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Loan Agreement Considerations in the COVID-19 Environment

By Paul Wolpert

During this unprecedented time, most corporate borrowers are facing a significant decline in revenue and liquidity resulting from the impact of the COVID-19 pandemic. In light of this, borrowers and lenders must consider multiple issues under their loan agreements.

Borrowers should be aware that their lenders have a vested interest in their success. Most lenders will appreciate the financial issues facing their borrowers and will seek to work together to formulate creative solutions. In this regard, however, early and proactive engagement with lenders is paramount.

In this post, we set forth some key issues that lenders and borrowers should consider carefully as they navigate this crisis. Whether you are a borrower or a lender, Vela Wood is happy to assist as you address these issues.

Liquidity

As revenue continues to decline, the most pressing issue for many borrowers in the short term is the preservation of liquidity, and the ability to access additional liquidity. In this regard, borrowers should seek to secure any payment relief that may be appropriate in light of their financial condition, including, potentially, a payment holiday or an amendment converting upcoming payments into payment-in-kind (PIK) payments.

Borrowers should also consider whether they need any accommodations to allow them to draw down on their revolving facilities as needed. Most loan agreements include conditions to borrowing that require the borrower to “bring down” the representations and warranties in the agreement as of the date of any draw down. In light of COVID-19, borrowers should carefully review these representations and warranties to determine whether any additional carve-outs or qualifications are required. In particular, borrowers should consider requesting an amendment carving out the effects of COVID-19 from the definition of “Material Adverse Effect.”

With respect to ABL facilities, borrowers that have seen a sharp decline in their borrowing base should consider requesting an amendment modifying the advance rate or allowing them to temporarily “over-draw” the facility in relation to the borrowing base.

To the extent additional debt financing is necessary and available, borrowers should consider securing amendments to their debt covenants permitting such additional debt, which will likely need to be subordinated. This includes any stimulus loans, such as loans under the Payroll Protection Program.

In the event that asset sales are needed in order to provide liquidity, borrowers should consider requesting an amendment to their asset sale covenant permitting the required sales. To the extent the loan agreement includes mandatory prepayment provisions requiring asset sale proceeds to be applied toward repayment of the loan, such provisions will also need to be amended. If any such asset sales will result in a permanent reduction in future earnings, borrowers should consider whether any earnings-based financial covenant levels will need to be adjusted accordingly.

Financial Covenant Compliance

As borrowers experience lower revenues and increased costs in dealing with COVID-19, many will face breaches of their financial covenants that are based on calculations of EBITDA, net income or other similar measures of earnings. Borrowers should consider requesting a temporary “covenant holiday” with respect to any financial covenants that they will not be able to meet for upcoming periods because of the effects of COVID-19. With respect to covenants based on EBITDA, borrowers should consider requesting additional “add-backs” for expenses and lost revenue related to COVID-19. Alternatively, borrowers might request amendments that exclude periods affected by COVID-19 from the relevant test period, instead annualizing pre-COVID-19 results.

Financial Reporting

To the extend necessary in light of COVID-19, borrowers should seek to extend deadlines for financial reporting requirements, particularly with respect to audited financial statements.

Default Waivers

Borrowers should carefully review their loan agreements and seek to secure waivers with respect to any defaults that have already occurred. This may include a waiver of the resulting default interest (or an amendment converting such default interest to PIK interest). Borrowers should also be sure to secure waivers of any cross-defaults that may have occurred with respect to other indebtedness.

Lender Considerations

When working with borrowers to provide amendments and waivers addressing the above considerations, lenders should be mindful of the following:

  • Lenders should consider whether to require additional collateral or guarantees as a condition to providing an amendment and/or wavier.
  • Lenders and their counsel should take this time to ensure that their existing security interest is properly perfected, including that any necessary Deposit Account Control Agreements (DACAs) are in place, all UCC filings are valid and up-to-date, and any certificated investment property has been taken possession of.
  • When providing amendments to debt covenants allowing the incurrence of additional indebtedness, lenders should consider including a requirement that such indebtedness be subordinated. This applies to both secured and unsecured debt, including any stimulus loans, such as loans under the Payroll Protection Program.
  • Lenders should consider whether to limit, during the continuance of any payment or covenant relief, the borrower’s ability to continue making any junior payments that may be permitted under the current language of the credit agreement, including any dividends and subordinated debt payments.
  • Lenders and their counsel should review the assignment provisions included in the credit agreement and consider requiring amendments allowing for free transferability of the loan in order to ensure that it is as liquid as possible.

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Posted in General Business
Paul Wolpert
Paul Wolpert is a senior attorney at Vela Wood. He practices in all areas of corporate law, including securities and corporate finance, mergers and acquisitions, corporate governance, and fund formation. You can see Paul's attorney profile here.