COVID-19: how borrowers can manage the impact on their financing arrangements

The COVID-19 pandemic and its impact on the global economy has resulted in challenging times for businesses, which will continue in the weeks and potentially months ahead. In these uncertain times, borrowers will need to consider the impact of the pandemic on their existing funding arrangements in order to keep businesses viable as a going concern and to ensure that businesses are in the best position to return to normal post-pandemic.

We outline in this article some practical steps borrowers should consider taking to manage the impact of the pandemic on their existing financing arrangements, and some logistical considerations for new facilities or facility amendments.

Existing Financing Arrangements: Practical Steps for Borrowers

The key for borrowers is early and open engagement with lenders in relation to a potential breach of loan facilities resulting from the COVID-19 pandemic. This will provide lenders and borrowers with time to discuss the potential impact for the financing arrangements and to work constructively to negotiate amendments or temporary waivers of financing terms with a view to the borrower emerging at the other side of the pandemic with a viable and functioning business.

We have set out below some of the key considerations for borrowers under existing financing arrangements:

• Working capital / revolving credit facilities – Such facilities usually contain provisions which give lenders the right to stop making further advances for actual or potential events of default. This may have a substantial impact on the cash flow of a borrower and the ability of the borrower to meet its payment obligations, whether to suppliers, lenders or employees.

Action: Borrowers should carefully assess how they can access working capital in the short to medium term as this will be key to ensuring that they can continue their business in these uncertain times. Funding through a government-backed scheme such as the Coronavirus Business Interruption Loan Scheme could be a possible source of emergency funding for the business.

• Market disruption provisions – A market disruption clause allows a lender in certain circumstances to calculate interest on a different basis, for example, when a lender's cost of funding exceeds the relevant interbank lending rate benchmark. It is possible that rates may start to be superseded by lenders cost of funding in the market. A lender may therefore be able to change the interest rate on a facility to the lender's costs of funds plus margin.

Action: Borrowers may want to engage with their lenders early to ensure that such additional costs are not passed over to the borrower.

• Cross default – Bank facilities typically include cross-default provisions whereby certain defaults arising under a separate facility or borrowing arrangement of the borrower can automatically trigger an event of default under the Bank facility, having a domino effect for the borrower.

Action: Borrowers should check the details of, and be live to, the representations and default provisions contained in all of their financing arrangements.

• Undertakings – Information undertakings typically included in facility documents allow lenders to request additional information in relation to the finances, operation and assets of a borrower at any time.

Action: Borrowers will need to ensure that such information is readily available and be aware of the consequences of a deterioration in their circumstances. Borrowers should be aware that facilities usually include an obligation to notify the lender if a Default (an event of default or potential event of default) has occurred and in relation to facilities secured over investment or operational real estate an obligation to notify the lender of any breach by a tenant of the terms of its lease documentation.

• Financial covenants – Financial covenants set out the parameters within which a borrower requires to operate throughout the term of a facility. They are used by a lender to monitor the financial health of the borrower and to flag when a borrower may be facing financial difficulty and potentially unable to meet their financial obligations. Government restrictions imposed due to COVID-19 may have a financial impact on borrowers across all sectors due to a reduction in cash flow and operating income. This could in turn result in a default or potential event of default in relation to debt service and interest cover covenants. If a breach of financial covenant appears likely early engagement with lenders will be key.

Action: Borrowers should check the terms of the facility to ascertain if they have the right to cure a breach of financial covenant by way of payment of funds to a blocked deposit account with the lender or by paying down the loan.

• Repayment – Government restrictions imposed due to COVID-19 may have a direct impact on a borrower's ability to meet scheduled loan payments.

Action: Borrowers should plan ahead and engage with lenders as early as possible if they require to defer scheduled payments, restructure their existing debts and/or seek specific waivers or amendments to facility agreements in order to adapt to their current financial circumstances.

• Events of default – If a borrower is unable to pay their debts as those debts fall due, this may trigger an event of default under a borrower's financing agreements and can be used as a trigger for the commencement of insolvency proceedings in relation to the borrower.

Action: The Government has announced that the wrongful trading provisions contained within the Insolvency Act will be suspended with effect from 1 March 2020 (although legislation is still awaited). Our Legal Update on the suspension of wrongful trading rules can be found here. However, Borrowers should be aware that, notwithstanding the foregoing, if they continue to operate in these circumstances, there may also potentially be personal implications for the directors if they breach their directors' duties. An overview of the duties of directors of a UK limited company can be found here. Borrowers should also be aware that the commencement of informal measures in relation to financial difficulty (actual or anticipated) with creditors, such as discussions with landlords or trade creditors, may potentially be caught by the events of default in a facility agreement. Borrowers should check the terms of each facility agreement.

• Material Adverse Change (MAC) – MAC clauses are included in financing documents as a 'catch-all' to capture unpredictable or unforeseen events or circumstances which would otherwise be difficult to prepare for when drafting the documentation. These are generally wide in scope to capture the business, operations, property, financial condition or prospects of the borrower or its group which would impact the ability of the borrower to perform their obligations under the finance documents or the effectiveness of guarantees or security. The occurrence of a MAC is usually an event of default and allows a lender to accelerate repayment of the facility. Lenders are however often reluctant to rely solely on the MAC event of default to default a borrower, as it is frequently difficult for a lender to prove that a MAC has occurred. In the current circumstances, a lender would need to prove that the impact of COVID-19 will have a sustained adverse effect on the borrower's business, that the current effects are not temporary and will continue to negatively impact the borrower for some time.

Action: Borrowers should consider their contingency planning and capital reserves to assist with managing the impact of COVID-19 on their business and their debt facilities and equity investments.

• Cessation of business –An event of default may be triggered if there is a cessation of the business or operations of the borrower (e.g. as a result of the Government's social distancing measures).

Action: Borrowers should engage early and openly with their lenders to negotiate any required amendment or waiver to their facilities to cater for this.

New and Amended Financing Arrangements: Practical Considerations

In addition to the specific provisions in existing financing agreements highlighted above, there are a number of practical points that require to be considered by borrowers and lenders alike in order to document new financings or restructurings or amendments of existing transactions, including:

• Location of signatories – The global reach of the COVID-19 pandemic will have an impact on the ability for documents to be signed. With the majority of signatories working remotely there may be restricted access to printers and scanners for the signing and return of documents in the usual way. Different jurisdictions have adopted different policies and are placing different restrictions on their residents, therefore borrowers, lenders (and their lawyers) need to be mindful of the measures in place in each jurisdiction when co-ordinating signings to 'get deals done'.
• Electronic signatures v. 'wet ink' signatures – Scots law permits many documents to be signed electronically, which is likely to become more and more important given the location and availability of signatories mentioned above. However, a number of documents, including those relating to the creation or transfer of an interest in land (such as a standard security), will still require to be signed in the traditional way by 'wet ink' signature in order to be effective. Furthermore, Scots law governed documents which require to be signed in a 'self-proving' manner (which would usually include security documents) require a Qualified Electronic Signature. Presently we are not aware that the main e-signing platforms meet the requirements for a Qualified Electronic Signature and so until such e-signing platforms are revised all Scots law documents requiring to be signed in a 'self-proving' manner should be signed in 'wet ink' signature. For further guidance on signing documents electronically please see here.
• Registration of documents – In order to be effective, certain security documents granted in connection with financings require to be registered. For example, fixed security over land in Scotland (standard security) requires to be registered at the Land Register of Scotland, and, if granted by a UK registered corporate entity, the standard security will also require to be registered at UK Companies House. The Land Register of Scotland and Companies House, like all businesses, are having to adapt their processes to meet the requirements of the current global climate and to ensure business continuity. Further details of the current position with regard to the Land Register of Scotland can be found here. It is anticipated that Registers of Scotland will move to electronic registration over the coming weeks. Please speak to your usual Brodies contact to ascertain the most up to date position or if you wish to discuss this in more detail.

Government support

A number of Government-backed loan schemes are available which aim to ensure that businesses have access to additional funding during the high economic impact phase of the pandemic. Borrowers requiring additional funding during this period should ascertain whether they would meet the eligibility criteria for such schemes. Further information in relation to the available Government loan schemes, including eligibility criteria, can be found here.

Brodies is ideally placed to advise on the implications of COVID-19 on existing and new lending facilities, as well as on the Government support package for businesses.