Cautionary steps in troubled times: A summary of some key financier considerations26 March 2020
Banks and non-bank financial institutions will be confronted with many challenging situations involving their borrowers in the coming months. It's important to look at some of the key borrower obligations and facility agreement provisions that financial institutions should bear in mind in their dealings during these troubled times.
There will undoubtedly be much pressure on financial institutions to demonstrate compassion and understanding towards their borrowers in circumstances where the difficulties confronted are not within the borrowers’ direct control.
It is nevertheless timely to consider some of the key borrower obligations and facility agreement provisions that financial institutions should bear in mind in their dealings during these troubled times.
Events of Default
Is there a monetary and/or a non monetary breach?
This is pretty straightforward. The borrower will either have missed an interest payment or a principal amortisation (or both).
Tip 1: check carefully grace periods and whether the respective borrower has a grace period within which to make such payments.
Tip 2: in the current climate you may need to serve a demand notice or potentially arrange for a conditional waiver or forbearance arrangement to be signed. For further comments on demand notices, see below.
Non monetary breach:
Breach of general obligation
There will always be a broad range of “Undertakings” or “General obligations” in a facility agreement. A few examples of such undertakings might include:
- an obligation to carry on the business of the borrower continuously
- complying with all regulatory requirements
- complying with any undertakings given to the financier
- giving notice of any litigation, and
- giving notice of any changes to the circumstances of the borrower (not necessarily limited to material adverse change).
Moreover, borrowers will be obliged to inform the financier of any such occurrence/breach—at all times.
Tip: it is worth closely reviewing the facility agreement for such general obligations to ensure that in any dealings with a borrower you have covered off all of the rights in your armoury.
Financial Covenant breach
This is a much more challenging potential breach. More sophisticated borrowers are, ironically, likely to have a suite of financial covenants, including ICR (interest cover ratio), Gearing Ratio, Fixed Cover Charge Ratio, DSCR (debt service cover ratio), Tangible Net Worth, Borrowing Base and LVR (loan to value ratio). Less sophisticated borrowers will still be likely to have at least one financial covenant, often LVR.
A typical facility agreement (in whatever form) will state that “the financial covenant(s) must be met at all times during the term…”. Testing on a formal basis (usually supported by a directors’ certificate of compliance) will often only occur quarterly or six monthly.
We would generally expect borrowers to warrant that they are in compliance with all of the terms of the facility agreement at all times. In such cases, a breach of a financial covenant at any time must be reported by the borrower. In reality, less sophisticated borrowers may not necessarily be aware that they may be in breach. A particularly problematic potential breach is the LVR. Valuations take time to be obtained and financial institutions have their panel valuers and are usually reluctant to rely on non-panel valuers.
In the absence of a borrower coming forward and advising that there has been a breach, the financial institution usually has the power under the facility agreement to call for a Compliance/Directors certificate.
Tip 1: check whether under your facility agreement you have the right to call for a Compliance Certificate at any time.
Tip 2: even if you do have the right to call for a certificate at any time, is there a qualification to that right, such as the requirement for the financier to form a belief that an “Event of Default” has occurred or that there is a “material adverse change” (MAC).
Tip 3: if there is a qualification of the kind above (such as MAC), then you must make sure in any correspondence with a borrower requesting a Compliance certificate that you incorporate language to the effect that “we believe a [Event of Default/MAC] has occurred and accordingly require you to provide us with a Compliance certificate within [X] days”.
Tip 4: assuming you receive a Compliance certificate, make sure within the terms of the certificate is a schedule to the facility agreement AND that it is signed by the specified signatories—nearly always directors but occasionally a director and the CFO.
Tip 5: if you believe there is an LVR breach then, depending on the terms of facility agreement, a valuation will need to be obtained or given by a panel valuer, which may take some time so make sure you factor that delay in.
It goes without saying that insolvency, or as is often stated a deemed insolvency by reason of not being in a position to pay debts as and when they fall due, or insolvency that arises due to the appointment of a so called “External Administrator” (such as a voluntary administrator, receiver or similar) will constitute an Event of Default.
Similarly, a cross default, that is where another debt (subject to a materiality threshold) of a borrower outside of the specific facility that the financier is dealing with, is triggered.
Tip: with borrowers of any consequence it will often be the case that they will have multiple credit lines with more than one financier, so it is important to be asking the question and seeking disclosure of all credit lines a borrower has. While this should have been done at inception of the relevant facility, circumstances change and it is prudent to ask for updated financials generally.
We will be providing a more comprehensive overview of insolvency in a future article. You’ll be aware that there is likely to be a material enhancement (from directors’ perspective) of the safe harbour rules in light of the current circumstances.
Many facility agreements will incorporate “review events”. The type of events may vary, depending on the amount of negotiation when the document was entered into and the specific nature of the facility. Some examples of review events include:
- termination, revocation or suspension of a material contract
- change in key management, and
- loss of a key tenant (in property deals).
There is usually a reasonably detailed regime involving
- consultation between financier and borrower as to the reasons and/or explanation for the occurrence
- a cure or restructure proposal with time lines
- a right of the financier to vary terms of the facility agreement, such as re-pricing, top up security, and
- failing agreement, a requirement for the borrower to re-finance within a specified period (for example 60 days)
Tip: make sure each step in the regime referred to above is fully documented and all time lines adhered to
Notice of demand
Reference was made above to demand notices. It is crucial that such notices:
- are in the form scheduled in the facility agreement or, if there is none, are reviewed by a lawyer
- fully set out the relevant breach in sufficient detail so that the borrower and its advisers cannot claim insufficient detail is provided and thus the borrower is not in a position to comply
- are served strictly in accordance with the “Notices” clause in the facility agreement, for example time periods, manner of service (post, email), and
- are signed on behalf of the financial institution (if the facility agreement so specifies) by an authorised person.
These are indeed troubled and difficult times requiring sound and experienced advice and good judgment.
We will be publishing more material on related topics in the near future. In the meantime if you have any need for further information contact our Banking & Finance team or our Commercial Litigation team.