How to deal with your lenders during COVID-19 – The elbow tap!
Managing your lenders during a financial crisis is critical. So what is best practice? How should a good business engage with its lenders in times of uncertainty and distress?
If you are suffering distress or are concerned about your cash-flow or covenants, "engage" is the key word. The single most important rule of any pre-distressed and workout situation is to communicate. Indeed, it is so critical that it bears repetition: communicate, communicate, communicate.
Given the extraordinary situation that the world faces, the finance sector has naturally indicated that it will provide support wherever it is at all feasible, but the critical issue of feasibility needs to be addressed by the customer as part of any workout plan.
Tips for engaging with your lenders
Step 1: Initial engagement with your lenders
The following needs to be included in any substantive communication with lender(s).
| Have a plan | Most lenders will expect that you have some proposal for them to consider (rather than the other way around). |
| Gather key financial information to inform the plan | Be up to the date with the group's latest financial information (including trading updates, cashflow position and forecasts and upcoming liquidity requirements of the business), together with any suggested financial levers within the business which the borrower can potentially flex in order to ride through the turbulent cycle. |
| State clearly what you are asking | Be armed with a cogent plan and your key asks. What are the primary objectives behind your proposed going-forward plan? Is your plan realistic and how quickly can it be implemented? Is consent needed, and if so, for what and from whom? |
| Be prepared to answer how equity is contributing | In the current world situation, it would not be a surprise if a lender will expect a capital restructure to include some form of injection of new equity (or at least a commitment to do so in the near future). |
Step 2: Be aware of potential pressure points within existing financing arrangements
As part of the planning stage, a borrower should undertake a detailed review of its existing financing documentation to identify any potential pressure points which may arise due to the uncertain market conditions.
We have set out below examples of some areas within finance documents which may become relevant in current context that you should bear in mind:
(a) amortisation, interest and fee payments: Borrowers should urgently identify any upcoming payment obligations which are required to be made under its financing arrangements and determine whether those payments can be met when due;
(b) financial covenants: Will any of the financial covenants in its debt package be tested in the upcoming months, and if so, are there any adjustments available under the finance documents which may help take into account current market conditions (eg, EBITDA adjustments for abnormal or extraordinary items). If a breach of a financial covenant is anticipated, are there any available equity cure rights and what is the regime to implement such cure?
(c) available facility headroom: Do any of its existing funding lines have available headroom and should they be drawn down now? And are there any conditions precedent which could potentially draw stop a funding request?
(d) reporting obligations: What financial reports and other additional information is the borrower required to share with its lenders? Are there additional reporting obligations if a potential or actual default is anticipated?
(e) MAE/MAC: Could the current market conditions in any way trigger a "material adverse effect" or "material adverse change" under the finance documents? This will depend on quite a number of different factors including, how the specific provisions have been drafted in the finance documents, which industry the borrower group operates in, when the finance documents were entered into and the anticipated length in time of the relevant adverse effect.
(f) cross default: Has the current market conditions led to breaches of any material contracts within the business which may trip a cross-default under the finance documents (eg, documents for another debt funding line or derivatives facility)? What is the cross default monetary threshold under the finance documents?
(g) solvency representation: If liquidity is becoming an issue for the borrower group, then it will be important to carefully review the solvency representation and related default provisions in the finance documents to understand whether those provisions have been, or may be, tripped.
(h) default interest: When does default interest kick in under the financing arrangements – upon a payment default only or is it at any time whilst an event of default is continuing?
(i) guarantor coverage tests: Do borrowers have a guarantor coverage undertaking tested by reference to EBITDA? If so, is there a need to accede additional obligors?
(j) dividends, permitted debt, acquisitions: Borrowers should consider other consequential impacts on their finance documents of reduced earnings eg. restrictions on dividends, the incurring of further debt, the making of acquisitions.
(k) lender transfer rights: Can a lender transfer or assign its debt commitments to a new third party without the borrower's prior consent? This typically can only occur if an actual event of default is continuing although it would be worth checking the fine print of the finance documents to confirm. It will be important for a borrower to know the make-up of its lender group as it looks to seek the lenders' support in order to implement a restructuring plan.
Step 3: What to do when faced with a default?
If a borrower is anticipating an upcoming potential or actual default under its financing arrangements, then it will be imperative to discuss those issues as soon as possible with its lender group.
Depending on the specifics of the situation, a number of options may be available, for example:
(a) seeking a temporary (or permanent) waiver, suspension or amendment from the lenders regarding the anticipated or actual breach;
(b) requesting a payment deferral (eg, capitalising upcoming interest obligations) and/or extending maturity dates or instalment repayment dates;
(c) raising new debt and/or equity capital in order to boost liquidity;
(d) sale of assets (including sale and leaseback arrangements) to generate additional capital; and
(e) if a default waiver is not available, then seeking an enforcement standstill arrangement from the lenders to enable sufficient time to devise and execute a turnaround plan.
The key objective is to commence prompt discussions with the lender group so you can put in place some form of short term relief with the aim of providing a runway to formulate a longer term restructuring solution.
Other considerations
Drawing down on available lines of credit
Businesses may be looking to drawdown on their available lines of credit to increase liquidity and it is likely that the banks will support these drawdowns. However, when drawing on such lines, ordinarily a certificate of solvency is required. Borrowers, directors and advisors who arrange further drawdowns with knowledge of impending financial doom risk litigation and investigation (such as for the breach of directors' duties) down the track if they fail to disclose facts which may have caused the lender(s) to refuse the drawdown. Communication is critical. When drawing down further lines of credit where there are doubts as to solvency, prudence is required.
Safe Harbour
Businesses may also need to rely on the Safe Harbour regime.
In September 2017, Australia introduced new laws relating to insolvent trading liability for company directors and officers. The Safe Harbour regime offers protection from liability for debts, by providing a carve out if the director or officer can show that the debts were incurred as part of them pursuing a turnaround plan that was reasonably likely to result in a better outcome than insolvency. The Safe Harbour regime is aimed at encouraging directors and officers to pursue rescue plans likely to result in better outcomes, rather than place an insolvent company immediately into external administration. One of the requirements of Safe Harbour is the development of a course of action that is reasonably likely to lead to a better outcome than an immediate liquidation or voluntary administration.
To assist businesses and advisors, the following resources may be of assistance:
- The sheet was produced for the 2019 ARITA National Conference for best practice in providing Safe Harbour advice: see download link below.
- Our previous five-part series on the Safe Harbour regime is available here.
Practical recommendations for management and boards
Some general advice to management and boards when handling times of financial crisis is listed below:
(a) convene regular board meetings to monitor the development and implementation of a workout plan to save the company, and to assess the company's solvency on an ongoing basis, having regard to future debt obligations;
(b) consider in detail the proposed next phases of the restructuring plan to form a view as to whether it continues to be reasonably likely to result in a better outcome than an immediate liquidation or administration;
(c) determine a materiality threshold for new debts, having regard to the size and nature of the company's business, above which you should require that it be taken into account whether the relevant debt is being incurred directly or indirectly in connection with the workout plan;
(d) ensure the following is thoroughly documented:
(i) the information that the Board is regularly obtaining to stay informed of the company's financial position;
(ii) the decision by the Board to enter into Safe Harbour;
(iii) the steps taken to date to prevent any misconduct by officers or employees that could adversely affect the company's ability to pay all its debts;
(iv) the maintenance of appropriate financial records;
(v) the periodic assessment of whether the workout plan of the company remains reasonably likely and whether the Board remains of the view that, if implemented, it will improve the company's financial position; and
(vi) if any further debts are incurred, whether at that point the company:
- has paid the entitlements of its employees as and when they fall due; and
- is up to date with its tax reporting obligations.
Companies may wish to consider engaging legal and accounting advisors to assist with the restructuring planning set out above.
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