Covid-19 has spread rapidly throughout the globe since it first emerged in China at the end of 2019. As governments, businesses and individuals all take measures to protect against the potential public health issues that the coronavirus poses, its outbreak has led to volatility in worldwide financial markets and has hit a number of already troubled sectors especially hard, namely retail, hospitality and leisure and will likely lead to significant economic disruption and dislocation around the world. This alert:
- summarises briefly the key features of the UK government’s recently announced stimulus package; and
- highlights some issues for corporate borrowers and funders to consider in their finance transactions in light of the potential impact that virus-induced disruption and dislocation may have.
The UK government’s stimulus package
Rishi Sunak, Chancellor of the Exchequer, announced yesterday an “unprecedented” £330 billion stimulus package to shore up the UK economy and businesses as Covid-19 escalates. The measures include:
- the scrapping of business rates – taxes paid on commercial properties – for 12 months for all companies in the retail, leisure and hospitality sectors. Taken together with existing small business rate relief, HM Treasury estimates that 900,000 properties, or 45% of all properties in England, will receive 100% business rates relief in 2020 to 2021;
- an additional £2.2 billion funding for local authorities to support small businesses that already pay little or no business rates, which will translate into a one-off grant of £3,000 to approximately 700,000 businesses;
- a new temporary “Coronavirus Business Interruption Loan Scheme”, delivered by the British Business Bank (“CBILS”). CBILS is set to launch at the start of next week to support businesses to access bank lending and overdrafts from accredited lenders and will temporarily replace the Enterprise Finance Guarantee scheme (“EFG”). CBILS will provide the accredited lenders with a guarantee of 80% on each loan (subject to a per-lender cap on claims) to give those lenders further confidence in continuing to provide finance to small and medium size enterprise borrowers in eligible sectors. HM Treasury has said that the government will not charge businesses or banks for a CBILS guarantee (as compared to the EFG scheme where the government charges a 2% fee), and the CBILS will support loans of up to £1.2 million in value. Full details, including the exact eligibility criteria, will be announced shortly; and
- utilising HMRC’s Time To Pay service to defer payment of outstanding tax liabilities, with these arrangements being agreed on a case-by-case basis.
This comes hot on the heels of the Chancellor’s previous announcement and the measures already taken by the Bank of England to support businesses and banks through these uncertain times (including lowering the base rate from 0.75% to 0.25% and relaxing the capital adequacy requirements on banks in order to release further funds to support businesses). While all of these measures may go some way to mitigating the potential economic impact of Covid-19, they will not entirely neutralise the impact the outbreak may have on borrowers and lenders and their finance transactions. We note some risks and issues to consider below.
Financial covenants
Financial covenants (particularly revenue, cash flow and debt based ones like gross/net leverage, debt service cover, minimum EBITDA and rental income) could be impacted by the economic effects of Covid-19 in the short to mid-term and by additional borrowings designed to mitigate those effects. A borrower and a lender might consider relaxing financial covenant ratios for a limited period to provide more headroom and help the borrower through the expected high impact period of Covid-19.
Negative undertakings on borrowings & intercreditor issues
Many borrowers will be prohibited under the finance documents from incurring additional borrowings or other forms of financial indebtedness, albeit subject to any agreed exceptions (i.e. “permitted financial indebtedness”). Any additional coronavirus-related borrowings from central banks, government backed lenders or other third party funders and/or incurring extra counter-indemnity obligations (e.g. relating to CBILS and/or EFG scheme guarantees) are likely to require lender consent (usually at the majority lender 662/3% level) because they would almost certainly fall outside the agreed exceptions.
Any change to a borrower’s capital structure resulting from the incurrence of additional borrowings or other financial indebtedness consented to by an incumbent lender could also trigger complex intercreditor issues depending on the ranking and priority position which an additional funder requires (e.g. super senior or “last in first out”).
A material adverse change?
Most facility agreements contain a material adverse change (“MAC”) event of default clause. The purpose of a MAC clause is to protect a lender against unforeseen changes which have, or may have, a significant detrimental effect on a borrower’s business or financial condition, its ability to comply with its payment and other (material) obligations under the relevant facility agreement or the lender’s security or (material) rights and remedies.
It is clear from case law that whether or not the relevant MAC clause has been triggered by a particular event or circumstance will depend on the specific drafting of the provision and how it applies to the facts of a particular borrower and its business.
It is possible that a single event with a regional, global or cross-sector impact like coronavirus could ultimately cause a MAC. But the burden of proof will generally be on the lender to show that the event or circumstance described in the MAC clause has occurred in relation to a particular borrower and has had an actual and non-temporary effect on that borrower’s business.
For that reason, we anticipate that lenders are likely to think very carefully about invoking a MAC clause. There is always likely to be an element of doubt about whether something falls within the scope of a MAC provision. Most lenders will want certainty before calling a MAC event of default, which means that non-payment and/or a breach of financial covenants and/or insolvency events of default will in most cases be a greater risk for borrowers in the current climate. Moreover, we expect that for relationship and reputational reasons most lenders will be reticent about taking enforcement action against previously performing borrowers solely on account of coronavirus.
Other events of default
As noted above, non-payment and/or a breach of financial covenants and/or insolvency events of default will in most cases be a greater risk for borrowers in the current climate:
- payment default: the borrower’s ability to make interest payments and capital repayments may well be subject to additional “stress” reflecting the possibility of reduced cashflow in the expected Covid-19 impact period; and
- financial covenants & insolvency: a decrease in revenue stemming from coronavirus substantially reducing demand for or sales of a borrower’s product or service could result in a borrower being unable to meet its debts as they fall due and being “cash flow” insolvent or in an inability to meet its financial covenants
A cessation of business is also likely to constitute an event of default under many facility agreements. For example, property developments could be halted by lack of workers having the potential to force a temporary suspension of relevant business.
As with the MAC clause event of default noted above, we expect that for relationship and reputational reasons most lenders will be quite reluctant to take acceleration action against previously performing borrowers solely as a result of Covid-19.
Whilst lenders may be reluctant to invoke any such breach or event of default in order to accelerate repayment of their loans, that is not the only problem which such breaches or events pose. For example, many working capital facilities impose drawstops (i.e. preventing the borrower from rolling over its loans or making fresh drawings) where there is an uncured and unwaived event of default. Also, such breaches or events of default – if not expressly waived by the lenders – could trigger cross-defaults (and therefore termination rights) under the borrower’s other key commercial contracts. Therefore, a borrower may find that mere forbearance on the part of its lenders is insufficient to address these problems and that an express waiver from those lenders may be necessary.
Distressed debt purchases
A further point to note is that a borrower in financial difficulty as a result of Covid-19 whose debt is either freely transferable (or transferable with limited conditions which are easy to satisfy) could present opportunities for distressed debt purchasers, and that a purchaser of distressed debt may be more likely to call an event of default than a traditional high street bank lender.
Tags: coronavirus, corona, COVID-19, virus
Jonathan Porteous
Andrew Dodds