Covid-19: the impact on real estate borrowers


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In this article we reflect on the impact of Covid-19 on investment and development borrowers' loan arrangements.

Many real estate investors will have funded their investment using third party debt and as yet the Government has not announced any formal measures to prevent lenders taking action against the borrowers. In the short term, borrowers need to review their loan arrangements to see which potential events of default could affect their ability to continue drawing funds under revolving credit and development loans, or result in actual events of default that need to be waived.

Financial covenants

Loan agreements typically contain a number of different types of financial covenants which are designed to monitor both the value of a lender's security and the underlying health of the business.  Most borrowers with operating covenants which test cash flow may need to seek waivers of these where their operations (whether derived from rental or retail) are restricted by the Government's policies.  For borrowers with loan to value covenants, many lenders will have the right to and will want to check, the value of their security by calling for valuations, although in practice this could be problematic during the lockdown.  

Material adverse change

Most loan agreements contain a material adverse change (or material adverse effect) clause and many lenders are reviewing whether the Covid-19 pandemic will, unusually, give them the right to use this clause to drawstop loans, require additional security from borrowers or, ultimately, to accelerate loans.  It would be an almost unprecedented move as lenders are generally reluctant to rely on MAC clauses given that, among other things, incorrect use of a MAC clause could result in the lender becoming liable for a repudiatory breach of the underlying agreement, coupled with that the fact that there has been very little judicial consideration given to the issue; but current circumstances may see that change.  However, each MAC clause is different and will need to be reviewed in the context of the actual position of a borrower to determine the extent to which that borrower may be in breach.

Cessation or suspension of business

Another common event of default contained in loan agreements is an event of default that arises when a borrower ceases or suspends all or the majority of its business.  Given that most borrowers in the retail and hospitality sectors have had to suspend, indefinitely, a portion or all of their business, this is an event of default that many will need their lenders to waive.

Compliance with laws

Borrowers in the accommodation sector and potentially landlords, could find themselves with a "choice of defaults". For private rented sector borrowers, not complying with the new law to provide relief to tenants in financial difficulty will be an event of default, notwithstanding the fact that complying with the legislation will likely leave them in financial difficulty because they will not then have sufficient income to meet certain of their financial covenants.  

Insolvency

Borrowers will need to monitor insolvency events of default and agree terms with key suppliers and contractors so as to prevent a situation where failing to pay monies owed to those counterparties could result in winding up proceedings being initiated against the borrower.  Those proceedings could trigger an event of default.

Change of use

It has been reported that the ExCeL Centre in East London is being converted into a makeshift field hospital, capable of holding up to 4,000 coronavirus patients. Other countries have already taken similar steps with the exhibition and convention centres in Madrid and New York being used as field hospitals.

On a smaller scale, with the forced closure of cafes and restaurants, some businesses have converted their sit down service model to take away and delivery.  Whilst this will help to keep cash flow problems at bay (which may help to ameliorate a breach of financial covenants and insolvency events of default), it does leave borrowers open to breaches of loan agreements surrounding use of the property and planning regulations.  Arguably lenders with borrowers who are taking such action should adopt a pragmatic approach to a change of use if it helps to keep the cessation of business at bay.  Moreover legislation has been passed in the form of The Town and Country Planning (General Permitted Development) (England) (Amendment) Order 2020 to allow for a time limited (temporary) change of use to the provision of takeaway food, so any borrower changing the use of its property within these parameters would be doing so in compliance with laws.

Representations, warranties and undertakings

Borrowers also need to be mindful that non-compliance with underlying transaction documents and financial difficulties experienced by key transaction parties (such as construction contractors or suppliers) could trigger events of default under their loan agreements. 

Borrowers should take care to monitor all repeating representations in their loan agreements as they will still be required to repeat them at agreed intervals (usually on each interest payment date and on the date of any drawdown).  The repeating representations will include the representation that there is no actual or potential event of default at the date it is repeated. 

Additional care should be taken to monitor all covenants in the loan agreement as a breach of any covenant could also lead to an event of default (subject to materiality and remedy periods).  Where groups of companies have more than one facility, borrowers will need to be alive to the possibility of cross-defaults across those facilities.  

Interest rates and new business

Interest rates are now at historic lows and it is hoped that in the long term, this will ensure that UK plc is kept open for business.  Despite this we anticipate that there may be some delays in new lending as lenders focus on supporting existing clients through the difficulties caused by Covid-19 and, themselves, grapple with the practical issues of remote working and potential sickness which may mean that key credit committee members are not available to assess new loans.

As the crisis continues it is becoming increasingly clear that most, if not all, businesses are going to face financial and other difficulties at some point in the coming months. Given that, and absent legislative relief, borrowers should consider reviewing their financing arrangements at the earliest opportunity and engaging with their lenders (and other creditors) to ensure the continued success of their business as we emerge from the coronavirus pandemic.

To view our article on the impact of the Covid-19 pandemic on real estate investment in the UK, please click here.

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