OVERVIEW

Australia saw its first case of COVID-19 on 25 January 2020. Since then, Australia's interest rate has been cut twice to 0.25%, the lowest in Australia's history. The AUD has sunk to a 17-year low. The ASX has seen its largest daily percentage fall on record. Australia's unemployment rate is expected to soar in the coming weeks. Notwithstanding the promise of emergency packages to be injected into the economy, the impacts of COVID-19 have created unprecedented challenges for financiers and their borrowers arising from the disruption being caused to workforces, service providers, supply chains and customers.

For corporate borrowers, it is prudent to manage and mitigate the potential impacts of COVID-19 on your existing financing arrangements by revisiting the terms of the relevant finance documents, identifying any areas of potential non-compliance and engaging with your lenders and advisers early to agree how to deal with the relevant issues.

Identify any potential defaults

If you are a borrower, anticipate where the challenges will lie for your particular business, revisit the terms of your existing loan documents and underlying material documents – the terms of which are critical to your financing arrangements – and determine which provisions are at risk of non-compliance. Engage your lawyers and other advisers early if you require assistance in reviewing and assessing the terms and your legal and financial position.

Generally, the key areas to consider are as follows:

  • Payment defaults – the most obvious effect is that the disruption of payment flows arising from the business interruption events (such as forced closure of business, disruption of supply to the business and reduced revenue (such as sales or rental income)) will lead to cash flow issues for borrowers, impacting their ability to make scheduled repayments of principal and / or interest. Payments may also be missed simply because staff making or authorising payments are absent due to illness or required self isolation.
  • Financial covenants:
    • which rely on earnings such as interest cover and debt service cover or minimum EBITDA tests – as the business of a borrower is disrupted, its earnings are likely to decline in the short to medium term. This means that its ability to comply with look back and look forward financial covenants based on those earnings may begin to come under pressure; and
    • which rely on equity values such as net worth or funds under management tests – as share values plummet in the wake of the economic uncertainty caused by the outbreak, the value of portfolios will have decreased and it will be harder for borrowers to comply with financial covenants tested by reference to the value of those equities. On the other hand, the volatility of the markets will be attractive for speculators, notwithstanding the risk the current market position poses for potential margin calls.
  • Project delays – the real estate sector relies heavily on imported goods and materials for use in the construction of large scale commercial and residential projects. Developers and builders are already experiencing delays in this supply chain and are concerned about the impact that this will have on their ability to deliver construction works on time and on budget. Both of these factors are tested in construction finance agreements and we expect that developers are already speaking to financiers about requests for extensions of time for the completion of separable portions due to complete shortly. In the longer term, 'Sunset Dates' in contracts with purchasers of the finished product – again the subject of tests in construction financing agreements – may also soon be tested.
  • Material adverse change – aside from payment defaults and financial covenant breaches, the economic impacts of the disruption may lead to material adverse impacts on a borrower's business or prospects and / or its ability to comply with its obligations under its financing arrangements. In the current circumstances, we expect that financiers will be reluctant to rely on a material adverse effect (MAE) to be able to enforce rights against particular borrowers – however, if they do decide to go down that route, they will need to consider the drafting of the relevant MAE provisions in their facility agreements to determine whether the circumstances are such that they are able to do so.
  • Cessation of business clauses – the majority of financing arrangements include undertakings and defaults regarding a borrower ceasing to carry on its business or a material part of it. Government mandated closures of types of businesses will mean some businesses, particularly in service industries, may face prolonged or undefined periods of closure.
  • Cross defaults and breach of material documents – even if a borrower is able to comply with its obligations to its financiers, business and / or cash flow disruption may lead to defaults under its obligations to other counterparties. For example, a supply agreement to supply certain goods to China may be unable to be fulfilled due to a ban on entry with no defined end date.
  • Others provisions – consider any facility specific provisions. For example, 'key person' review events may be triggered if a named key person falls ill and is forced to resign.
  • Maturity of facility – if your facility matures or is due for renewal in the near future, consider your ability to extend or refinance that debt with the same or a different lender.

Engage with your counterparts early

Having identified the potential breaches under the financing documents, engage and discuss them with your lender as soon as possible. Banks will likely experience a higher volume of enquiries, so it may take time for enquiries to be processed and any proposals to be approved (especially those requiring credit approval).

Any amendments to the terms of a facility, and any waivers, standstill or other arrangements may need to be documented, which may require lawyers to be involved. Lenders and borrowers will also need to consider any potential logistical issues associated with re-documentation, such as the availability and capacity of the board of directors to meet, review and discuss the draft documentation, and the availability of signatories to execute the documentation.

WHERE TO FROM HERE?

The economic impacts of the virus are now certain to be longer lasting than the health ones. The government has announced an unprecedented series of stimulus and assistance packages designed to assist businesses and individuals through the crisis with the explicit intention of bridging the gap to recovery. Banks are also leaning in and have voluntarily launched assistance packages including payment holidays and covenant relief, amongst other measures, to assist their customers. Please contact us if you would like assistance in understanding your obligations under your loan documents, engaging with your counterparts or ascertaining whether you are eligible for any of the relief being offered by government or your bank.

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.