Impact of the Coronavirus on Credit Facilities
The coronavirus ("COVID-19") pandemic has increased uncertainty and disrupted the economy on almost every level. The credit market is no exception with borrowers seeking to tighten up their expenditures and draw on additional lines of credit to account for the continued uncertainty in revenue and liquidity. At the same time, borrowers and lenders are considering how the COVID-19 pandemic impacts their existing credit facilities. Below we highlight some areas of credit agreements that may attract extra attention due to the COVID-19 pandemic, but each credit agreement is unique and should be reviewed carefully to ensure all applicable provisions are considered.
I. Representations and Warranties
Representations and warranties are generally made (i) as of the effective date and signing of a credit agreement, (ii) upon any new credit event under agreement and (iii) under some agreements upon delivery of required annual or quarterly compliance certificates. The occurrence of one of these events should trigger another look at the representations and warranties in a credit agreement. In particular, the following representations and warranties may be particularly impacted by the effects of the COVID-19 pandemic on a business:
- No default/compliance with material obligations: borrowers should review all other applicable contracts or credit agreements to ensure they are not in default under any such provisions;
- Solvency: borrowers should review current and future expectations as to solvency to ensure they continue to meet the required thresholds under their credit documents; lenders should review long-term solvency and business impacts to each borrower, as well as short-term solvency with an eye toward governmental intervention and the potential for a rebound after the COVID-19 pandemic subsides;
- Disclosure: borrowers and lenders should keep in mind and discuss the potential unknowns related to the COVID-19 pandemic to ensure disclosures in their credit documents are complete and accurate; and
- Financial condition of borrower/absence of Material Adverse Effect: borrowers should carefully review their financial condition as impacted by the effects of the COVID-19 pandemic and whether this has triggered a Material Adverse Effect as defined in their credit documents.
II. Affirmative Covenants, Financial Reports and Notice Requirements
Covenants regarding reporting obligations and deadlines should be reviewed to ensure adequate time is provided for remote compilation of financial reports (in particular, audits which have historically been done onsite) and additional revisions due to the continuously changing effects of the COVID-19 pandemic. When an officer certificate is required, the signing officer(s) should ensure they have enough time to adequately review the accuracy of such financial reports. Additionally, a borrower who intends to utilize an extension provided by the Securities and Exchange Commission for any reporting requirements should ensure such action would not trigger a breach or default under any credit documents.
Borrowers should also review any required budgets and similar financial statements that have been previously submitted to auditors or lenders. Adjustments or additional footnotes should be considered, especially for budgets or projections prepared before the onset of the COVID-19 pandemic which may now be inaccurate. Projections or financial statements yet to be submitted should include disclosure as to anticipated short- and long-term effects from the COVID-19 pandemic. In some cases, auditors have been including more "going concern" qualifications in response to the COVID-19 pandemic and financial uncertainty which may trigger an event of default or breach under some covenants.
As a general reminder, borrowers should review notice requirements, especially those that might relate to changes in credit ratings, events that could have a Material Adverse Effect, breaches in material contracts or defaults under other credit arrangements. At the same time, lenders are reminded to review their inspection rights or simply request from their borrowers additional information in order to make informed decisions.
III. Negative Covenants and Financial Covenants
Borrowers with specific leverage ratio requirements or requirement baskets based on leverage ratios should review these requirements in detail, including the associated tests and time periods. Agreements with financial covenants containing maintenance tests are typically tested at the end of each quarter and borrowers should begin projecting the results of these tests. Borrowers should also be aware of springing financial covenants that may be tested for the first time as a result of impacts to borrowers’ financial conditions as a result of the COVID-19 pandemic. When financial covenants are based on EBITDA, borrowers should be aware of (i) the time periods over which EBITDA is calculated and (ii) when EBITDA can be adjusted or allows for expense to be added back in – such as one-time expenses, business interruption insurance and/or costs of finding replacement goods or supply chains.
Borrowers should review the specific terms of any liquidity covenants, reserve requirements or asset-based lines of credit which may be evaluated on short time periods. Where asset-based revolving credit lines are based on borrowers’ accounts receivable and/or inventory, borrowers may seek to anticipate how the COVID-19 pandemic may affect or reduce funds available under such credit lines.
IV. Material Adverse Effect Clauses
As noted above, both borrowers and lenders should carefully review any Material Adverse Effect ("MAE") clauses contained in a covenant, representation or warranty of their credit agreements. Enforcement of such clauses are typically specific to individual facts and circumstances. MAE case law has focused on continued good faith efforts of a party prior to seeking enforcement of an MAE clause and emphasized that the financial impact must be "durationally significant." Each MAE clause should be reviewed based on its specific language and, at the current time, it may be too soon to know if the COVID-19 pandemic will be "durationally significant" for a particular business.
V. Events of Default, Suggested Solutions and Important Discussions
Lenders should begin to discuss with borrowers the likelihood of an event of default such as a payment default, breach of a covenant or a default under other credit arrangements. Lenders may consider giving borrowers a holiday on delivering audited financial statements free from "going concern" qualifications and/or the right to extend deadlines by 30 to 60 days without resulting in an event of default or breach.
Borrowers with financial covenants can ask to be allowed to add back lost revenues or make calculations without giving effect to the impacted period when appropriate to avoid an event of default or breach. Borrowers can request to be allowed to temporarily add equity capital, usually called an equity cure, for current and/or upcoming quarters to prevent an event of default or breach, if not already provided for in their credit agreements. Additionally, any borrower who anticipates governmental relief should ensure that such relief would be allowed under their credit documents and ensure that such proceeds are properly accounted for in applicable covenant calculations.
Further, it is important to consider that borrowers seeking forgivable loans under the CARES Act should review their existing credit facilities to determine whether any restrictions on the incurrence of additional debt need to be waived by their lenders.
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Sullivan has developed a rapid response team of attorneys to help our clients and our communities cope with the impact of the COVID-19 pandemic. Please refer to Sullivan’s resource center at sullivanlaw.com/COVID19 for more information and for access to Sullivan’s library of related advisories.
Please know that Sullivan is focusing substantial efforts to provide assistance to businesses and individuals affected by COVID-19. If you have questions about how to move forward and navigate the novel legal issues raised by COVID-19, please contact your primary Sullivan attorney or send a message to CARES@sullivanlaw.com.