COVID-19 - how will it impact on loan agreements?

As this is a fast moving topic, please note that this article is current as at 27/03/20. For further information, please contact Andrew Robinson.

We have seen government measures provide relief for property owners in respect of mortgage payments. However, while individual banks may adopt policies to support their borrowers through these difficult times, there is no official guidance as to what steps might be taken to assist businesses struggling to make payments under their financing arrangements, nor as to how lenders’ rights under loan agreements will be affected in light of the ongoing public health crisis.

We have identified below a number of areas where rights and obligations under financing documents might be affected:

Interest rates

On 11 March 2020, the Bank of England announced a 0.5% cut in interest rates in response to the coronavirus outbreak. On 19 March 2020 a further emergency rate cut was announced reducing the interest rate to an unprecedented low of 0.1%. Lenders and borrowers should check the terms of their facility agreements to see how interest is calculated and ensure that, if applicable, this reduction is reflected in the amount of interest paid going forward.

Non-payment

It seems likely that many borrowers will struggle to make repayments in the coming months as a result of the challenges created by the government advice in response to the pandemic. Borrowers whose businesses are affected will need to proceed with caution as:

1. Non-payment is an event of default under their financing arrangements
2. A technical default might also be triggered simply by a borrower entering into discussions with its lenders around rescheduling debt
3. Any attempt to obtain additional financing is likely to be subject to restrictions on incurring additional debt.

That said, it is to be hoped that lenders will be supportive of borrowers facing a short-term liquidity crisis in the current circumstances.

Covenants

The ongoing crisis is likely to impact the ability of many borrowers to satisfy their financial covenants, although these are only tested periodically. Further, depending on when the next test dates are due to fall, these might not be the most urgent priority for borrowers. There may also be cure measures built in which can be utilised. Other covenants in the loan documentation may present more immediate challenges. For example, it is common for facility agreements to include a covenant against cessation of business. This may be triggered in the event of a borrower halting its activities, even if such a move is intended to be temporary. Similarly, a borrower seeking to dispose of assets or make other material changes to its business in response to changing circumstances may be required by the terms of its financing to obtain consent from its lenders before doing so.

Material Adverse Change

If the loan documentation includes a “Material Adverse Change” clause, this is likely to give the lender enhanced rights and remedies where the borrower’s business, prospects or ability to make loan repayments is impaired by changing circumstances. In some cases, it might allow a lender to stop making advances or demand early repayment. Lenders and borrowers should review such provisions carefully and be aware of their possible impact. In doing so, they should note that there is a lack of legal precedent around the use of these clauses and that parties should therefore tread carefully when considering them.

Comment

Borrowers will need to review the terms of the loan agreement to assess whether they are likely to be in breach and whether they have an obligation to notify the lender of that. Lenders will no doubt face requests for additional financing and/or a relaxation of covenants, and will need to consider whether waivers of breaches or short term forbearance of repayments may be appropriate. Early communication is recommended so that the parties can aim to mitigate the effects of the crisis on financing arrangements.