Information – keeping everyone apprised of developments is critical. As far as a lender is concerned, information is key so that it can record warning signs and monitor the situation. Moreover, failure to do so is more likely than not going to result in an antagonistic response, undermining other attempts to be collaborative.
Standstill – as part of a collaborative response to a breach, all parties should be encouraged in the strongest terms to sign up to a standstill agreement which would effectively put any potential enforcement action on hold up until such time as the picture is clearer and ideally a strategy has been agreed by key stakeholders. Generally speaking, if other creditors have rights which may be triggered because of a cross default provision, lenders will want to put in place a standstill arrangement to prevent others from taking action which could otherwise frustrate an overall recovery strategy.
Obtain independent financial advice – alongside the legal advice, independent financial advice is often very helpful. For example, if a borrower is facing solvency issues, having an insolvency practitioner produce options for administration whilst these are remedied will potentially give a lender comfort of its long term prospects, and encourage them to refrain from enforcing security.
Solutions – ultimately, enforcing loans is bad business (both from an economic and reputational point of view) as far as a lender is concerned. Therefore, a lender may have an open mind to any feasible solutions. Consider the options – does insurance have a role to play? Can new money be added into the structure via equity cure or other funds to see off the problem in question?
Restructuring – a restructuring in the widest sense could include:
- A pre-pack administration – a pre-pack is where a company is put into administration and then immediately sold pursuant to a sale which was arranged before the administrator was appointed.
- Company Voluntary Arrangements – the CVA procedure is intended to allow companies to avoid potentially terminal insolvency proceedings by coming to a binding agreement or compromise with its unsecured creditors. CVAs may also be used to help implement a compromise between the debtor company and its creditors while the company is being administered through a formal insolvency procedure such as administration. Typically, a proposal for a CVA will include a rescheduling or reducing of the company's debts, but this may also be part of more complicated arrangements that balance the interests of many different parties.
Capital restructuring – some form of capital restructuring or introduction of additional equity from its shareholders or new third parties.
Redemption – if matters have reached an irretrievable state such that maintaining a relationship with the lender is not feasible, redemption of the loan may be the only non-contentious route available. A borrower, probably with the help of a debt broker, would need to be tapping the refinancing market as soon as possible to see if another lender will replace the existing lender.
Litigation – litigation should never be entered into lightly, and is often particularly difficult for a borrower because the terms of finance agreements tend to provide lenders with extensive contractual protection. Nevertheless, there may be circumstances where a robust recourse to the courts is the best option. For example, there may be a dispute as to whether an event of default has actually occurred, or whether the lender has correctly exercised its contractual rights. Generally speaking if an event of default has occurred, a borrower is stuck with the consequences. However, lenders are not entitled to exercise their rights in bad faith or capriciously or arbitrarily. It may be possible to argue that even where an event of default has occurred, lenders should not (because of their behaviour) be entitled to exercise their contractual rights.
These are practical tips based on our extensive experience acting for borrowers. However, when an actual issue arises it is obviously important to obtain legal advice on the terms of the facility agreement in question - even market standard documents can contain variations which can have important consequences in a default scenario.