Common Loan Agreement Compliance Issues Resulting from the COVID-19 Crisis
DATE: March 26, 2020
TO: Kane Kessler, P.C. Clients
FROM: Kane Kessler, P.C. Corporate Department
RE: Common Loan Agreement Compliance Issues Resulting from the COVID-19 Crisis
The COVID-19 crisis has greatly limited, and in many cases, completely shut down business operations throughout the world causing a spiraling of substantial economic injury. In doing so, the economic effect of COVID-19 will, among other things, create a wide range of contract issues including difficulties in complying with and interpreting various sections contained within a company’s loan agreement. In this regard, we urge our borrower clients to carefully examine provisions contained within their loan agreements. This memorandum will highlight what we believe are key provisions contained in loan agreements (other than payment terms) that may be impacted in our current economic state. Each loan agreement will differ and will necessitate a thorough review. Nevertheless, consideration should be given to the following:
Material Adverse Effect. The Material Adverse Effect (an “MAE”) standard is often used throughout the loan agreement including representations, covenants, conditions precedent to borrowings or opening LCs. In fact, many affirmative covenants provide that the borrower is required to give written notice of an MAE within a specified period of time after knowledge of such event. As to whether the COVID-19 crisis has or will have an MAE on a particular company is very fact sensitive, and could lead to disagreements between the borrower and the lender as to whether an MAE has occurred. Each borrower should assess whether COVID-19 has had, or could create an MAE, and this impact on their particular loan agreement.
EBITDA and Financial Covenants. As a result of declining revenues created by the COVID-19 crisis, borrowers could confront difficulties in financial covenant compliance and other provisions tied to EBITDA or other financial measures. This could apply to maintenance covenants, interest rate step-downs, or baskets for permitted transactions involving incurrence of debt or making restricted payments. It could also apply in trigger springing financial tests that kick in after a borrower exceeds a certain threshold in a revolver loan, caused by the necessity to borrow additional funds in this current economic state. It is important to consider that certain EBITDA definitions contain add backs. There are questions arising as to whether cost consequences arising from COVID-19 would fit within an existing addback such as “extraordinary, unusual, or non-recurring” clause. We urge that borrowers carefully review how their financial covenants and relevant definitions may be impacted by the downturn in revenues and added costs, and analyze whether they can take advantage of addback allowances.
Financial Statement Delivery. Loan agreements generally require borrowers to provide quarterly and annual financial statements, reports and certificates. The deadlines are often tied to timing requirements for public filings with the Securities and Exchange Commission (the “SEC”). Although the SEC has granted reporting companies impacted by COVID-19 additional timing relief by delaying the due dates to file certain financial and other information, those extensions do not necessarily apply to the covenant requirements contained in loan agreements. So the failure to comply with the deadlines set forth in loan agreements may still violate the applicable covenant under a loan agreement. In addition, private companies may also have difficulty timely compiling information with smaller staffs and working with auditors that are overstretched while working at home. We urge that borrowers get ahead of this prevailing issue by reaching out to their relationship person at their banks and seeking a waiver/amendment or other extension in advance of an impending default rather than waiting until the deadline has passed.
Notice of Defaults. Borrowers are generally required to notify its lenders of any defaults that have occurred. The notice provision is a separate covenant apart from the instance creating the default. As described in Material Adverse Effect Section above, often loan agreements provide that the occurrence of an MAE is an event that necessitates written notice to the lenders. Failing to provide the notice could be a default whether or not an MAE itself creates another default.
Cross-Defaults. It is important to monitor defaults in other non-loan agreements that could create notice requirements or a default in a loan agreement.
Cessation of Business. Certain loan agreements contain covenants or events of default in the event that a borrower stops conducting a material segment, line or portion of its business. As COVID-19 has caused the shutdown of certain businesses, these latent provisions should now be reviewed and considered.
For additional information including assistance in review of loan agreements, preparation of applicable notices or compliance reports, or obtaining waivers or amendments, please feel free to reach out to Robert Lawrence (at 212-519-5103, rlawrence@kanekessler.com), Mitchell D. Hollander (at 212-519-5119, MHollander@kanekessler.com), or any partner in our Corporate Department.