The COVID-19 pandemic affects borrowers and lenders and their financing arrangements. The most significant clause to consider is the Material Adverse Effect (MAE) clause – this clause broadly captures unpredictable and unforeseen events or circumstances that would otherwise be difficult to incorporate into the agreement specifically. Read our article on the impacts of COVID-19 on the MAE clause for more detail.
Apart from the MAE clause, both parties must identify other contractual terms that may become relevant for determining the impact of the pandemic on their financing arrangements. While there are many terms that require consideration, here are three relevant significant clauses that require consideration:
A draw-stop event allows the lender to refuse to make further loan advances, if there are any undrawn amounts available. Draw-stop events usually includes an event of default (or potential event of default), misrepresentation, and the occurrence of a funding shortfall. Even if a lender is reluctant to seek acceleration or enforcement solely due to an MAE, the event could nonetheless result in the lender refusing to provide further funds under a revolving working capital facility. This could negatively affect the borrower’s liquidity, because its working capital needs are likely to increase due to the adverse impact of COVID-19 on its business and supply chain.
- Financial covenants
Financial covenants assess the ability of a borrower to service its debt, often on a backward-looking and forward-looking basis. Covenants include ratios such as a debt service cover ratio, interest cover ratio, local life cover ratio and project life cover ratio, which are tested at set measurement dates in a borrower’s financial year. This ensures that the lender is able to detect any financial distress of the borrower, early.
A reduction of revenue due to the adverse effects of COVID-19 could result in the breach of one or more of these financial covenants, allowing the lender to accelerate the loan and enforce its security rights. Whether the facility agreement requires the borrower proactively to inform the lender of any such developments must be checked.
A cross-default provision in a facility agreement permits a lender to call an event of default if an agreement with another creditor is breached by the borrower. This protects lenders in cases where other creditors are exercising their rights to repayment against the borrower. In other words, an MAE under a given facility agreement could lead to default under other facility agreements. Therefore a borrower’s full range of loan obligations must be considered in relation to cross-default clauses.