COVID-19 and Leveraged Businesses
This article examines the implications of the novel coronavirus for Australian businesses at particular risk due to high debt, and the free movement of consumers and goods. Steps can be taken to minimise damage to your business, including seeking leniency from creditors with a view to avoiding voluntary administration or liquidation.
The easy flow of credit (and of course cashflow) represents the lifeblood of many businesses. Credit can be obtained by way of finance pursuant to a bank loan (on the strength of projected cashflow). Bonds, a private placement and/or structured financial products are other viable means of raising capital. Private placement, otherwise known as a non-public offering, relates to raising funds by private offering of securities to a limited group of select investors without a prospectus (i.e. by offering memorandum), while structured financial products may include collateralised debt/bond obligations (CDOs/CBOs), which are a type of derivative backed by a pool of loans/other assets which become the collateral in the event of default (the classic example of CDO being the infamous MBS, but also ABS or “asset-backed securities”; CBOs include investment grade bonds backed by a pool of high-yield but lower-rated bonds). Such alternative forms of capital raising from the usual banks are favoured by guarantors who promise to reimburse investors for losses on tranches in return for the payment of premiums (i.e. finance).
An intervening event such as the coronavirus pandemic quickly throws the finely balanced operations of many businesses into something more closely resembling chaos. If the impacts are not remedied with quick action, problems can compound with dire consequences for stakeholders. Australian businesses are particularly vulnerable due to their heavy reliance on imports and exports. Highly leveraged businesses are particularly vulnerable to deteriorating business conditions, as are tourism, hospitality and retail businesses that rely on normal freedom of movement. While it may be the last thing that stressed business people want to do, they should be checking their finance contract obligations in order to minimise harm.
Cashflow, ‘MAC’ Clauses and Impacted Operations
It is essential that parties review covenants under financing agreements, as any breach may be perceived by a lender/financier as a sign of distress (with the damaging consequences that tend to follow, despite assurances to the contrary). Affected business may request a waiver of obligations for a specified period where they are unable to meet repayments, or alternatively amendment of the agreement or even the restructuring of arrangements with the lender in question. However we draw directors’ attention to their obligations, and potential personal liability (even during the 6 month reprieve), where there is a risk of insolvency and negotiations do not bring the parties to an understanding.
‘MAC’, or “material adverse change” clauses are commonly seen in the project financing and M&A areas and are inserted into security documents by lenders. They serve to apportion risk in the face of adverse economic developments which occur before completion, and may allow for termination by the parties or renegotiation. These clauses may additionally give a lender an ability to exercise rights with respect to collateral and/or project accounts, and are typically narrowly construed by the courts (the primary purpose of such clauses typically being their use by lenders for strategic purposes with a view to approaching negotiations from a position of strength). Where negotiations are ongoing, we recommend businesses ensure the immediate consequences of the pandemic do not constitute a material adverse change for the purposes of such a clause (thereby avoiding the triggering of such a clause for the benefit of the lender).
When reviewing agreements we are now placing particular emphasis upon the importance of seeking to obtain continued access to working capital wherever possible, for example by checking to see if the borrower can rollover loans and whether there are any implications regarding access to credit/facilities for the particular entity in circumstances where other companies in the group may have defaulted. Clearly agreements also need to be checked for the presence of indemnities granted by members of a group of companies on a credit facility. This last is relevant in the context of syndicated loans where a facility agent is the primary point of contact between the parties, syndicated loans being the primary method employed by lenders in spreading risk in the project financing area where large sums or specific asset classes are involved which require specialised expertise. Undertakings to give disclosure to a lender in times of financial duress should also be considered in light of present circumstances.
Covenants which contemplate addbacks where losses in certain agreed categories are anticipated should be included, and/or other balance sheet adjustments as necessary. State intervention in the ability of parties to contract freely should be monitored, as we anticipate increased interference and regulation of finance documents as government moves to mitigate the effects of a possible impending economic depression.