During these unsettled times, there is heightened concern around the implications for borrowers under their secured credit facilities. Broadly these fall into three categories: (1) drawing funds under existing committed credit lines; (2) obtaining permission to access additional liquidity from the Government or Sponsors/Shareholders; and (3) the impact of the crisis on financial covenants:
1. Utilising Facilities
There are concerns for businesses in ensuring sufficient cash balances to meet their future payment obligations (to employees and suppliers and to maintain supply chains etc.). New commitments at this stage of the crisis are unlikely to be sanctioned. However, subject to assessing the adverse impact of additional borrowings on leveraged financial covenants, there is some merit in utilising available undrawn commitments under revolving credit facilities (RCFs). Funds can be held on deposit and then repaid if not required to be used, but there may be problems that arise drawing funds in the future (either as a result of availability or a change in circumstances creating a drawstop). So it is worth borrowers actively considering doing this now.
RCFs are a ready form of liquidity for businesses. Typically the requirement for drawings under RCFs is that there is no “Default” continuing. A “Default” may arise for a number of reasons, but in the current circumstances we consider that the biggest barrier to a drawing being made will be if the RCF lenders allege that there has been or is reasonably likely to be a material adverse change on the group as a result of a “Material Adverse Effect”. This definition is hotly negotiated by borrowers within a facilities agreement and relates to circumstances where there is a material impact on the business or financial condition of a Group and/or its ability to meet its payment obligations under the facility agreement. This definition can often be wider and there is scope to argue that a severe contraction in the economy and/or a borrower’s business as a result of COVID-19 will constitute such a circumstance.
Once borrowed, RCF drawings are typically only repayable (out-with the expiry of the facility) upon a Declared Default and therefore will roll automatically on each interest period.
The other option available to a number of borrowers, is to draw down funds available under committed acquisition or accordion facilities in order to refinance cash balances of the borrower group used to make acquisitions or fund capital expenditure. These are often only subject to leverage tests and so can be a ready form of liquidity.
2. Accessing Additional Liquidity
The UK Government has pledged to make available the following financial accommodation to businesses:
(a) a Covid Commercial Financing Facility (CCFF), operated by the Bank of England on behalf of HM Treasury, will be available to all companies making a material contribution to the UK economy, and can demonstrate they were in sound financial health prior to the coronavirus shock. The CCFF will provide up to £330bn worth of funding by purchasing commercial paper of up to one year maturity and is available even if a business has not issued commercial paper before; and
(b) a Coronavirus Business Interruption Loan Scheme (CBILS), operated by the British Business Bank, will offer small and medium sized businesses a government-backed 80% guarantee on loans up to £5m. The loans will have an initial 6 month interest-free period and be originated by one of the scheme’s accredited lenders but guaranteed by the UK Government. The loans will be available to those businesses with a maximum turnover of £41m per year which operate in eligible sectors. Further eligibility criteria requires the businesses to be viable but otherwise unable to obtain finance in the market.
Whilst the trend in leveraged facilities in recent years has been to permit borrowers the right to access more borrowings (either based on a ratio limit or with fixed amounts subject to a “grower” element pegged to Adjusted EBITDA), all debt facilities have some form of cap on borrowings. This would extend to any loans or repayable grants borrowed from the UK Government/Bank of England and/or British Business Bank/Accredited Lender (Support Lenders). A majority of lenders under a borrower’s debt facilities (typically 66.67%) would need to consent to these additional borrowings.
We would hope, at this difficult time, there will be accommodation made by lenders to facilitate borrower’s accessing additional liquidity - especially if third parties are willing to provide that gap funding. However, there are some specific considerations in relation to this:
(a) It is not clear which businesses may access this funding. Current guidance states that it will be made available to “fundamentally strong” businesses, but the final criteria for lending has not yet been released. We consider it likely that credit ratings will be taken into account when making that determination, but we do not know if eligibility will be assessed on a wholly objective or subjective basis (or a combination of the two). If the former, we do not know if the tests will also take into account consolidated net assets or leverage multiples or just be an analysis of available working capital (or rely on ratings to assess this). There may be some exclusions that apply depending on the availability of capital which can be injected by sponsors/shareholders. Clearly there is likely to be some subjectivity linked to the importance of the business to the economy or society (for example, care homes or logistics companies). This will become clearer in the coming days. Clarity will also be needed on the timing of obtaining a rating or an updated rating if one is required for those who have not previously issued commercial paper previously.
(b) If support funding is made available, it is not clear on which terms these loans will be advanced, when they will be required to be repaid and what, if any, rights will be attached to the loans once they are repayable. Control (and the potential loss of it) is always key for lenders when considering making decisions in respect of participations. The potential loss of it to a Support Lender may be a key consideration in whether or not they give consent or the terms of consent. It may be that the terms imposed by a Support Lender are more permissive than the consent conditions imposed by lenders (for example, whether they insist on additional sponsor/shareholder funding at the same time).
(c) On enforcement or insolvency, it stands to be determined how these loans will rank against secured creditors and/or other unsecured creditors. Of particular interest will be if the advances are deemed to be preferential creditors in insolvency processes.
Another source of additional liquidity is the injection of cash from Sponsors/Shareholders. This is typically permitted under secured credit facilities without impact on group financial covenants or other limitation (provided that the mechanism for subordination is adhered to). Whilst the right to inject funds is generally permissive, the ability to repay them in advance of the repayment of secured credit debt is less so. Lenders do give enhanced rights to Sponsors/Shareholders to advance funds for particular purposes with recall rights better than the 2x-2.5x Permitted Payment right a number of facilities have and we see no reason why they would not be as accommodating in the current environment.
This new Sponsor/Shareholder financing can be injected in advance of a quarter date so as to preserve rights under equity cure provisions. It creates a pre-cure for a net leverage test by increasing balance sheet cash (and thus reducing net debt) without requiring prepayment of the debt facilities. If the borrower has a gross leverage test, then monies can still be used in order to prepay facilities and reduce leverage (to offset any short-term reduction in EBITDA), however, this prepayment will not solve the underlying concern of businesses about have additional working capital. Equity cure provisions are always available and can be drafted in a borrower-friendly manner (for example, not requiring the prepayment of debt and/or adding injections to EBITDA). Monies generally do not need to be injected until 10-15 business days after the delivery of a compliance certificate – which is delivered 30-45 days after the end of a financial quarter. For the end of March quarter date, then businesses should consider if they need to exercise their equity cure rights during mid to late May.
It is worth considering, as well, how any new Sponsor/Shareholder funding will rank against pre-existing investor and management debt and what consents are required from management to make that injection. Typically we would expect emergency funding rights under shareholder agreements to permit an injection of additional funding where it was required to stave off a default under the secured credit facilities. Obtaining priority ranking against other unsecured creditors in those circumstances is a matter of deeper consideration.
3. Financial Covenants
As noted above, the ability to draw down surplus cash under available lines immediately will be limited by headroom under financial covenants. This will not be an issue where the leverage test is calculated on a net basis as the cash balance will neutralise the additional borrowings, however, it will be different under a gross test. Sponsor/Shareholder injections will generally always be excluded from debt calculations and therefore be neutral for the purposes of a gross leverage test (but provide working capital) and beneficial for net leverage tests.
Cashflow covenants can generally be adjusted by adding-back injected funds where spent on Capex and Acquisitions in the last twelve months.
Of greater concern for businesses will be the increased expenditure associated with the current pandemic and associated economic conditions on maintenance financial covenants. We would expect, in these circumstances, that additional expenditure can be categorised as “Exceptional Items” given it will be non-recurring and/or exceptional in nature. Whilst facility agreements generally have a list of items which are considered between the parties to fall within that categorisation, the definition of “Exceptional Items” is typically non-exhaustive and it is therefore for CFOs – along with their auditors – to make a determination on what is permissible to be included based on the borrower’s applicable accounting principles.
Furthermore, we would anticipate that borrowers who have the ability to pro-forma cash savings or synergies through a group as a result of a restructuring event or more generally for re-organisations, should consider whether costs arising from the crisis can be used to ameliorate the impact on financial covenants.
We would be happy to discuss your financial covenants with you to provide analysis on levers that can be pulled to mitigate any negative impacts. Nevertheless, we would recommend seeking accounting advice regarding this so that you have a firm grasp on what add-backs you can make to ensure that the effects are limited.
Finally, we would recommend considering terms on which lender transfers can occur. It was a key concern of businesses under pressure during the global financial crisis of 2008/9 that loan-to-own lenders would acquire their debt well below par and seek to enforce the attached security in order acquire the Sponsor’s/Shareholder’s equity upside when the trading environment improved. We have not yet heard rumours of this being the case. Certainly the profile of lenders is different as debt funds form a core part of the market and they are subject to less stringent obligations dictated by the public markets, so it may not be as keen an issue in this crisis. Further, consent rights on transfer are often stronger in the current market than they were then so that may reduce relevance. Notwithstanding this, it is worth considering the terms of transfer provisions as a precaution.
In respect of the above, and all other questions or concerns you may have on your debt facilities, then the team at Goodwin is available at any time to assist. Further, in the unfortunate event that you have genuine concerns about the impact of this situation on your business or investments, then we have a team of restructuring and insolvency specialists able to advise you on director duties and best practices.
Please contact us to review or continue the discussion.
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Simon ThomasPartnerFinancial Restructuring, European Offices