As the COVID-19 pandemic progresses, both borrowers and lenders will need to consider their rights and obligations under the financing documents. Freshfields has identified 11 important issues that should be top of mind for borrowers and lenders:
- Draw-Downs and Liquidity. Borrowers are improving their liquidity by drawing down on delayed draw and revolving credit facilities. Borrowers may believe that they need to draw these facilities now, while they can still meet incurrence tests and before they struggle to meet their incurrence reps and warranties (no material adverse effect, no material adverse change and no insolvency). Lenders, should scrutinize any information received for financial risk, and may want to use these draws as on opportunity to push for greater transparency or to open a dialogue with the borrower.
- Lender Oversight. “Cov-lite” loans may not contain maintenance covenants to allow lenders insight into the financial condition of their borrowers. Lenders may want to look for other covenants or potential defaults for an opportunity to engage with their borrowers before a payment default is imminent.
- EBITDA and Consolidated Net Income. Borrowers and lenders should scrutinize loan documents to determine whether the borrower is entitled to make any adjustments to EBITDA or CNI based on COVID-19.
- Material Adverse Change / Material Adverse Effect. Lenders have historically been reluctant to refuse to fund a draw on the basis of a perceived MAC/MAE. Nevertheless, lenders should scrutinize the specific terms of their MAC/MAE language both to ensure compliance and also because these provisions may provide a basis to request additional information.
- Solvency. Lenders may decide to push back on a borrower’s solvency representation, particularly if cash flow solvency is thought to be an issue in view of economic conditions. Lenders may wish to consider requiring borrowers to produce projections demonstrating that their anticipated cash flows are sufficient to meet upcoming cash needs during the next 12 months.
- Ratings Downgrades. A ratings trigger may have implications for both investment grade and high yield debt, including mandatory borrower offer to repurchase or changes in covenants. Ratings downgrades can be a termination event in swap agreements. Ratings downgrades may also put downward pressure on the trading price of a bond or loan.
- Deadlines for Financial Reporting. Companies whose fiscal year coincides with the end of the calendar year may be required to deliver audited annual financials on or about March 31. Given current challenges and the need for outside auditors, many companies will struggle to meet the deadline for delivery of financials. The inability to deliver timely financials may afford borrowers and lenders the opportunity to discuss the borrower’s plan.
- Projections. Lenders should run a sensitivity analyses over delivered budgets and financials to assess liquidity, whether the borrower will meet debt service and evaluate covenant compliance.
- Mandatory Insolvency Filing Requirements. Companies with global operations should consider whether they have statutory obligations in certain countries to report financial distress. For example, in Germany, managers of insolvent company have a statutory duty to file for insolvency, or risk personal liability (however, the German government is expected to suspend those obligations in the short term).
- Special Concerns for CLOs. CLOs failure to meet overcollateralization (OC) tests generally requires that cash flows that would otherwise be used to make distributions to equity and pay interest on junior tranches instead be used to pay down one or more senior tranches (and, in extreme circumstances, may constitute an Event of Default). Concern over this haircut may be causing outstanding CLO debt to trade at a significant discount and CLO sales of underlying loans not carried at par may be putting downward pressure on loan prices.
- Special Concerns for Project Finance. Lenders should consider how project supply chains likely to be affected, to what extent are suppliers and customers permitted to claim force majeure or other excuses to performance, and whether force majeure provisions consistent across all project documents. Also, lenders will want to consider step in rights to prevent the termination of key project contracts.
