COVID-19: How crisis-resistant are financings?
Many companies are currently facing major challenges due to the corona virus (COVID-19). If these should lead to negative economic developments, it is advisable to take a closer look at certain provisions in financing agreements. These often contain clauses that entitle the lender to terminate and accelerate the financing if a material adverse effect occurs. Borrowers are often obliged under financing agreements to comply with certain financial ratios. Furthermore, banks are usually entitled under their general terms and conditions to terminate the loan agreement for good cause if the financial situation deteriorates or is jeopardised. However, even in the event of a breach of contractual obligations, it must be verified in detail whether a financing agreement can actually be terminated prematurely.
If loans have not yet been disbursed or have not yet been fully disbursed, it should be assessed whether such disbursement may be refused under certain circumstances.
In addition, it seems advisable to take preventive measures for possible absences of employees who are responsible for the operational tasks in connection with the financing agreements.
Governmental aid measures have now been introduced for affected companies.
Existing financing agreements
Material Aversed Change (MAC)
Financing contracts contain MAC clauses in different forms. Generally speaking, these clauses refer to events or circumstances that have certain material adverse effects, se.g. on the ability of the borrower to meet its obligations under the financing agreements or, more generally, the business, financial position or results of operations of the borrower (or the borrower's group). In case such an event or circumstance occurs, the lender is usually entitled to terminate the financing agreement.
Whether the effects of the corona virus constitute a material adverse effect pursuant to the respective MAC clause depends on the specific effects on the borrower (or the group) on the one hand and on the wording of the respective MAC clause on the other. It should be noted in particular that some MAC clauses refer to material adverse effects that are threatening. However, the lender's right to terminate the agreement is limited by law. For example, clauses granting the lender a termination right that is not linked to objectively justified reasons are invalid.
Deterioration of the financial situation of the borrower
Unless the respective financing agreement already provides for a right of termination by the lender in the event of deterioration of the financial situation of the borrower, general terms and conditions of banks (if applicable) usually entitle the lender to terminate the financing agreement if the financial situation of the borrower or another obligor deteriorates or is endangered and the fulfilment of obligations towards the lender is thereby jeopardised.
Accordingly, if COVID-19 or the measures taken in connection with COVID-19 cause such effects on the financial circumstances of the borrower or another obligor and either the finance contract or the general terms and conditions provide for such an event of default, the lender might have the right to terminate the finance contract. There are usually no "force majeure" clauses in financing agreements according to which the borrower could invoke a "force majeure" event in order to avoid such termination. However, the lender can only terminate the financing agreement for objectively justified reasons.
Under financing agreements borrowers are often obliged to comply with certain financial ratios (such as debt service coverage ratio or net debt to EBITDA ratio). Such financial ratios reference a certain benchmark with, for example, EBITDA of the borrower (or the borrower’s group). Should the effects of the coronavirus lead to a reduction in the sales and/or revenues of the borrower (or other companies of its group), there could be a breach of such financial ratios. Besides the lender might having a termination right in the event of a breach of financial covenants, the financial covenants may also have an impact on the interest rate. It should therefore be examined whether
- adjustments to or revisions of the EBITDA can be made, for example, due to extraordinary expenses or one-off effects,
- existing buffers are sufficient to absorb the effects of COVID-19
- effects of COVID-19 on future review dates continue to affect the financial measure(s) in backward looking tests; and
- the parties have agreed on cure rights for non-compliance with such financial covenants.
There is no general rule that financial ratios (or other contractual provisions) do not apply in case of force majeure. Therefore, borrowers should analyse different scenarios at an early stage and proactively seek discussions with the lender before a (threatened) breach of financial covenants and request alternative measures such as a (temporary) waiver by the lender of financial covenants or a reassessment of financial covenants (i.e. an amendment of the credit agreement).
Particularly in economically difficult and uncertain times, borrowers should take care to comply with repeated representations and ongoing undertakings.
In credit agreements, a business day is generally defined as a day on which banks are open for general business at the locations specified in the credit agreement (and which is also TARGET2 day). It is currently uncertain whether banks will be closed temporarily in the course of the corona crisis. It also seems possible that extraordinary holidays will be introduced. This might change the deadlines provided for in the credit agreement.
Future loan disbursements
According to many financing agreements the lender is only obliged to disburse the loan if no event of default under the financing agreement has occurred or threatens to occur. Accordingly, if the lender could terminate the financing agreement due to a material adverse effect, the lender would not be obliged to make (further) disbursements. Similar provisions are often found in commitment papers, according to which the granting of a loan is subject to the condition that no material adverse change occurs before the date of the loan agreement. However, even if no such provisions were agreed, a lender could be entitled by operation of law to refuse to grant or to disburse the loan in case of a deterioration of the financial situation of the borrower or a devaluation of collateral so that the repayment of the loan or the payment of interest is jeopardized even if the collateral is realized.
It is therefore advisable to examine the consequences of COVID-19 on the future loans and disbursements.
Further so-called "market flex" provisions in syndication letters or commitment papers, which give the arranger the right to change commercial (or sometimes other) conditions, should be assessed in detail in times of volatile financial markets.
Preventive measures for employee absences
Borrowers have numerous ongoing obligations under financing agreements and the lenders may terminate the agreement in case of a breach of such obligations. Besides certain information obligations, payment of interest and capital often has to be made on an ongoing basis. In the event of absences or home office of responsible employees, it should be verified whether other employees are familiar with the tasks and procedures in connection with the financing agreements and whether any necessary bank transfers can also be made from home.
If companies are already affected by the consequences of the coronavirus or if this is foreseeable, it seems advisable to seek early discussions with the financing banks. The expected economic situation of the company and the measures planned by the company should be addressed candidly and actively in order to strengthen the reliance of the banks in the company's crisis management. In addition, the involvement of a commercial bank is usually required in order to benefit from governmental support.
In this situation, companies in particularly affected sectors need state support. We have briefly summarised the current status of support programmes (13.3.2020) for you.
Please note: This newsletter merely provides general information and does not constitute legal advice of any kind from Binder Grösswang Rechtsanwälte GmbH. The newsletter cannot replace individual legal consultation. Binder Grösswang Rechtsanwälte GmbH assumes no liability whatsoever for the content and correctness of the newsletter.