A guide to the practical steps that borrowers can take when experiencing financial difficulties as a result of the COVID-19 pandemic.
Complying with existing financing arrangements
When considering how best to deal with a lender in times of financial instability, it is important for borrowers to try to achieve a compromise between their interests and the lenders.
If a borrower has concerns regarding the financial impact of COVID-19, including its business prospects, its short or longer term financial position, the deterioration of its cashflow position, and/or any other logistical barriers to running its business, then it should consider – at the earliest opportunity – the impact this may have on any of its existing financing arrangements.
When reviewing existing financing arrangements, borrowers should pay particular attention to (and assess the potential impact of) the following:
- Scheduled repayments of principal and/or interest: a borrower needs to assess whether it will have sufficient funds to make any scheduled payments of principal and/or interest due under the terms of a finance agreement.
- Representations and warranties: finance agreements will often include “representations and warranties”. Representations and warranties are factual statements that are made by the borrower before entering into a loan in order to help the lender determine the level of risk involved in lending the money. Typically the borrower must “repeat” these statements during the term of the loan to confirm that the statements are still true. If a borrower’s circumstances change, it should assess whether the representations and warranties will remain true when it next needs to repeat them.
- Covenants: a covenant is a promise made by a borrower that certain actions will (or won’t) be taken or that certain targets or thresholds will be met. Covenants can include financial covenants (e.g. maintaining acceptable loan-to-value ratios), information covenants (e.g. promises to regularly deliver financial accounts to the lender), and general commercial covenants (e.g. restrictions on the borrower’s ability to take on additional debt or sell certain assets). Borrowers should monitor these covenants carefully to check whether they can continue to comply with them.
Missing a scheduled payment, making a false representation or failing to comply with covenants contained in a finance agreement can have serious consequences (as outlined in more detail in the “Consequences of non-compliance with a finance agreement” section below).
If a borrower is concerned that it might struggle to make any scheduled payments on time, repeat any representations or comply with any covenants, it should:
- Check whether its finance agreements contain any grace periods (which might afford additional time to fix any actual or potential breaches) or cure mechanisms (which might explain how the borrower can adequately remedy a breach) and if so, assess whether these mechanisms could help in the circumstances; and
- Consider whether there is a requirement to notify the lender of any breaches or potential breaches. If there is such a requirement, the borrower should notify their lender at the earliest opportunity following an actual or potential breach and explain any action being taken to fix or remedy the situation. For finance agreements that permit multiple drawdowns of loan capital, a breach may give the lender the right to refuse further drawdowns.
- Discussing any potential issues with the lender at an early stage will usually lead to a more positive outcome (e.g. an extension of the loan term or payment holiday in respect of principal and/or interest). Once the lender has been notified of a breach or potential breach, it will likely want to assess whether the issue is of a short term nature and whether it needs to take immediate steps to protect its position but often it will try to work with the borrower to ensure an outcome that benefits both parties.
Consequences of non-compliance with finance agreements
A finance agreement will set out the steps that a lender is entitled to take if the borrower commits a breach of the terms that is significant enough to amount to an “event of default”. Finance agreements will specify what constitutes an “event of default”, and this will usually include missing scheduled payments, making false representations and failing to comply with certain covenants. We have set out below some of the key rights that may arise for lenders under such circumstances.
Restrictions on borrowing
Following an event of default, finance agreements will typically entitle a lender to:
- Preclude the borrower from drawing down any further funds that might otherwise have been available under the terms of the finance agreement;
- Stipulate that moving forward, the loan will be immediately repayable on the lender’s request;
- Actually demand that all amounts due under the finance agreement be repaid immediately, including the loan principal and any accrued but unpaid interest, fees and costs; and/or
- Take steps to enforce any security granted or guarantees given to the lender in support of the finance agreement.
Reservation of rights
If a breach has occurred or is likely to occur, lenders may issue a “reservation of rights” letter to the borrower. Such letters do not automatically mean that a lender will enforce its rights; instead, these letters formally notify borrowers of the breach(es) and reserve a lender’s right to take action in relation to such breaches in the future.
This buys the lender time to properly determine whether any action should be taken, whilst preventing the borrower from later trying to assert that the lender’s initial inaction constituted an implied waiver of its rights.
Following a breach, a lender may also request additional financial or other reports in order to inform its assessment of the borrower’s circumstances. We would advise that a borrower fully co-operates with its lender under such circumstances, including commencing an open and honest dialogue.
While it is often better for a lender to support a borrower through a period of short-term financial difficulty, lenders will need to put in place contingency planning in case the borrower’s financial position deteriorates (and additional requests for information may form part of this process).
Potential solutions to short-term cash flow issues
In times of economic uncertainty, lenders generally take a pragmatic approach to supporting their borrowers and will often only look to take formal enforcement action as a last resort. If a lender has satisfied itself that any cash flow issues experienced by the borrower are only short-term or that restructuring the debt would likely ensure the viability of the borrower’s business in the long term, then it may consider one or more of the following measures to alleviate the immediate financial pressure on the borrower:
- Repayment holidays: lenders could offer temporary “repayment holidays” that allow borrowers to cease making interest payments and/or capital repayments for a limited period of time. Such repayment holidays should be formally documented, clearly setting out the duration of the break. Borrowers should be aware that payment holidays do not involve lenders waiving payments that would otherwise have been due under the loan; lenders are simply agreeing to pause repayments, and interest will continue to accrue on the balance of the loan during the repayment holiday.
- Reducing amortisation: if a loan has been provided on an amortising basis, the repayment schedule could be amended to reduce the amount of the actual loan that is being repaid by the borrower on each payment date (e.g. monthly/quarterly). However, borrowers should be mindful that the overall amount of interest charged in respect of the loan will increase, because the loan will be repaid – and thus the interest will accrue – over a longer period of time. Note that any amendments to the amortisation schedule should be clearly documented.
- Further lending: another option would be for the lender to lend additional funds to the borrower to help it through its short-term financial issues. A lender is likely to only consider this if it is comfortable that the borrower’s financial position will improve to the extent that it will subsequently be able to repay both the original and additional debt. However, lenders may ask for additional security and/or guarantees before agreeing to lend such additional funds.
- Amending the finance agreement: borrowers could also request that its lenders amend the financial covenants set out in a finance agreement to reflect the short-term cash flow issues and ensure that the borrower doesn’t repeatedly breach such covenants in the short-term. Borrowers could also request a deadline extension in relation to the delivery of financial or other information or seek waivers in respect of any minor breaches.
- Refinancing existing assets: if cash flow issues are putting a strain on a borrower’s business, the borrowermay want to consider refinancing existing assets to help free up working capital. Refinancing involves borrowing money against the value of an asset and is usually only available in respect of assets that businesses own outright. However, there may be circumstances in which lenders will enable borrowers to borrow against the value of equipment purchased on finance (e.g. via hire purchase). Refinancing arrangements can be complex and should be discussed with lenders on a case-by-case basis to determine which solutions might be available.
- Invoice financing: often, businesses may be stuck for cash when their invoicing cycle means that incoming payments are delayed for a month (or more) after they supplied the corresponding product or service. If slow-paying debtors are causing cash flow problems, a borrower may want to consider invoice financing, which helps borrowers access some of the cash they are due to receive under unpaid invoices. Usually borrowers will receive an advance payment representing a pre-agreed percentage of the full value of the invoice, meaning that the borrower’s cash flow into the business is accelerated.
Additional funding requirements
If a borrower has additional longer-term funding requirements, there are several options it could consider for meeting such additional requirements. These options include drawing down further amounts under existing facilities (if available) and/or obtaining loans from existing shareholders or directors. In either case, a borrower should consider whether taking on additional borrowing is permitted under its existing financing arrangements.
Coronavirus Business Interruption Loan Scheme
Certain small and medium sized businesses may be eligible for a loan under the Coronavirus Business Interruption Loan Scheme. Larger business may also be able to apply for the Coronavirus Large Business Interruption Loan Scheme or the COVID-19 Corporate Financing Facility. Details of these schemes are available in our “Managing Cashflow Throughout The COVID-19 Pandemic” guide (which is also accessible via www.ignition.community/blog/managing-cashflow-covid19).
As outlined above, one option for borrowers looking to alleviate financial pressure is to seek additional debt funding. As an alternative, or to compliment this approach, borrowers should also assess whether they can take other measures to manage cash flow and preserve cash more generally. For further detail on the actions that businesses can take to manage cash flow, please refer to our “Managing Cash Flow Throughout The COVID-19 Pandemic” guide (which is accessible via www.ignition.community/blog/managing-cashflow-covid19).
This short guide has been prepared for directors and owners of private limited companies for information purposes only, in particular to provide a summary of key practicalities that should be considered in the context of a borrower managing its existing financing arrangements and possible options for raising further finance. This guide does not constitute legal advice and should not be relied upon. For specific queries and any further information, please contact Ignition Law for advice relating to your particular circumstances.