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Published 20 marzo 2020
The full economic fall-out from Covid-19 is still to be seen but it seems clear that businesses directly or indirectly involved in (among many others) the travel, leisure, hospitality and retail sectors are going to be hard hit.
This briefing sets out some high-level considerations for borrowers to assist them in considering the impact of the business disruption from the Covid-19 outbreak on their debt financings. It is not intended to be focussed on any one particular product or sector nor does it constitute an exhaustive analysis of every point to be considered.
We would be happy to arrange a call to go through this and other questions you have on this briefing or other debt financing related issues (including product specific questions) in further detail.
Cash is king
Even in good times, liquidity is an important issue for most businesses but in times of economic uncertainty liquidity is one of the most critical considerations. The hit to consumer demand resulting from the Covid-19 outbreak will likely result in material operating cashflow reductions for some businesses.
Access to debt facilities is usually conditional on the absence of continuing defaults at the time of drawdown and the accuracy of a suite of representations (including, in some cases, as to the absence of any events having a material adverse effect on the borrower group’s business or assets or its ability to perform its obligations under the finance documentation (referred to, broadly, as a “MAC”) and no insolvency events). “Insolvency events” are generally widely drawn and include, in addition to actual inability to pay debts as they fall due, commencement of discussions with creditors.
Potential drawstops could also affect cashless rollovers of revolving credit facilities (“RCF”). This will be particularly relevant on deals were the rollover is conditional on the absence of an event of default rather than the absence of an actual acceleration event.
Lenders under receivables-backed lending structures (e.g. receivables backed loans, invoice discounting or debt factoring lines) typically have a broad right to limit the amount the borrower can draw against the underlying receivables (e.g. by adding a discretionary reserve to the face value of the receivables). In addition, if the borrower’s underlying debtors themselves face stress and delay payment on debts owed to the borrower, this may render such debts ineligible for financing purposes and as a result further reduce the borrower’s access to funding.
The fall-out from the Covid-19 outbreak could result in a number of events of default:
- depending on the terms of the relevant build contract, cost increase claims could result in cost overruns exposing the borrower group to default risk if the cost overrun is not funded. Whether any contingency or cost savings elsewhere in the project can help here will depend on the terms of the financing.
- disruption to development programmes caused by Covid-19 (e.g. from site closure following an outbreak) could put pressure on practical completion and other milestone covenants.
- The effect of this will turn on the drafting – loosely drafted MAC clauses may extend to, among other things, an assessment of the impact of the event / circumstance on the “prospects” of the borrower group which could exacerbate a borrower’s liquidity constraints (e.g. if lenders refuse to lend under an RCF) or expose the borrower group to risk of enforcement where it is otherwise not currently suffering any material adverse impact. Apparent drafting nuances can make a difference (e.g. whether an event “has” or “could reasonably be expected to have” a material adverse effect or whether the materiality of the effect of an event is objective or subjective).
- Nevertheless, we think lenders are very unlikely to rely on a MAC event of default to demand repayment or enforce their security but they may be (relatively) more inclined to attempt to rely on it to refuse to fund under RCFs or similar lines. Any such assessment would always be fact specific.
Likely lender response to defaults resulting from Covid-19
- most lenders will tread very carefully before taking affirmative enforcement action on the basis of defaults resulting from Covid-19 (given the reputation impact of doing so); and
- other than in respect of very short term life saving fixes, lenders will require management information on the impact of Covid-19 and borrowers should provide this with any waiver / consent request to pre-empt the dialogue.
Other documentary considerations
Practical and other considerations
Borrower liquidity considerations
Borrowers might consider addressing their liquidity needs by:
What we can do to help
The DAC Beachcroft banking and debt finance team advises borrowers, lenders and other stakeholders across a range of financing transactions including leveraged and acquisition financing, real estate finance, receivables backed lending, distressed refinancings/situations and growth capital lending. Some of the areas where the team stands ready to help clients include:
Bristol, London - Walbrook
+44 (0)117 366 2445
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