[co-author: Federica Lombardo]
We describe below the legal impact on Italian loan transactions of the current health emergency caused by COVID-19 in light of the latest legislative measures, including a suspension of interest and principal payments on loans to SMEs, the rescheduling of repayment plans, and financial support for loans to larger corporates. Most of the measures are not available for non-performing or otherwise impaired loans, and our observations relate to loans which were fully performing until COVID-19.
The framework is fluid as the Italian authorities continue to devise special legislation to contain the impact of the epidemic, with the outright restriction of movement of people and goods, and constraints on other fundamental personal and economic freedoms. The impact of COVID-19 on loan transactions also needs to be considered as a matter of general contract law, and we consider the main implications below.
Payment obligations absolute
Generally, a Borrower's obligations to pay interest and to repay principal under a loan agreement are not conditional on the Borrower's financial condition, and must be performed as an absolute obligation, often supported by collateral available to the lender in priority to unsecured creditors.
Force majeure in Italian law
However, under Italian law1 a debtor is not responsible for contract breach in circumstances where the performance of an obligation is prevented by supervening impossibility not imputable to the debtor (impossibilità sopravvenuta non imputabile al debitore), broadly akin to the concept of force majeure in international commercial practice.
Italian Courts have been reluctant to recognise this exemption for payment obligations, on the grounds that a shortage of cash cannot strictly speaking be regarded as an objective impossibility. At least in theory, a debtor can source funding from another lender or sponsor.
To date the exemption has been recognised mainly for obligations for specific performance, i.e. a supply or service that cannot be obtained elsewhere. However, none of the Courts engaged so far on this topic2 had to address circumstances as widespread as COVID-19.
Impact of the latest legislative measures on this analysis
The measures include general declarations of a state of force majeure (in a Government order which probably lacks the legislative rank required to regulate loans to private sector businesses), and 'exceptional occurrence' and 'serious disturbance' for the purpose of EU rules on State aid.
It could be argued that the existence of these legislative measures supports the argument that a borrower should be exempt from performance of its payment obligations, at least in proportion to its loss of revenues ensuing from COVID-19. The borrower would also be excused from the need to demonstrate causation between the virus and its loss of revenues in the aftermath.
Italian Courts usually regard a binding order from an authority which prevents the performance of a debtor's obligation as sufficient force majeure. So the various containment orders issued by central and local authorities during this health emergency might of themselves provide sufficient grounds for affected borrowers to be exempt from liability under their loans (in other words, their payment obligations could be suspended with no liability for default interest on overdue sums).
Impact on loans
Lenders would probably be prevented at this stage from accelerating or terminating loans on the grounds of the increased credit risk or loss in revenues ensuing from COVID-19. As mentioned, in most circumstances a borrower may be exempted from complying with its payment and operating obligations on grounds of impossibilità sopravvenuta, and the same would probably apply to any form of material adverse effect (MAE) trigger, most financial ratios and other indicators of a borrower's general creditworthiness.
Termination for breach unlikely
Quite apart from the debate on force majeure, Italian Courts are fairly conservative when it comes to questions of contract termination on grounds of breach. There are findings that an express termination clause (clausola risolutiva espressa, which in theory would allow a party to terminate a contract on the occurrence of a given event) should not permit termination where the occurrence of the sanctioned event is not imputable to the negligence (colpa) or wilful misconduct (dolo) of the other party. Also, an express termination clause is not, in itself, sufficient to declare the termination of a contract on the occurrence of the sanctioned breach, and the termination requires the breach to be material in respect of the overall balance of interests (economia del contratto) in the contract.
Cancellation of commitments
The Government's recent measures require lenders to stand behind their commitments for loans to micro businesses and SMEs until 30 September 2020. In the absence of this, general contract law would allow lenders to cancel commitments for loans or bank credit facilities in case of a material deterioration in the condition of the borrower's assets, or the collateral provided. Where permitted under the COVID-19 measures, a lender could probably cancel a loan commitment under a term sheet or arrangement mandate which is still subject to documentation, syndication or due diligence.
Again, where permitted under the COVID-19 measures, for committed facilities made available under existing loan agreements, most lenders would have sufficient grounds to cancel (or at least delay) new utilisations on the basis of COVID-19. This is though subject to the Italian law doctrine of wrongful breach of lending (interruzione abusiva del credito), preventing lenders from cancelling available credit abruptly or otherwise unreasonably. The cancellation of a commitment during the health emergency would need to be limited to what is strictly necessary, supported by analysis of the borrower's financial condition, and must allow sufficient notice for the borrower to mitigate the impact on its business.
When reviewing potential contractual remedies, lenders and borrowers owe each other an obligation to act in accordance with good faith. Italian law applies this duty to the performance of all contracts, and even to pre-contractual negotiations, including at mandate or term sheet stage. If a lender’s behaviour were to be questioned, a Court would review this earnestly against the background of the pandemic.
Italy's main commercial banks have voiced support for the affected people and corporates, even in advance of the publication of the new legislation. The business community generally prepares to support with the available means, in anticipation of tax incentives and other aid as permitted and available. There is a shared awareness of the reputational impact of a lender's debt recovery policies given the scale of this emergency.
In each case, the impact of the COVID-19 measures on existing contracts, as well as of force majeure on loan commitments and contracts depends on the documented terms, date of execution, and the location and status of the parties. We express our views above in very general terms, on the understanding that no one-size-fits-all assessment can address the current uncertainty, and any review of a lender's or borrower's legal position requires a specific analysis of that position.
1 Articles 1218 and 1256 of the Italian civil code
2 The Supreme Court of Cassation did conclude for a finding of impossibilità sopravvenuta in a case of local epidemic, although again in respect of obligations to provide a transportation service, not a payment obligation (Cass. III Civ. n. 16315 of 24 July 2007)