Like the rest of the world, you probably did not contemplate a global pandemic when taking out your business loan. Now, as a result of the economic downturn from the coronavirus (COVID-19) pandemic, you are unable to meet your loan repayments. So, what are your options?
Stay Informed
The government is constantly implementing new ways of helping businesses that are financially distressed. Make sure you stay informed about any relief that may apply to you and take advantage of it. For example, the government has agreed to guarantee 50% of certain new loans (such as short-term unsecured loans to small to medium-sized businesses) up to an individual loan amount of $250,000. This could help you attract a new lender if you need to refinance an existing loan.
Equally Australian banks have been asked to press pause on small business loan repayments. If these measures apply to you, they could really help you stay afloat during the current crisis.
Talk to Your Lender
If the government measures do not apply to you, talk to your lender. In times of widespread economic adversity, lenders will be more flexible. They are less likely to enforce your legal obligations and more likely to resolve issues through discussion and compromise.
This means your lender is more likely to work with you to ensure that you will not default on the loan, which could, of course, be crushing for your business and eventually lead to insolvency (which is in no one's interest). You should consider and discuss the following eight options with your lender:
1. An Extension to the Principal Repayment Date
Negotiate an extension to the date on which your principal loan amount is due. If your loan is due for repayments in the next few months (during the downturn's likely peak), ask your lender:
- to extend the repayments date to a new date that you believe you can reasonably meet without putting the business into financial distress; or
- for loans being repaid in monthly instalments, ask for a period of relief during which no monthly payments are due. You could make up the difference later (with higher monthly payments for a while) or, better still, restart monthly instalments of the same amount at a later date, again pushing back the ultimate repayments date.
2. A Break From Monthly Interest Repayments
The key to surviving in the current economic environment is a strong cash balance. Businesses need to:
- maximise the cash they are receiving; and
- minimise the cash they are spending.
Even modest interest repayments could be detrimental (or even impossible!) in the current climate.
Ask your lender for a period of time during which you do not have to make monthly interest payments. A complete break from interest repayments would be ideal, but as a compromise you could suggest that interest continues to accrue and is compounded (i.e added to the principal) monthly. This means that the lender will end up receiving more interest as you will be paying interest on a higher principal amount. Obviously you will eventually have to repay this interest, but hopefully at a time when the situation has improved and you are in a better position to do so.
3. Renegotiate Financial Covenants
A financial covenant is essentially a promise you make to the lender that the company will meet certain agreed financial metrics during the life of the loan. A common financial covenant is a promise to maintain a certain cash balance (i.e a minimum cash reserve) during the term of the loan. This gives the lender comfort that you will be able to meet your loan repayments and will not go insolvent whilst the loan is outstanding.
If there are certain financial covenants you cannot meet in the current climate, you should try to renegotiate these (at least for a certain period of time) so that you do not breach the loan agreement. If you breach a financial covenant, it allows the lender to immediately call the loan (i.e. require that you repay it in full before the original due date) and/or enforce any security it holds.
4. Accuracy of Representations and Warranties
Representations and warranties are factual statements about your business that you give your lender when you enter into the loan agreement. You give these representations and warranties when:
- you enter into the loan; but
- you might have to repeat them at other times during the loan term (for example, on an interest payment date, or even on an ongoing basis throughout the term of the loan).
You must tell your lender if you have provided representations and warranties for the loan agreement that are no longer true. For example, you may have provided a representation that you are meeting your contractual obligations. But if your business is in financial difficulty, and you are no longer meeting these obligations, then you need to tell your lender.
If a representation or warranty is proven to be untrue, then the lender can regard your business as having defaulted on the loan (again, allowing the lender to call the loan and/or enforce any of its security). It is important to ensure that the lender does not do this. You could ask them to:
- amend the representations and warranties so that they are not incorrect; or
- you could ask them to temporarily waive their rights in connection with any misrepresentation, again to give you some relief.
5. Ability to Meet Undertakings
An undertaking is a promise to either:
- do something (a positive undertaking); or
- to not do something (a negative undertaking).
If you are no longer able to do (or not do) the things you promised you would under the loan, you should speak to the lender. For example, you might have undertaken not to sell any of the businesses assets, but now you find yourself in a position where you have to sell an asset in order to stay afloat. You should seek the lender's consent before you breach an undertaking because, again, a breach could result in an event of default.
6. Renegotiate Events of Default
Your loan agreement likely contains a number of events. If these events occur, the lender will regard you as having defaulted on your loan, known as an Event of Default.The loan agreement usually provides you with a period of time to fix the situation before the lender can take action against you.
If you are experiencing financial hardship, it is more likely that an event of default will occur. We, therefore, suggest you ask your lender if they can lengthen the time in which you have to remedy an event of default and, if possible, limit the types of events that would lead to a default.
For example:
You could ask for this event of default:
- to be removed altogether; or
- softened so that, as long as you keep the lender informed of such changes, it will not be considered an event of default.
If the lender refuses to re-negotiate events of default, you could ask them to waive their rights in respect of events of default for a period of time, to enable you to get back on your feet.
7. Renegotiate Cross Defaults
A cross default is a common type of event of default. A cross default means that if you default on a different loan agreement, you will be regarded as also defaulting on this loan agreement.
To avoid defaulting on your loans, you will need to renegotiate the cross default provision in your loan agreement with all affected lenders. There is no point negotiating with one lender and not the others. This may mean talking with all of your lenders simultaneously, if necessary.
If you are asking your lender for leniency (which would result in them taking on more risk), they may ask for something more in return. For example, they might ask for:
- additional security for the loan (e.g an interest in your business assets);
- a higher interest rate (once interest becomes payable again); or
- a personal guarantee for the loan. Try to avoid personal liability if at all possible. You do not want to be personally liable for the loan in such an uncertain time. Instead, try to convince the lender that it is in their interests that they help you weather the storm so that your business can survive and be in a position to repay the loan eventually.
8. Refinance
If your lender will not assist you, you may need to consider refinancing the loan. Refinancing is essentially taking on another loan from a different lender and using that loan to repay the existing loan. When refinancing, make sure that you can meet the terms of the new loan; you do not want to start creating additional financial challenges for yourself.
Key Takeaways
Stay on top of the government initiatives that are being implemented to assist businesses in financial difficulty. These could prove to be extremely helpful. If you do find yourself in a situation where you know you are not going to meet your obligations under your business loan despite any government help that may be available to you, you should immediately reach out to your lender and start a conversation. In times of widespread economic hardship, lenders are much more likely to work with their borrowers to avoid default events.
Remember, the lender is also motivated to keep your business afloat, as this will give them the highest chance of being repaid in full.
Originally published March 26, 2020
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
