Navigating the impact of COVID-19

The impact of the crisis on business performance may affect companies’ access to liquidity, ability to comply with their representations and warranties, financial covenants and other undertakings and increase the risk of other triggers in financing agreements.

Access to liquidity

Access to financing to fund working capital and other requirements during this challenging time will be critical for business.

For facilities that are already committed by lenders, notably revolving credit facilities, borrowers will need to assess whether the facility is fully drawn or has available headroom, and what conditions to drawdown apply.

Other uncommitted financing may be available, subject to terms and to lender appetite. For private companies, equity funding from shareholders may be an option.

For any new funding (committed or uncommitted), directors’ duties should also be considered, together with the interplay with other terms of the financing documentation (eg financial covenant testing).

MAC/MAE

An event of default for material adverse change (MAC) or material adverse effect (MAE) in a loan agreement entitles lenders to accelerate the loan and enforce security, and also acts as a drawstop on further utilisations.

MAC clauses normally require a high threshold before they can be invoked (they may be specifically drafted this way or, for more general provisions, tend to be interpreted this way).

A decision to call a MAC is highly subjective and is usually a last resort, with creditors often preferring to rely on other contractual triggers (eg a payment default or financial covenant breach).

In determining whether the outbreak of COVID-19 would trigger a business MAC on market standard terms in finance documentation, the key question is the extent of the impact of the outbreak on an individual company/group.

• A business MAC on market standard terms would only be triggered if the impact of COVID-19 constituted a material adverse effect on a company’s business (usually taking the group as a whole, and often with other qualifications), but bespoke clauses may differ – in all cases, the drafting of clauses should be checked.
• For some companies – particularly those in sectors which have been significantly impacted by the outbreak – economic repercussions of COVID-19 in the short or medium term may give creditors grounds to argue for a MAC/MAE on a company’s business, financial condition or prospects.

Risk of financial covenant breach

Companies whose financing is subject to financial covenants will need to consider whether disruption caused by the COVID-19 outbreak will have an impact on their ability to comply. 

For example, impact on EBITDA when testing leverage ratios, and any devaluation of assets when testing loan to value (LTV) ratios.

The impact on financial covenant ratios of the incurrence of any additional debt for liquidity purposes should also be borne in mind. Covenant relief from creditors may be required.

Risk of breach of representations and undertakings

Companies may find it difficult to continue to give representations and warranties which repeat over the life of the financing, and to comply with general undertakings/covenants.

It will be important to review their terms, and consider grace periods, thresholds, carve-outs and qualifications.

Events of default

Drafting of events of default, particularly de minimis thresholds and grace periods, should also be analysed closely.

In addition to payment defaults, some other clauses that could pose a risk include:

• MAC events of default;
• events of default triggered by breach of financial covenants or representation/undertakings;
• cross default, where a default under other debt has the potential to trigger a cross default under the main financing;
• insolvency events of default, including where a company is unable to pay its debts as they fall due and other insolvency triggers; note also that events of default where a company commences negotiations with any of its creditors with a view to rescheduling indebtedness due to actual or anticipated financial difficulties are also common (although negotiations with the finance parties are usually excluded); and
• audit qualification events of default, where auditors qualify their report with a ‘going concern’ qualification; and cessation of business, where a member of the group suspends or ceases to carry on all or a material part of its business.

Other issues

Other issues to be aware of include:

• transferability, if lenders have the right to transfer their debt without the company’s consent while an event of default is outstanding;
• practicalities for creditors and the agent – in particular timing for lender credit committee approvals (which will be much longer than usual, so borrowers will need to factor this into their own timing) but also impact of absences/remote working on operations at the agent or the syndicate and consequential delays in responding to waiver and amendment requests;
• practicalities for the treasury team – eg impact of absences or remote working on delivery of financial statements and other reporting obligations; and
• definitions of ‘business day’ that refer to a day ‘on which banks are open for general business’ – consider the implications of bank closures, and consequent impact on payment dates and notice periods.