If businesses had hoped 2022 would be the year of recovery after the COVID-19 pandemic, it has not come to pass. Instead, macroeconomic challenges such as rising interest rates, the highest rate of inflation for 40 years and a significant increase in cost pressures, have affected their ability to manage their banking and finance arrangements.
Whether lending money or borrowing it, we set out five areas for businesses to think about in these difficult times.
As well as the economic challenges, businesses are facing operational challenges such as labour shortages and having to confront shifting consumer habits due to the COVID-19 pandemic which has resulted in more uncertainty about demand outlook.
Now more than ever corporate borrowers need to ensure they have the necessary cash flow to make interest payments, and scheduled repayments of principal, whilst also keeping day-to-day operations running.
In addition, businesses that received funding from government lending schemes in 2020 and 2021 now have to start repaying those loans. Businesses will need to consider repayments of government backed loans in assessing what headroom is available for other arrangements.
Some borrowers may need to approach their lenders to defer scheduled payments under their financing agreement or perhaps seek a broader rescheduling of debts and terms to allow more headroom, in particular financial covenants. Borrowers with floating rate arrangements may need to consider refinancing to combat higher borrowing costs which decimates cashflow.
Speak to your finance providers – often, they will be far more sympathetic if they are involved from the start. Any quid pro quo for such concessions however, for example providing personal guarantees (see here), should be considered carefully.
Borrowers may want to consider alternative forms of finance, such as seeking an overdraft with existing funders, or shareholder loans from investors.
Lenders and borrowers should consider what products would enable them to best weather the current economic uncertainty, for example invoice finance and asset-based lending advances. One important caveat is that borrowers and lenders should enquire whether any new financing will breach existing arrangements.
Another option to manage cashflow is to restrict outflows of cash and assess potential saleable assets to generate cash, which a borrower may be able to do, for example, by:
(a) reducing or delaying expenditure;
(b) minimising prepayments: a borrower could also save cash by not making any planned voluntary prepayments; and
(c) a sale of assets: any disposal of assets during the term of a loan will typically be subject to restrictions which the borrower will need to check carefully.
As an alternative to seeking new funding, if borrowers have on-going funding requirements and have committed facilities that are not fully drawn, they will need to check whether all conditions to be fulfilled prior to drawing the facility can be met – having the relevant corporate approvals, confirmations and necessary documentation in place.
Borrowers may be able to draw under existing facilities in order to (i) have sufficient funds to meet payment obligations and/or (ii) borrow now when the organisation is able to satisfy all relevant conditions to the drawdown, rather than at a later date when there might be a potential or actual event of default that could act as a draw-stop.
Certain finance arrangements may provide that drawdowns under term facilities will occur throughout the life of the arrangement (for example, finance for developing a property may require certification that certain works have been completed before making further loans). Borrowers are encouraged to think ahead on future milestones to be sure that it will still be able to fulfil the conditions precedent to each further drawdown.
If fulfilling conditions may not be possible, borrowers should approach the lender to seek to renegotiate these conditions precedent.
Borrowers and lenders will need to examine their loan documentation to review, among other things, any financial covenants (including the definitions of financial terms), grace periods and potential penalties for breaches of representations and warranties, covenants and notice requirements in these documents, keeping in mind that resolving these complex issues will depend, as always, on careful analysis of the specific contractual wording in the relevant finance documents.
Borrowers should review their existing facility agreements to ensure they can continue to comply with their ongoing obligations and that an event of default will not arise, in particular:
(a) Covenants: Breaches of covenants usually allow lenders to declare a default under loan documents and demand early repayment of loans and/or act as a draw-stop, so that borrowers will not have access to their facilities.
As a result, if you are facing a potential breach as a result of cost pressures, or negotiation with other creditors which can be classified as an insolvency event (discussed further below), you must consider further steps on a timely basis to determine whether you can or should draw on existing available debt commitments (and lenders will pay closer attention as to whether the conditions to borrowing have been satisfied), or whether it would be prudent to proactively seek waivers in advance.
(b) Asset based lending: due to higher energy prices and ongoing supply chain and manufacturing issues globally, the available “borrowing base” for businesses reliant on asset-based liquidity facilities may be negatively impacted as the value of such businesses’ inventory and receivables decline. In addition, as excess availability under these facilities declines, borrowers may be faced with increased reporting obligations, more stringent limitations on their cash management and required compliance with additional financial covenants.
Lenders and borrowers should consider the following customary events of default may be relevant in the current climate of economic uncertainty. Should an event of default occur, this would be a ‘draw-stop event’ (where the lender does not have to provide any further loans), and could result in the lender calling for all amounts lent to be repaid immediately.
The extent to which the challenges faced give rise to an event of default will depend on the description of such events in the relevant loan documentation and any applicable grace periods. The key events of default to be aware of, which are likely to be present in most loan agreements are:
Given these uncertain economic times, it is in the interests of both borrowers and the lenders to work together. Borrowers should make early contact with lenders if any issues are on the horizon, especially where waivers of events of default or amendments of covenants or grace periods may be required. Borrowers should be proactive and keep lines of communication open at all times.
If you have any questions about these issues in relation to your own organisation, please contact a member of the team or speak with your usual Fox Williams contact.
You can register online or follow us on Twitter or LinkedIn to receive our latest news, events and publications.