Coronavirus: Implications for borrowers and lenders

The impact on turnover of the current lockdown, and the increasing prospect of a Coronavirus-induced recession, mean that it is only a matter of time before many businesses are likely to default on their loan facilities.  Lenders and borrowers alike will need to consider carefully the options open to them.  In the current climate banks will face reputational pressure to accommodate payment holidays and debt restructuring; borrowers should act swiftly to take advantage of this, whilst considering carefully any terms proposed.  This note highlights the main issues of which both parties should be aware.

Default trigger

The most likely default event is a failure to pay interest or principal.  Borrowers should, however, be aware that even if they are able to service interest for the next few months, they may well already be in default.  Most facility agreements incorporate detailed financial covenants and so-called “cross-default” clauses whereby a default is triggered by a failure to repay third party debt. 

A dip in turnover, or a deterioration in the value of underlying assets, may therefore automatically lead to a breach of the facility terms even if the debt continues to be serviced.  Moreover, any delay by a borrower in providing regular financial information required by a lender is likely in itself to constitute a breach.

Even short form facility agreements with no specific financial covenants usually include a “material adverse effect” clause, whereby the existence of any circumstance likely to impact adversely on a borrower’s ability to service the facility will constitute a breach.  Whilst few lenders would seek to enforce their security on the basis of this alone, many will no doubt seek to open discussions with their customers due to the fact that few businesses are likely to avoid the material adverse effect of the current crisis.

Restructuring options

Given the above implications of loan terms, it would be commercially sensible for businesses who anticipate experiencing payment difficulties to initiate a conversation with their lender before matters get out of hand. Banks will not have unlimited scope or resources to reach agreement with all of their customers, and those who are first in line, and who have a realistic prospect of trading through the current crisis, are likely to be able to negotiate the most advantageous terms.

Most borrowers are likely to request a payment holiday or loan extension.  If agreed, they should ensure that they fully understand the terms proposed.  For example, following expiry of the payment holiday, any periodic payments will usually be increased to ensure that the loan is repaid in full by the end of the loan term – will the business have sufficient cash flow to manage those payments?

Any extension of the loan term may well be conditional on payment of a fee, part-payment of the facility or an increase in the interest rate.  Any borrower with a number of facilities should consider whether any such terms constitute a cross-default under their other finance documents.  Any restructuring is likely to require the agreement of all lenders.

Any lender faced with a default scenario (whether an obvious payment default, or a wider default such as a failure to provide financial information) should communicate with the borrower at the earliest opportunity.  They should clearly reserve their right to take action as a result of the breach (failure to do so may well result in an implied waiver) while also clearly informing the borrower of the steps they are required to take (whether providing information or suggesting a revised payment plan), and relevant timescales, in order to avoid an immediate enforcement.

Lenders and borrowers who negotiate carefully and transparently, with a clear knowledge of the underlying loan terms, are more likely to achieve a successful restructuring package.

If you or your business require information regarding debt restructuring, please call our Banking and Finance Partner, Philip Round, on 07826 906849 or e-mail him at pround@georgegreen.co.uk for advice and assistance.