Emerging from COVID-19 - how loan agreements have evolved

The impact of legal, regulatory and documentary safeguards on loan financings.

June 2020: Many Asian countries are now in the process of re-opening or re-booting their economies which have been devastated by the effects of the COVID-19 pandemic. On 23 March 2020, the Financial Times article titled "Coronavirus threatens $32 trillion of Asia corporate debt" reported that the coronavirus outbreak has forced (or is threatening to force) companies across the Asia-Pacific region into significant debt default.

In this article we share our observations on how this has changed the way we prepare, negotiate and finalise documentation for loan financings in Asia.

This article is useful if you are a lender or borrower. Do feel free to contact us if you have any queries.

1. Steep drop in deal activity

On 15 April 2020, Changyong Rhee, the International Monetary Fund's Asia director warned that Asia’s economic growth is expected to stall at zero percent in 2020. This is the worst growth performance in almost 60 years – easily surpassing the impact of the last Global Financial Crisis where growth dropped to 4.7% and the Asian Financial Crisis, where it stalled at 1.3%. That said, Rhee also added that Asia still looks to fare better than other regions in terms of activity.

• Market report released by the Asia Pacific Loan Market Association ("APMLA") showed that deal activity in the first quarter of 2020 fell to its lowest level since 2016.
• Year-to-date deal volumes across Asia Pacific (ex Japan) stood at approximately US$75bn; roughly half of that reported for the previous two years.
• Most countries have posted steep declines in loan transaction volumes in 2020 including Singapore (64.1%), China (36.8%), Hong Kong (32.4%), India (32.2%) and Australia (7%).¹

Against this backdrop, we highlight and examine the impact which moratoriums, material adverse change triggers, market disruption, cessation of business, force majeure and frustration have on loan financings in Asia.

2. COVID-19 related considerations for debt financing in Asia

COVID-19 Moratorium

Due to the financial distress brought on by COVID-19, governments in many Asian countries have introduced various relief packages for borrowers. Many of these include a temporary moratorium (or freeze) on loan repayments and/or enforcement of loan obligations.

Lenders should consider if the COVID-19 related relief measures will affect their ability to accelerate and/or enforce any loan which is in default. Rather interestingly, as the pandemic has impacted not only lives but also livelihoods, a number of lenders have also started to ask if the Courts have or are willing to intervene to provide COVID-19 related relief to debtors when debt disputes are brought before them.

There is no specific COVID-19 related doctrine of relief for debtors. However, a debtor may try to rely on grounds of frustration of contract to absolve itself from its debt. The risk to a lender of such an argument succeeding is still relatively low as it is difficult for a debtor to prove that a loan agreement has been frustrated. We discuss the doctine of frustration in further detail below.

From a legislative and regulatory perspective, COVID-19 related relief measures for debtors do exist for a number of Asian jurisdictions. However, in most cases the relief measures do not apply generally, but are targeted at certain groups or sectors (like small, medium enterprises ("SMEs")). They also apply (at present) for a limited period of time.

Some examples of these measures in Asia are as follows:

• In Hong Kong, the Hong Kong Monetary Authority and the Banking Sector SME Lending Coordination Mechanism² has rolled out a "payment holiday" for payments due from 1 May 2020 to 31 October 2020. Principal payments of loans (including revolving facilities) will generally be deferred by 6 months, whereas trade facilities, given their short-term nature, will be deferred by 3 months. The payment holiday applies to corporate customers within the SME category that have annual sales turnover of HK$800 million (c.US$103 million) or less.³

• Similar to Hong Kong, the loan relief measures in Singapore⁴ are targeted at SMEs with no more than S$100 million (c.US$71.5 million) turnover in the latest financial year as a group. The relevant SME must also have 30% of shares or ownership interest held by Singapore citizens or Permanent Residents. The moratorium prohibits lenders from commencing or continuing a broad range of legal actions, including Court actions, domestic arbitral proceedings, enforcement of security (including appointment of receivers or managers), execution processes, and insolvency proceedings.

• In Indonesia, the government has not imposed any COVID-19 related moratoriums on debt enforcement. Instead, the focus has been to provide guidance to the banks to help debtors restructure their debt obligations. In particular, the OJK⁵ issued certain policy guidances to restructure debt to affected debtors in certain sectors like the tourism, transportation, hotel, trading, processing, agriculture and mining sectors. Once restructured these loans will have the benefit of being re-classified as a "performing loan (lancar)".⁶

Similarly, borrowers should also consider if any of the COVID-19 related relief measures are applicable to their current circumstances, and if so, how to apply for the measures.

More broadly, it is also important for borrowers to understand how they should approach lenders when the loan financing is under severe stress. Please refer to our article titled "How to deal with Lenders during COVID-19 – the elbow tap", dated 20 March 2020, which includes practical tips for borrowers on how to manage lenders during a financial crisis.

Material Adverse Change ("MAC")

A MAC clause typically provides that a change giving rise to a material adverse effect will lead to an event of default. In light of the steep deterioration in the markets due to the pandemic, we do see lenders considering whether events and/or circumstances triggered by the pandemic qualify as a MAC.

In most loan agreements, if the MAC event of default is triggered, lenders have the right (amongst others) to accelerate the payment of any drawn loan and/or refuse the drawing of any loan when requested by a borrower.

A MAC clause is a contractual construct, meaning that the concept of MAC will not be implied if it is not drafted into the contract. The wording of the clause is important as to whether it can be triggered in light of COVID related events.

The APLMA standard form loan agreement contains a standard form definition of what would constitute a MAC. The first limb of the definition is typically the most heavily negotiated. It covers the situation where there is a "material adverse effect on the business, operations, property, condition (financial or otherwise) or prospects of the Borrower Group taken as a whole".

A plain English interpretation of this limb does suggest events that have since occurred as a result of COVID-19, could potentially trigger a MAC. However this is a sensitive topic and a lender needs to take a considered approach if it decides to rely solely on a MAC event to trigger an event of default.

Lenders should consider our helpful and detailed analysis set out in our article titled "Is coronavirus (COVID-19) a material adverse change" dated 10 March 2020. While this article discusses the question from an English law perspective, it is relevant to other common law jurisdictions in Asia, such as Singapore and Hong Kong.

The article notes that precedent case law on MAC is limited (perhaps due to the general reluctance of lenders to declare an event of default on the basis of MAC alone). However we highlight the main considerations from one relatively recent English High Court decision:

• MAC provisions will be construed in accordance with usual principles of contractual interpretation – so the precise words used really do matter;

• to be material, the adverse change must substantially affect the borrower's ability to perform the transaction in question;

• the change in question cannot be temporary or transitory; and

• a lender cannot find a MAC on the basis of circumstances of which it was aware at the time of the agreement, although it may do so where conditions worsen in a way that makes them materially different in nature.

Separately, borrowers of revolving loan facilities should note in particular that we have seen an increased use of the MAC event of default to refuse the roll-over of an existing revolving loan if the lending is made to borrowers in certain distressed sectors.

Many borrowers have an expectation that their revolving loan will be rolled-over (sometimes automatically) for each interest period (which is usually for intervals of 1, 3 or 6 months) repeatedly until the end of the tenure of the facility (which may be between 1 to 5 years for a working capital facility).

If a lender triggers a MAC event of default to refuse a subsequent roll-over of a loan, borrowers who have been relying on a roll-over period should be aware that this is akin to an early repayment of a loan – in other words, the borrower would need to repay the relevant revolving loan at the end of the current interest period, not at the end of the (much longer) term of the facility.

Market disruption

These clauses are most commonly found in syndicated loan agreements.

This clause gives lenders the right to trigger a process to recalculate the interest rate applicable to a loan on the basis that its cost of funding has exceeded the benchmark rate (eg. LIBOR) set in the loan agreement.

Many lenders do face liquidity issues due to COVID-19 related market instability. Unsurprisingly, in certain instances this has led to a rather significant increase in the cost of funding. However, there are mixed views as to whether lenders have or will trigger their rights under the market disruption clause to push the increased cost of funding onto borrowers.

Regardless of the above views, such discussions have only reinforced the now widely accepted view that interbank offer rates such as LIBOR are not an accurate estimation of lenders' cost of fund.

This provides more impetus and support for IBOR rates to be phased out in the next year or so.

Cessation of business

Many loan agreements provide that an event of default may be triggered if the borrower (or sometimes, any member of the borrower group) ceases all or a substantial part of its business operations.

Some lenders are considering whether the lockdown imposed by COVID-19 which has caused some if not most borrowers to suspend part or all of their business qualifies as an event of default.

The prevailing view appears to be that this event of default should only be triggered if business has ceased permanently. However, as the lockdown continues to persist (or as the threat of a second wave of lockdown looms) for some jurisdictions, it is possible that it may be triggered in certain circumstances due to closures as a result of COVID-19.

It is also likely that for sectors badly affected by COVID-19, certain affected businesses will not resume fully in the near future, if at all. Under such circumstances, lenders may examine whether they would want to or if they have grounds to trigger their rights under this provision.

Force majeure and frustration

It is not market standard to have a force majeure clause in a loan agreement. Force majeure is a provision more applicable for contracts relating to the performance of services or delivery of goods.

Generally speaking, a force majeure event should not excuse a borrower from fulfilling its monetary obligations or repaying its debt owed to the lender when due. However, some have considered whether an argument could be made that COVID-19 has resulted in a contract being "frustrated".

Further details:

• Our Ashurst article titled "COVID-19: force majeure and frustration related considerations for financings" dated 14 April 2020 provides an overview of the operation of force majeure clauses and the doctrine of frustration, in the context of COVID-19.

• As noted above in relation to MAC, although the article examines these doctrines from the perspective of Australian law, the general principles are applicable to common law jurisdictions in Asia, such as Hong Kong and Singapore.

Doctrine of frustration:

• The article explains that if a contract does not contain a force majeure clause, a contracting party may look to the common law doctrine of frustration to relieve it from its obligations. Unlike force majeure (which focuses on the parties' express intention on how to deal with supervening events), frustration is implied by law.

• Frustration may arise where an event occurs after the contract is initially entered into, which renders circumstances "radically different", beyond what was contemplated at the time of the contract, not due to the fault of any party.

• While not a typical basis for a borrower seeking relief under a loan agreement due to the high threshold required, the unpredictable and unprecedented nature of COVID-19 means that this could be worth considering in certain circumstances.

Recent development:

Rather interestingly, the Indian courts have more recently granted relief to a debtor due to the outbreak of COVID-19.

In Rural Fairprice Wholesale Limited v IDBI Trusteeship Services Limited, the Bombay High Court on 3 April 2020 granted temporary relief to a debtor against its creditors from enforcing their rights to sell the debtor's pledged assets. The debtor argued successfully that relief should be granted on the basis that the margin cover fall (which triggered an event of default) had arisen on account of stock market fall due to COVID-19.⁷

However, this decision (which was an interim order) has been since described as a "unique" case – and is unlikely to establish a basis for future borrowers to seek relief on the basis of force majeure or frustration. The prevailing view remains that a borrower will need to fit within the parameters of the relevant regulatory measures in order to apply for relief due to the impact of COVID-19.

It will be interesting to see if the Courts in any other jurisdiction follows suit to grant relief on similar grounds. However, this should be strictly regarded as an exception.

3. The outlook from here

New issues, and new solutions, will no doubt continue to emerge in the coming months, as the market works around the ongoing challenges presented by the current climate. If you would like more information or would like to discuss further, please reach out to any of the contacts below across our Asia offices.

With special thanks to Cara Stevens, senior associate, for her contribution.

1. Information above from Debtwire: 1Q20 APAC (ex-Japan) Loans League Table Report released on the APLMA website on 6 April 2020.
2. The Banking Sector SME Lending Coordination Mechanism was established by the HKMA in October 2019. Participating banks have expanded from the 9 banks most active in SME lending at establishment to 11 banks at present.
3. .https://www.hkma.gov.hk/eng/news-and-media/press-releases/2020/04/20200417-3/
4. COVID-19 (Temporary Measures) Act 2020
5. Indonesia's Financial Services Authority (Otoritas Jasa Keuangan)
6. OJK Regulation No. 11/POJK/03/2020 on National Economic Stimulus as a Countercyclical Policy on the Effect of the Coronavirus Disease 2019 Outbreak ("Reg 11/2020")
7. https://www.lexology.com/library/detail.aspx?g=2735246d-68a4-43e2-94c9-73fbd20c9dbb