How are banks currently responding to the COVID-19 pandemic?

A number of banks have announced measures they will be taking to ensure they can offer flexibility and support to their business customers during the current circumstances. These include additional financing (in some cases to be offered on a fee-free basis), loan repayment deferrals and temporary credit and overdraft limit increases, all designed to alleviate cash flow pressures. Offerings vary and it is worth looking into any announcements made by your bank in this regard. Decisions are likely to be made on a case-by-case basis and it may be that your relationship manager contacts you proactively to ascertain what support your business might require. Refamiliarising yourself with your existing arrangements can only aid these discussions.

Can financial help be sourced from elsewhere?

Your existing finance documents will almost certainly restrict additional borrowings and the granting of other security. Therefore, if you are considering taking on additional debt, you will need to get consent from your existing lender (as failing to do so will be an event of default) and intercreditor arrangements will need to be agreed.

Subject to obtaining the consent of your existing lender (where required), you may of course consider other sources of funding. The Coronavirus Business Interruption Loan Scheme (providing government-backed loans of up to £5 million to small and medium businesses) or the Bank of England’s Covid Corporate Financing Facility (for larger business) may also be of assistance. Please click here to see our article on Financial Support for SMEs and the Coronavirus Business Interruption Loan Scheme (CBILS). 

What if I am unable to make scheduled payments?

If you are likely to have problems complying with your current repayment or interest schedule, then it is important to engage with the lender as soon as possible. It may be that a repayment or interest holiday is a possible option that can be mutually agreed, or discussions may lead to a wider consensual restructuring of your debts. If you wait until a payment is missed, this may trigger other cross-default provisions (see below).

Are financial covenants a cause for concern?

You should consider carefully whether your ability to comply with any covenants (including financial covenants) is likely to be affected. Financial covenants act as an early warning system to lenders so that they can monitor whether you are likely to keep up with your financial obligations. If sufficient headroom was not built in when the relevant tests were set then any negative impact on your numbers could affect your ability to satisfy these covenants. A breach of any covenant will generally be an event of default. It is worth checking when your financial covenants are to be tested next so that you can consider if you need to take any action before a breach occurs.  

How likely is it that a MAC clause will be triggered? 

A “MAC” clause serves to protect a lender against any “material adverse changes” that could affect your business and/or your ability to repay a loan. Such a clause is designed to be a “catch-all” covering the lender against events or circumstances that were unforeseeable at the point the finance documents were entered into, be they specific to your business or market-wide. MAC clauses generally feature in two places in a loan agreement: (1) in the representations and warranties (meaning each time the representations and warranties are repeated you are deemed to have confirmed that no MAC has occurred – a breach of any of the representations and warranties is generally an event of default); and (2) as an actual event of default (putting you in default if a MAC does occur).   

Whether or not COVID-19 will constitute a MAC depends on the precise drafting of the relevant provisions in your finance documents and the effect of the pandemic on your business. Given the extent of the pandemic and the fact that it is expected to last for months or even years, it is likely that it will become easier for lenders to invoke MAC clauses, particularly those widely drafted on a lender’s standard terms. In practice, however, it is unusual for lenders to rely on MAC clauses alone and we hope that lenders will adopt a common-sense approach in the current unique circumstances  

Could any other clauses pose a problem?

It is important to review your finance documents in detail to ascertain whether there are likely to be any other areas of concern. Examples of other common provisions that could cause an issue include:

• Events of default on insolvency: you should consider whether any dip in revenue could affect your ability to meet your debts as they fall due or otherwise constitute an event of default. Under many finance documents, the act of entering into (even informal) negotiations with any creditor, regardless of the amount of that creditor’s debt, can be caught. This is something you should bear in mind if you are considering renegotiating any payments, even with trade creditors.
• Misrepresentations: you should review any representations and warranties that are due to be repeated to ensure they remain correct (if not this is likely to be an event of default). 
• All or a material part of your business ceasing to operate: if COVID-19 is actually preventing you from doing business this common event of default provision may be relevant. 

What does it mean in practice if an event of default occurs?

If a lender can prove that an event of default has occurred (and any relevant grace period has expired without you remedying the situation), this usually gives the lender the right to demand repayment of its debt in full immediately and to refuse to lend any further amounts. Secured lenders will also be able to enforce their security over assets (subject to statutory duties). Even if a lender chooses not to take these actions, there is a risk that even the existence of the circumstances enabling them to do so could trigger other cross-default provisions (see below).

What is the impact of cross-default provisions? 

A cross-default clause in a contract (contract 1) means that an event of default under that contract will occur if there has been an event of default under another contract (contract 2). Depending on the drafting, consequences under contract 1 can be harsh even if no action is actually taken under contract 2 and you would not otherwise be in breach of contract 1. If you are party to a number of contracts (financing or commercial) containing such provisions, allowing a breach of any contract to occur can lead to an unpleasant ripple effect.  

Should a lender be informed of any concerns?

We would generally advise proactively starting a dialogue with a lender if you foresee issues arising that might put you in breach of your finance arrangements. Most finance documents require a borrower to inform the lender of any events (or potential events) of default so keeping quiet is only likely to compound the issue. Lenders should hopefully be more understanding if they have been pre-warned and it will allow more time to consider a solution before a breach actually occurs. Hopefully in many cases all that will be required is some short-term breathing space that a lender will be able to offer if they are satisfied with the long-term risk profile of the loan.  

What are the possible solutions that could be agreed with a lender?

There are various options available to parties to deal with the current (hopefully temporary) circumstances:

• You may agree to a formal variation of your finance documents, for example to carve the current scenario out of relevant provisions, to amend the repayment schedule or to build additional headroom into financial covenants. 
• The lender may be willing to issue waiver letters in respect of specific breaches.  
• A wholesale restructuring of your debts may be agreed.
• You may decide that it is appropriate for you to seek funding from elsewhere (with the lender’s consent).