ANALYSIS
Considerations for Commercial Borrowers in the Midst of the COVID-19 Pandemic
As the COVID-19 pandemic wreaks havoc on current and projected financial performance for many businesses, commercial borrowers are well-advised to start taking steps to position themselves for what might lie ahead in terms of their existing credit facilities. The following summarizes some steps you can be taking and issues you can be considering as you face the coming weeks and months.
Re-familiarize Yourself with Your Credit Facility Structure
Whether the ink is still wet from a recent signing or your loan documents are sitting in files gathering dust, find the documentation and review it. Your facility paperwork would typically include a loan agreement or credit agreement that sets forth many of the overall terms and conditions of the facility. In addition, you might have one or more promissory notes (notes are not required but often utilized), and company security documents such as a real estate lien instrument (called a mortgage, deed of trust, deed to secure debt or otherwise), a collateral assignment of leases and rents, a security agreement, a deposit account control agreement and/or a pledge agreement. Guaranties might be part of your structure as well, and those might be from individual principals of the company or provided by affiliated companies.
Specific Loan Terms: Understand the details of your facility terms. For example, you should know the length of your term, how much borrowing availability you have on current lines, whether you have options in terms of selecting an interest rate (variable vs. fixed rate) and if you do have options, what the requirements are, how long you have to lock in, the current rate index to which variable rates are tied, and whether switching to a particular rate option will reduce your interest expense given the current rate environment.
Collateral Structure: Make sure you understand what collateral you have pledged to secure your debt obligations. Have you granted a lien on your real estate? Tangible assets? Accounts receivable? Deposit accounts held by other banks? Other assets?
Guaranties: Understand how guaranties, if any, tie into the overall structure. If there is more than one guarantor, the liability is likely joint and several, but that should be confirmed. In some instances, a guarantor’s liability might be capped to a certain dollar limit or a certain percentage of principal, interest and fees due and owing at the time of default (in addition to 100% of collection costs incurred by the lender in enforcing the guaranty). Also confirm whether the obligations of each guarantor are secured by collateral.
Accordion or Bulge Line: Some loan facilities build in an option for the borrower to request additional funds beyond the originally committed line. For example, you might have a $20,000,000 line of credit you can draw upon with an option to request an increase by $10,000,000 so that your borrowing capacity expands to $30,000,000. These types of provisions allow lender discretion so even if you request expansion of the facility, it is not a certainty you’ll be able to get it. The first step, though, is to determine whether such a right even exists in your facility.
Review the Specific Document Provisions
Make sure you carefully review the loan document provisions so you can assess the current situation and be cognizant of future obligations and limitations.
Covenants: Your loan documents will contain covenants, some of which will be more onerous than others. Here are some to watch out for:
- Specific financial covenants or ratios that must be met on a quarterly or yearly basis tied to operating cash flow, debt service coverage, tangible net worth or other metrics
- Affirmative covenants to maintain your business in the ordinary course and consistent with past historical operations, keep your facilities open and operating, or timely pay obligations
- Negative covenants that preclude or limit your ability to incur additional debt or liens, wind down components of your business, make distributions or enter into transactions with affiliates
- Reporting obligations that require you to notify your lender if there occurs, or if there is a reasonable likelihood there will occur, a material adverse change in your operations, business, condition (financial or otherwise) or prospects
Representations and Warranties: Look for representations and warranties that might be in play at this point or in the near future. A failure of representations/warranties to be true and accurate will likely trigger a default under your loan documents. In addition, loan documents routinely provide that if your representations/warranties are not true, you cannot borrow more money under existing lines of credit. Here are some to watch out for:
- A statement that there has been no material adverse change since the date of the last financial statements you provided to your lender
- A statement that there has not occurred any material adverse change in your operations, condition (financial or otherwise), business prospects or ability to repay the indebtedness evidenced by the loan documents
- A statement that no default has occurred
Conditions to Obtaining Additional Funds on Existing Lines: If you have a line of credit, look for the section that lists conditions for being able to draw more money down. It likely states you cannot borrow more if you are in default under the loan documents, so if you are in monetary or non-monetary default or if any of your representations/warranties are not true, then you can’t borrow. Sometimes conditions to funding include an express condition that no material adverse change shall have occurred or be reasonably likely to occur.
Defaults: Understand what will actually trigger a default under your documents and whether you have a right to cure. Standard defaults include failure to timely pay your loan amounts, failure to perform any non-monetary obligation under the loan facility, insolvency events and a failure of your representations to be true. Additionally, a default might occur under your facility if you have judgments rendered against you, a material adverse change occurs, certain events occur related to your benefit plans, a change in control/ownership of your company occurs, or if you default under any other debt facility you have in place. The latter default can be particularly troublesome because the practical effect is that a technical default under one facility renders you in default under other facilities, whether or not you have failed to pay or perform under those other facilities.
Think About the Lender’s Perspective
Optics Matter. Even if you are not currently in default, be aware that optics matter to lenders. Lenders want borrowers who are prudent, thoughtful, proactive and keep their house in order. Borrowers who are sloppy—e.g., let their qualifications to do business lapse or change their name and forget to tell the lender—might not be in default under their facility, but from the lender’s perspective, these are companies that do not keep their house in order. Be a good housekeeper. Look ahead and think carefully about the decisions you make—how will it look to your lender? Will it look like you were in panic mode and made hasty decisions or will it look like you considered the options and made prudent and thoughtful choices? What about the details of your actions—did you try to cut expenses? Did you reserve back cash or distribute it all out to your owners? There certainly is not one right answer for all borrowers because the pandemic is causing unprecedented and chaotic times, but remember that your lender will make note of your overall approach as well as your specific steps.
Open and Active Communication is Advised. Our experience is that lenders don’t like surprises and they would prefer to be asked for permission rather than forgiveness. We advise borrowers to keep in touch with their lender. If you believe you will need a waiver or might need a modification of a covenant in order to get through the next few months, consider whether you want to initiate that conversation now rather than wait it out and go to the lender after you’ve defaulted.
Be Careful What You Wish For. Bear in mind that if you approach your lender and request modifications or waivers, you have opened up discussion about the documents and, to the extent you want changes, they might want changes as well. For example, in exchange for providing the waiver or modification you are requesting, the lender might require more frequent financial reporting, tighter financial covenants, additional collateral or expanded guaranty coverage.
Every lender, every borrower and every credit facility is unique, and one size does not fit all in terms of ultimate steps to be taken. Sitting and doing nothing, however, is seldom the right answer. Take steps now to understand your current position and anticipate the future possibilities. You owe that to yourself and your business.
