The Covid-19 pandemic has affected almost every corner of the economy with little if any businesses immune to the effects. The lessons learnt from the credit crunch means lenders are better capitalised and the funding undertaken with more due diligence and better structuring.
The closure of a vast number of public facing non-essential businesses in the UK and the UK government’s temporary requirements that landlords cannot forfeit leases and, soon to be law, restrictions on serving statutory demands on tenants in relation to failure to pay rent has meant that rental and operating income for many assets has dropped significantly and in some sectors (such as hotels) to zero. Even the best deals are being affected significantly.
The Bank of England and the FCA have put out statements that banks should support their customers and in relation to firms which lend to commercial borrowers (which is generally unregulated by the FCA and the PRA) they have recommended they do the same.
The problem is that no one knows how long the pandemic will last and when life will return to normal. This poses a difficult problem for lenders and borrowers in negotiating concessions to the terms of their loans. Lenders have been inundated by a deluge of waiver requests from borrowers and with no precedent of how you deal with a waiver for a situation which presently has no clear end is causing many lenders and borrowers to have to feel their way through in the dark.
What types of clauses are being discussed between parties in the loan agreements? The main ones include:
- Amortisation and interest payment – if you have no income or it has been greatly reduced then there will be an inability to make these payments and so a payment holiday may be needed
- Financial covenants – with greatly reduced income it will be difficult to meet standard debt service covenants and, whilst the next test may be months away, all parties know now that they will probably not be met
- Cessation of business – most loans contain a clause where if a borrower ceases to operate all or a material part of the business it is an event of default
- Material Adverse Effect – the subject of much debate over the years since the days of WPP’s attempted use of MAE to pull out of a deal in the early 2000s. What is enough to trip a material adverse effect, is Covid-19 material enough?
What are borrowers typically asking for?
- Deferment of interest payments for a period with such accrued interest then being amortised over a lengthy period thereafter
- Waiver of amortisation requirements for a period
- Temporary waivers of certain breaches and defaults
- Extension of termination dates where the loan is due to expire in the near future given the present lack of refinancing opportunities
- Wavier of the annual valuation
- More flexibility in relation to operational undertakings which cannot be met under the current circumstances. These could include everything from the provision of financial accounts to obligations to spend FF&E expenditure for hotel businesses
The question most often debated at the moment is how long the waivers/concessions should be put in place for. Without a clear end to the pandemic the general approach being taken presently by lenders appears to be a short to mid-term waiver and then revisit the situation at a future point.
The other side
Whilst the temporary waivers provide comfort to borrowers, many will know that the road back will take a lot longer and they will hope that the government guidance and existing support by the lenders will still be there then.
When we reach the other side of this crisis the economy is going to look materially different to before and it is likely more permanent solutions will need to be found to put loan agreements onto a footing that will work for the new world.