Scotland's deposit return scheme ("DRS") remains scheduled to go live on 16 August 2023.
In this blog we will move away from the specific requirements of the scheme (covered in our previous posts, including on producer and retailer obligations) and discuss some of the points retailers, producers and their lenders may need to consider in relation to debt provision and ongoing compliance with existing loan terms.
Cashflow and Financial Covenants
The potential for the DRS to cause cashflow challenges has recently been raised by representatives of the drinks industry, with the expectation that it will be particularly challenging for smaller producers, importers and retailers, especially in its early stages. As well as administrative fees and costs (upfront and ongoing) there will almost always be a delay between payment of the relevant deposit and receipt of that deposit back.
The immediate concern will be in relation to complying with payment obligations. It is hoped that the initial cashflow support Circularity Scotland (the body responsible for operation of the DRS) has announced will alleviate these concerns. However, until clarity is received on how that support will operate there remains the potential for the initial costs of the DRS to put pressure on borrowers' ability to make scheduled payments, whether under their loan agreements or otherwise.
As ever in these situations, early engagement between borrowers and their lenders will be important. Maintaining a clear dialogue with funders, demonstrating how the additional cash flow implications are being managed and flagging any issues early will be key for borrowers. A borrower may want to seek new or extended revolving and overdraft credit lines to assist in mitigating the impact. Whether such solutions are required on a permanent basis to assist in managing cashflow will likely depend on the business in question. In some cases, it may not be possible to assess this from the outset of the DRS and so an ongoing dialogue between borrowers and their lenders on cashflow needs will be important.
Variance in cashflow, ongoing costs of the DRS and the potential impact of the DRS on trade generally may in some instances require applicable financial covenants to be reviewed to ensure continued compliance. This is most likely to impact smaller businesses in the sector but will also be relevant to any businesses that are already close to covenant breach or any business offering trade credit to customers (especially where bank backed).
In most instances it is to be hoped that a review of financial covenants will simply require a test of the covenant with the DRS implications built in to confirm ongoing compliance, but in limited cases, there may be a need to consider revising covenants. Such revisions may range from the specific exclusion of deposit payments and receipts from calculations of cashflow to the loosening of covenant levels or covenant "holidays". As with payment issues generally, it may not be possible to assess the impact of the DRS on existing financial covenants from the outset of the scheme, making ongoing dialogue between borrowers and their lenders advisable.
Consents
Cashflow support – Circularity Scotland have announced £22m of cashflow support measures, including two months' credit terms on deposits, producer fees and retained EAN/barcode fees for all producers. There is not yet much detail on what the credit terms will entail, but there is at least a possibility that any borrower availing themselves of this credit will require consent to do so under existing loan agreements. Lenders will need to be aware of this possibility and borrowers will need to check their existing loan terms to make sure no consent is required or, where consent is required, that consent is obtained from lenders ahead of entering into any credit terms.
Return points – the DRS will require most retailers to operate return points for the collection of empty bottles / cans and the repayment of deposits. This can be done manually or by the use of a reverse vending machine. Where planning consents, lease variations or substantial development is required to provide a return point, borrowers should keep in mind that consent may be required from their lenders under the terms of their loan agreements. Consent will not be necessary in all circumstances, but loan and security terms should be considered by borrowers as part of their planning around return points.
Non-compliance
Once the DRS is in force it will be an offence to sell and market within-scope drinks to a consumer in Scotland if the producer is not registered (either directly with SEPA or through Circularity Scotland). A failure to register that led to a producer being unable to sell its products in Scotland may well result in the producer defaulting under any existing loan agreements.
Failure to comply with the DRS obligations (for producers or retailers) will have significant consequences under the scheme, ranging from criminal sanction and fines to de-registration of producers. Depending on the circumstances, non-compliance could have severe implications on a business's ability to continue operating.
Compliance with relevant laws and regulations applicable to a borrower will also be a requirement under most loan agreements and so failure to comply with obligations under the DRS will in many cases result in a borrower being in default.
Depending on the impact of a borrower's non-compliance, material adverse effect provisions and financial covenant breaches may also become relevant (both of which would be likely to be events of default and not remediable without a waiver from the lender). It is therefore essential that borrowers impacted by DRS, and their lenders, are alive to the potential issues that non-compliance could raise.
Conclusion
If and when the scheme goes live on 16 August 2023, all producers, importers, retailers and wholesalers that sell Scheme Articles in Scotland will take on compliance obligations under the 2020 Regulations. Whether you are a retailer required to set up return points or a producer with formal registration obligations, it is important to have a plan for the impact of the DRS taking into account the relevant compliance obligations and how these will impact on your existing loan arrangements and cashflow. For some these additional obligations may necessitate seeking further financial assistance, and so lenders should be alive to that need arising. For lenders, being aware of the terms of the DRS and its implications on your clients will put you in a good position to assist them in navigating the financial implications of the scheme.
If you have any queries on the issues noted above please contact Euan Wallace, and for more information on the DRS generally please get in touch with Charles Livingstone, Grant Strachan or your usual Brodies contact.
