The potential impact of COVID-19 on debt finance transactions in Spain

1. MAC

One of the most commonly asked questions is to what extent the COVID-19 pandemic or its impact constitutes a material adverse change (MAC). Can lenders invoke MAC provisions to accelerate the facilities and demand early repayment or as a drawstop of future or currently intended drawdowns (with companies wanting to prevent cashflow shortfalls in the current context)? We as a firm have already debated this in "Is Coronavirus (COVID-19) a Material Adverse Change?", but there are certain points worth remembering as there is not a "one size fits all" answer:

•  the exact terms of the MAC clause and, in particular, the definition of "Material Adverse Effect (MAE)" will have to be scrutinised, but this will typically include the borrower suffering (i) a material adverse change in its business, operations or financial condition or prospects; or (ii) its ability to perform its payment obligations under the finance documents or (iii) have a detrimental impact on any security package that has been granted. It is likely that the current situation will mean that some businesses will certainly fall within this scope;
• MAC clauses are rarely called on in practice and there is little case law around them. Epidemics or pandemics in the past have not led to MAC clauses being called generally, but perhaps the financial impact of COVID-19 is different and more acutely felt: there are some businesses where facts point towards a MAC, but there is clearly a need to analyse each case separately on its merits and on the basis of the drafting of the MAC clause;
• of the little case law available we can infer that (a) lenders calling a MAC clause will in principle have to provide evidence of the impact of such change; and (b) the change must be such that it needs to affect the capacity of the borrower to comply with its payment obligations; and (c) the MAC needs to have an impact beyond temporary or transitory, which is a key element in this COVID-19 context: it is a change rather than a temporary hurdle, and if you allege a MAC you need to be in a position to provide evidence that the changes are there to stay and are not recoverable; and
• there is obviously a reputational risk to be borne in mind, not just because of calling the MAC in the current context, but further in the event of wrongfully calling it.

2. Information undertakings

Facilities agreements typically contain an obligation to provide the lenders (or the facility agent, to the extent there is one) with sets of financial accounts which always include the (generally audited) annual accounts once approved. Spanish law provides for a three month period for the Board of directors of companies to draw up their annual accounts, and then a six month period from the end of the financial year for them to be approved by the General Shareholders' Meeting. Royal Decree-Law 8/2020, dated 17 March 2020, on urgent and extraordinary measures to face the economic and social impact of COVID-19, has suspended (for the time during which the state of alarm declared by the Spanish Government is in place) the time for the Board of Directors to draw the annual accounts up. This has a knock-on effect on the timing for approval of the accounts by the General Shareholders' Meeting, that will (unless the relevant companies foresee otherwise) slip accordingly (the "Delay in Approval of Accounts"). This Delay in Approval of Accounts may not only require Borrowers to request additional time to be able to produce their accounts in addition to the time periods prescribed in their facilities agreements, but will also have an impact on measuring financial covenants, as set out below. This will be particularly true if the Delay in Approval of Accounts has an impact on the determination of which subsidiaries qualify as material: the determination will be delayed accordingly, and such delay may shift which subsidiaries are deemed to be material as a result of the impact of COVID-19 on the group's assets, revenue and/or EBITDA.

3. Financial covenants

The current situation is likely to have three effects on financial covenants:

• a Delay in Approval of Accounts is likely to give rise to a delay in the ability to calculate the financial covenants and hence to a delay in the determination of how the company is performing in respect of the benchmarks set out in the facilities agreement. This would cause a delay in determining whether an event of default had occurred and (if foreseen in the agreement), the time in which the borrower has available to inject equity to cure such default;
• additionally, COVID-19 might have a significant impact on financial ratios. The acuteness of such impact will depend on the underlying business, and notably the sector and geographic spread. Some businesses will only experience a strain on their financial covenants for the period in which the state of alarm is in force (or a slightly increased time frame), whilst others will see their performance and their financial covenants materially disrupted by COVID-19 for a longer period. In a number of cases this will lead to events of default under the financial covenants (among others). In some cases (especially where the timing of the impact can be determined accurately) it could be possible to cater for this by amending the financial covenants in order for them to exclude the relevant period of time (e.g. one or two months), and work on the basis of the performance for the remainder of the calculation period. The longer the current disruption lasts the less feasible this route will be and borrowers may instead seek to negotiate a covenant holiday; and
• in project finance structures forward looking ratios may be impacted by declining projections in respect of income generated by the infrastructure project: this can have an important effect unless projections are adjusted in view of COVID-19 and the state of alarm for that particular calculation period.

4. Undertakings 

Under construction facilities, greenfield project finance or energy project finance that are in the construction phase, there will be a heavy reliance on supply chains and on the availability of workers to carry out their work under the relevant construction contracts or EPC contracts: delays in construction as a result of COVID-19 might in turn affect delivery dates on turn-key projects, give rise to penalties under the construction or EPC contract and (in the case of a concession) under the relevant concession contract. Under many of these contracts it is likely that many constructors and EPC contractors may attempt to rely on force majeure clauses in order to protect themselves and this would have a knock-on effect under the related facilities agreements where such delays and/or penalties are likely to trigger a breach of general undertakings.

Where a project has reached the operating stage the above risks are replaced by other risks which both the borrowers and lenders should monitor closely in the current situation in light of the repeating representations and general undertakings set out in the relevant facilities agreements. The following can be highlighted:

• availability linked concessions may suffer because of lack of workforce to keep the relevant infrastructure operating in accordance with the contractual requirements, or due to the lack of material to repair damages to the infrastructure;
• projects that are subject to demand risk might be impacted by the closure of infrastructure and/or measures taken by the relevant authorities to limit the population's movements (such as the state of alarm declared in Spain leading to the closure of almost everything other than essential services).
• insurance policies should be checked in order to ascertain the effect of the WHO declaring COVID-19 a pandemic, and the consequences this might have on the insurance cover. This is especially relevant in project finance transactions where insurance undertakings may be breached as a result of insurance policies having inadequate cover.

5. Other specific events of default

COVID-19 might lead to certain specific events of default being breached (in addition to the events of default already mentioned above). Each of them needs to be looked at separately on a case by case basis. We set out below some examples worth noting:

• the main and obvious one will be a payment default where the situation severely impacts the income of the borrower. There will be some protection for this in transactions with a debt service reserve account (though the knock-on effect will be that following the use of balance on such account to service the debt it will not be replenished as required by the agreement);
• qualifications in auditor's opinion: events of default might include just a refusal by the auditor to give its opinion or might also extend to any (or just certain) qualifications in the opinion. Special care needs to be taken in respect of situations where the impact of the COVID-19 is such that after the end of the financial year auditors may have to set out in their report that there are doubts on the feasibility of a given company to continue its activity as a going concern;
• in certain financings, especially in the real estate and renewable energy sector, lack of licences or failure to renew them can lead to a specific event of default. This will be particularly true in Spain during the state of alarm by the stoppage on all administrative deadlines to resolve procedures and requests, and hence currently sought licences or renewals thereof will not be resolved during the state of alarm;
• cessation of business might be a further event of default triggered by the current situation. Most companies will just see a slow down in their activity and a decline in sales, but transport related businesses in particular are likely to see their vessels docked and their aircraft grounded, which poses the question as to when will this be deemed to be a cessation of the relevant business. The closure of retail parks and shopping centres will also raise similar questions.
• cross default might also be triggered depending on the other financial and other liabilities of the borrower and the baskets that have been built into the relevant agreement. Particular care needs to be put on how any derivatives transaction linked to the loan is impacted by COVID-19.

6. Posting of additional security in margin loans

The current decreasing trend in share prices on the stock exchanges has led several supervisory authorities to implement protective measures such as (i) prohibition on short positions; and (ii) limitations to the acquisition of stakes in excess of a given percentage in listed companies taking advantage from the current low capitalisation. However, it is difficult to see such protective measures being put in place in respect of the impact these declining stock prices have on the collateral coverage granted in margin loans and the need to post additional collateral to comply with the "Loan to Value" requirements in the relevant loan agreement. The trading liquidity of a particular share may also be affected as a result of COVID-19 and this, too, is likely to trigger mandatory prepayment provisions under the relevant margin loan agreement. Furthermore, any dilution or adjustment of the value of the underlying shares (posted as collateral) as a result of capital increases or issuances of new shares in an attempt to protect a company against the impact of COVID-19 may well trigger the requirement to post additional collateral under a margin loan in order to maintain the relevant LTV ratio. These have a clear and direct impact on the ability to comply with the specific undertakings included in margin loan agreements, so careful attention and the weighing of alternatives should be paid to these scenarios.

7. Voting

The impact of COVID-19 is not only felt financially but also in all our day to day activities, including work. With different countries having shut down and individuals following a working from home policy, it might well be that the approval of waiver requests drags or even that such waiver requests are not dealt with at all by certain lenders and that the "Snooze and Lose" type clauses will become very useful. Borrowers in large syndicated facilities should verify that any such clause has been properly built into the agreement and discuss with the agent before launching any such waiver, especially waivers requiring unanimous lender consent or a super-majority. For waivers and/or consents requiring unanimous lender consent, the "Yank the Bank" clause may also become increasingly important where a disruptive member of a syndicate is blocking the will of the vast majority of lenders to protect a business and their investments as a result of the impact of COVID-19.

8. Additional financing needs

In addition to the possibility of draw stops being triggered under existing facilities (as described above), the current situation will increase other cashflow issues in a number of companies. The relevant borrowers (and, as the case may be, sponsors) will in some cases have to start looking at the capital structure and into the ways to most effectively inject new funds (be it by way of equity or debt instruments) to the extent amounts cannot be drawn under existing facilities (in particular, revolving and working capital facilities). Care will of course have to be paid to the tipping effect this might have on other financial undertakings of the borrower and if wider reaching discussions (e.g. a full fledged restructuring) need to be started.

9. New financings

Both borrowers and lenders should take each of the points above into account when drafting documentation for new transactions. In our experience during the credit crisis, there are lessons to be learned and some changes need to be implemented straight away. This has to be coupled with measures currently in force, such as the restrictions in Spain to notarial signings, which can only take place if considered urgent by the notary and providing certain health measures are taken. We are already seeing new facilities agreements incorporating longer availability periods for drawdowns, being signed in private format, with notarisation of the facilities agreement and the security package being left for when the drawdown occurs.