The impact of Covid-19 on the general economy will have a number of implications for lenders and borrowers under existing financing arrangements. These implications will potentially have an effect lasting beyond the current lockdown that is impacting the economy.
On 18 March 2020 the Minister for Finance issued a statement after meeting with the five (5) main banking organizations (Allied Irish Banks, Bank of Ireland, KBC Bank, permanent tsb and Ulster Bank) and representatives of the Banking and Payments Federation Ireland to announce short term measures for the market to assist borrowers. Among the measures announced were:
- three-month payment breaks; and
- the deferral of court proceedings for three (3) months (although the statement does not make it clear if the deferral applies to new proceedings being issued against borrowers or those already in existence).
There is no certainty that these arrangements will be rolled over after the expiry of this initial period.
Because of this uncertainty lenders and borrowers need to review the terms of financing agreements in place and assess where issues may now arise.
Common Provisions in Financing Agreements At Issue
- Financial Covenants: reduced cashflow for borrowers may result in a breach of financial covenants in a financing agreement
- Missed/Reduced Payments: borrowers may not be able to meet scheduled interest payments or scheduled capital repayments
- Cessation of Business: the stopping of business activity as a result of the Covid-19 restrictions may result in a breach of covenant in a financing agreement and in certain cases deemed insolvency on the part of a borrower
Information Covenants: practical difficulties may arise with finalization of accounts for borrowers and their delivery to lenders under information covenants in a financing agreement
- Asset Protection: the impact of the Covid-19 restrictions may prevent effective asset management and protection measures being put in place by borrowers that result in a deterioration in asset value and security value for lenders. The most obvious arena where this arises is in the property market where borrowers may not be able to carry out necessary repairs and maintenance to buildings to preserve or protect structural integrity
All business sectors not involved in “essential services” will be experiencing a significant downturn in turnover. This could lead to a breach of a financial covenant under a financing agreement. Where financial covenants are breached the three main actions that could be taken to remedy that breach are:
- an equity cure by the borrower with the injection of cash to remedy the breach. Equity cure rights are usually set out in the financing agreement and there may be limits on the number of times that a borrower can avail of this right to remedy (or cure) the breach. Where an equity cure right is not provided for in a financing agreement a borrower would need the lender’s consent;
- a waiver of the breach of financial covenant by the lender. A lender will normally reserve its rights in giving such a waiver so that it is not deemed a general waiver of future breaches of financial covenants; or
- re-gearing or amending the financial covenants to reflect the revised norm which would require the consent of the lender.
Given the uncertainty around the impact and extent (time) of Covid-19 restrictions on the economy in general lenders may be wary about consenting to the re-gearing or amending of financial covenants if there is a likelihood that there will be another breach on the next covenant testing date in the financing agreement
A reduction in cashflow for borrowers may mean that scheduled interest payments or scheduled capital repayments are not met in full or at all.
Lenders may consider waiving a payment default or granting forbearance but only on the basis that borrowers can evidence how the missed payment is to be made good or caught up on. Usually this will entail the borrower submitting revised financial projections and indicating the measures the borrower is implementing in its business to ensure that any missed payment is a one off event.
Lenders may also consider varying repayment obligations under a financing agreement if the business case produced by a borrower to support this shows the lender that repayment capacity exists. It is however likely that any variation of repayment obligations by lenders will be temporary in nature.
If the information produced by a borrower suggests to lenders that a business will continue to underperform and not have a repayment capacity then lenders may be forced to declare an event of default under the financing agreement and look to enforce the security held. However this step may have capital maintenance consequences/considerations for lenders that need to be borne in mind.
Most financing agreements secured by property will have covenants requiring borrowers to keep the property in good repair and not to allow anything happen to the property that diminishes its value as security to the lender.
The Covid-19 restrictions may prevent effective asset management and protection measures being put in place by borrowers to comply with this covenant.
Whilst certain damage to property may be covered by insurance normal repair and maintenance will not.
The Emergency Legislation that has been passed does not expressly restrict a lender’s right to take enforcement action against a defaulting borrower. The measures contained in the statement by the Minister for Finance on 18 March 2020 are voluntary on the part of the lenders (together with the eight additional lenders covered by the subsequent statement from the Banking and Payments Federation Ireland) and are not legally binding.
As such lenders can enforce security for breach of financing agreements by borrowers notwithstanding the impact of the Covid-19 crisis. Weighted against this however is the position of the Central Bank of Ireland which has stated that it expects all regulated entities to take a consumer-focused approach and to act in the best interests of their clients.
Borrowers with reduced cashflows and consequently a decreasing ability to meet payment obligations and comply with financial covenants are more likely to request an increase in their facilities from lenders to assist their financial position.
Lenders will need to consider the particular borrower’s position and the challenges facing each borrower.
Lenders may be able to accommodate requests of this nature from borrowers under existing financing agreements (particularly if there are undrawn commitments).
Lender considerations around requests of this nature will include:
- is there any risk of default or an event of default occurring?
- will the borrower be in a position to meet financial covenants in light of increased leverage?
- will waivers of defaults or payment forbearance be needed in the short term?
- what other measures is a borrower taking to protect its business and cashflow?
- how long will the debt be made available for and how will it be repaid?
- should additional security/collateral be sought from the borrower?
- are there alternative options available to the borrower?
New or additional facilities will entail amendments to existing financing agreements.
Lenders will also need to assess how new or additional facilities are to be treated for priority purposes in inter-lender arrangements.
This briefing note is for general guidance only. Professional advice should always be taken before acting on any of the matters discussed. Please contact a member of our team should you wish to discuss this topic further.