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COVID-19’s Cascading Impact on Corporate Finances and Loan Obligations: Key Issues Facing Lenders and Borrowers

Posted on: April 15th, 2020

By: Jill Dunn and Travis Cashbaugh

As COVID-19 continues to disrupt financial markets and businesses across the country, now is a good time for borrowers and lenders to review the terms of any loan documents to consider the impact of recent developments on their rights and obligations. FMG’s April 16th, 2020 Webinar, COVID-19’s Cascading Impact on Corporate Finances and Loan Obligations (click here to register), will address these issues in greater detail. In anticipation of the webinar, some key issues that lenders and borrowers should consider as they navigate the COVID-19 crisis are listed below.

Events/Developments that may trigger an event of default:

  • Financial Covenants.  Financial covenants are the promises or agreements entered by a borrowing party which set out various financial marks that gauge areas such as a borrower’s liquidity and cash flow. Lenders and borrowers will need to assess the impact of COVID-19 on borrowers’ ability to comply with their financial covenants. For borrowing based calculations such as EBITDA, a drop in revenue is likely to adversely impact compliance with financial covenants leading to breach or default. For borrowers who believe a violation of financial covenants is imminent given this crisis, it might be prudent to speak with lenders about the possibility of obtaining waivers and amendments to their financial covenants.
  • Liquidity. Many businesses, because of COVID-19, are experiencing considerable cash flow and liquidity challenges. Lenders and borrowers should consider whether the loan agreement permits the incurrence of additional debt (for example, through SBA loans) to address potential cash flow issues, whether such action requires other lenders to consent, and what the related documentation process involves.
  • Material Adverse Effect (MAE). This is a covenant in most commercial loans and lines of credit in the borrower’s representations and warranties section of the loan agreement.  Through the MAE, the borrower represents there has been no circumstances having a material adverse effect on assets, business or financial condition of the borrower since the date of the parties first signing the agreement. Representations and warranties are terms considered continuous, meaning the obligations extend beyond the time the agreement is signed. Businesses accessing their lines of credit to get through the COVID-19 crisis could be in a difficult situation as they determine whether they can represent to lenders no MAE has occurred. While whether COVID-19 constitutes a MAE is fact-specific and dependent upon the language of the agreement, lenders and borrowers should review the details of any MAE and determine any necessary reporting requirements.
  • Reporting and notification. Particularly relevant to the COVID-19 crisis, lenders may require current financial statements from borrowers. With cities and states under complete or partial lockdown, some borrowers (likely growing in number by the day) will face disruption issues in the delivery of required financial disclosures/reporting to lenders that could violate the information delivery covenant. Borrowers should review their obligations to provide proper notices under the agreement and meet any deadlines by which they must deliver any such information and notices.

If a borrower is in default, it may trigger remedies by the lender.  Sometimes, such remedies can also be triggered by failure to comply with the loan covenants. Although not an exhaustive list, below are common remedies available to a lender upon a borrower’s default which may be relevant in the COVID-19 context.

Remedies available to Lender:

  • Acceleration of loan payback requirements. A borrower’s failure to issue payment when due under the terms of the agreement generally triggers an immediate event of default and gives lenders the ability to exercise acceleration rights. With the potential financial covenant and liquidity issues (discussed above) resulting from COVID-19, borrowers and their lenders should know the terms and thresholds within their agreements causing acceleration and similar loan loss provisions.
  • Receivership. A receivership occurs when a court appoints a third party to exercise independent oversight on specific assets. Given the anticipated increase in real estate and commercial disruptions related to COVID-19—likely leading to increased loan defaults—lenders will want to consider which borrowers are good candidates for a receiver; entities or people the lender will contact if a receivership becomes necessary; and the anticipated limit that, when reached, will cause the lender pursuing receivership, as opposed to other options during these highly uncertain financial times.   
  • Foreclosure.  If default occurs, particularly relevant to real estate transactions, agreements permit lenders to seek foreclosure on property or collateral identified in the agreement. Lenders may utilize foreclosure when they have concerns that if a borrower is in default, the borrower will not maintain the property, and the value of the collateral will decrease. Note however, states along with the federal government have acted through executive order and other legislation to limit home foreclosures in response to the COVID-19 crisis. Besides determining applicable state law, and considering the relationship and size of the loan, lenders should weigh the cost effectiveness of pursuing foreclosure against other options, including forbearance agreements or restructuring the loan.

Remedies available to Borrower:

  • Forbearance. Generally, in a forbearance agreement, the lender agrees to reduce or suspend payments for a period of time. In exchange the borrower must resume paying at the end of the forbearance period. Such agreements generally come in short-term and long-term forms. For short-term forbearance agreements, both the borrower and the lender believe that key issues affecting the borrower will be resolved soon. However, when cash flow problems—likely resulting from the COVID-19 crisis—are expected to last for longer periods, depending upon the relationship between the parties, a long-term forbearance arrangement might be feasible. Given the current state of affairs, lenders may be more willing to negotiate forbearance options, given the anticipated defaults and losses resulting from COVID-19. Borrowers should review their relevant loan agreements and contact their lenders to determine and agree upon any forbearance actions.
  • Modification. Modification differs from forbearance in terms of definiteness.  While a mortgage forbearance agreement provides relative short-term relief, a loan modification agreement is a permanent solution. Generally, in the modification context, a borrower seeks: principal reduction; interest rate reduction; waiver or deferment of payments; waiver of certain financial covenants; an extended-term of repayment; or conversion to a fixed-rate loan. A borrower experiencing cash flow problems regarding the COVID-19 crisis should contact its lender to see whether modification is possible.

Additional Information:

The FMG Coronavirus Task Team will be conducting a series of webinars on Coronavirus issues on a regular basis. Other topics include COVID-19’s impact on finances and loans, the FFCRA, the CARES Act and more. Click here to view upcoming webinars.

FMG has formed a Coronavirus Task Force to provide up-to-the-minute information, strategic advice, and practical solutions for our clients.  Our group is an interdisciplinary team of attorneys who can address the multitude of legal issues arising out of the coronavirus pandemic, including issues related to Healthcare, Product Liability, Tort Liability, Data Privacy, and Cyber and Local Governments.  For more information about the Task Force, click here.

You can also contact your FMG relationship partner or email the team with any questions at [email protected].

**DISCLAIMER:  The attorneys at Freeman Mathis & Gary, LLP (“FMG”) have been working hard to produce educational content to address issues arising from the concern over COVID-19.  The webinars and our written material have produced many questions. Some we have been able to answer, but many we cannot without a specific legal engagement.  We can only give legal advice to clients.  Please be aware that your attendance at one of our webinars or receipt of our written material does not establish an attorney-client relationship between you and FMG.  An attorney-client relationship will not exist unless and until an FMG partner expressly and explicitly states IN WRITING that FMG will undertake an attorney-client relationship with you, after ascertaining that the firm does not have any legal conflicts of interest.  As a result, you should not transmit any personal or confidential information to FMG unless we have entered into a formal written agreement with you.  We will continue to produce education content for the public, but we must point out that none of our webinars, articles, blog posts, or other similar material constitutes legal advice, does not create an attorney client relationship and you cannot rely on it as such.  We hope you will continue to take advantage of the conferences and materials that may pertain to your work or interests.**  

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