Within a matter of weeks, many of the world’s strongest borrowers experienced a sudden and considerable drop in revenue as employees and consumers complied with various quarantine measures across the country and around the world. This decrease in revenue created short-term liquidity crises for otherwise healthy borrowers with the result that many have begun to fully draw down under existing revolving facilities, request emergency liquidity facilities and seek amendments and waivers under current credit facilities. Exacerbating matters, lenders (many of whom are working from home and experiencing their own operational hurdles) are receiving these requests en masse and are expected to satisfy them promptly.
As the pressure to advance additional credit mounts, lenders must be cognizant of the legal tools they have to manage and minimize the risks inherent in granting credit and amending existing terms in the current climate. This post is a starting point – highlighting a number of considerations lenders should bear in mind in assessing whether they should or are required to advance credit. While each loan agreement is unique and the construction of each provides the lender with varying degrees of flexibility, there are a number of common considerations and principles which lenders should consider:
- Reduce risk when papering any amendments requested by borrower. Lenders are being asked by borrowers, in record numbers, to amend loan agreements and to provide, covenant and payment relief. In many cases, lenders are providing such relief without requesting any material benefit in return. As it is unknown how long the COVID-19 crisis may last, lenders who agree to open their loan agreement, should consider using that opportunity to include provisions which will (i) provide them with increased visibility into the borrower’s financial performance in the near future; and (ii) clarify or enhance lender protections.
- Ensure sufficient financial reinforcements. Insurance, guarantees, and security requirements ensure that the loan is properly collateralized if the borrower defaults. Lenders should take steps to ensure that the borrower’s insurance policies are up to date with the lender noted as an additional insured on all liability policies and as a first mortgagee and loss payee on all property policies. With respect to security, additional security requirements are often built into the conditions precedent to all advances. This provides an opportunity to reassess whether the present security package is sufficient with respect to the additional credit requested.
- Reporting requirements. One of the principal challenges with assessing lending risk is the availability of information. Many borrowers have just completed their Q1, but with financial statements not yet being available for many weeks. Even when available, and though unintentional, these financial statements may not reflect COVID-19’s true impact on the borrower’s business. Check to see whether the conditions precedent section in the underlying loan agreement is sufficiently broad so as to permit the lender to request additional documents and information as may be reasonable from time to time. Where available, lenders should consider requesting additional information to better understand the financial health of the borrower in between reporting periods.
- Material adverse change or material adverse effect. The requirement that no material adverse change (each a “MAC”) shall have occurred is often a condition precedent to further advances. Historically, lenders have avoided declaring a MAC without some other specific Event of Default to reference due to the fact that they wish to safeguard their reputation in the borrower community and want to minimize any related litigation risk. Conversely, lenders understand that the underlying (and projected) financial health of each borrower (both before, during and after the COVID-19 crisis) varies and lenders do not want to advance further funds when they reasonably believe there has been a MAC and are doubtful that such funds will be repaid. When faced with these competing interests, lenders should remember that the terms of loan agreements can, in many instances, provide them with additional leverage to claim a MAC, and accordingly should speak with their legal team to understand these points of leverage.
- Representations and warranties. Even with respect to further advances under an existing loan facility, the representations and warranties will likely require updated disclosure. This creates an additional opportunity for the lender to gain valuable information with respect to the borrower’s business such that they are better able to assess and mitigate risks.
- When to enforce. A lender will not be able to call its loan unless it first provides written notice. A lender will then be required to comply with certain statutory notice periods before it can enforce on its security. Lenders should be cognizant of any COVID-related court delays and closures in analyzing whether and when to enforce on its security for the purpose of preserving its collateral.