COVID-19 – what could it mean for your portfolio company’s compliance with its loan agreements?

March 24, 2020

As the COVID-19 coronavirus pandemic spreads further around the world, the full impact of the virus on businesses remains to be seen.

For some industries (travel, hospitality, retail, health and leisure) the immediate loss of revenue is obvious, as consumer demand for certain services reduces significantly, or discontinues completely, as social distancing rules are applied by governments.

For other industries, a loss in revenue is likely linked to the disruptions in their supply chain or increased costs, related to travel restrictions or supplier closure, the implementation of higher hygiene standards, or indeed costs relating to remote working, illness or quarantine of their workforce (to mention a few).

It may feel that the points above are stating the obvious, however they serve as a reminder that whilst the expectation is for a significant number of businesses to be negatively impacted by this virus, how they are impacted will be different. Many of these business will have financing arrangements in place, and a number of provisions contained in the loan agreement relating to those arrangements may come into focus as businesses continue to feel the impact of this pandemic. Whilst the detail of each of these loan agreements will vary, listed below are some issues for you to consider when looking at your portfolio, and entering into discussions with your borrowers.

  • Liquidity

    • Does your borrower have any short-term liquidity concerns?

      • Is it able to pay upcoming suppliers, distributors, landlords, employees etc. in light of the impact coronavirus has had, or may have, on its cashflows?

      • Is it going to be able to service your debt – when is the next interest payment? Is the non-payment of interest purely a temporary cashflow issue, or is this an indicator of a broader issue on the horizon – i.e. insolvency?

    • Does your borrower have access to its working capital facilities? Note that a drawdown of a revolving facility will likely require the borrower to confirm the repeating representations in its loan agreement, as well as confirming no default/event of default.

    • Nearly all loan agreements will permit cashless "rollovers" of existing revolving facility drawdowns, until a certain event – usually a declared default/ acceleration event, but in some cases on an event of default. What would the implications of having to prepay outstanding revolving facility loans have on your borrower?

    • If your borrower may need to look to you to bridge immediate cashflow requirements:

      • What timing constraints do you have on calling for funds?

      • Does your loan agreement permit the incurrence of additional debt – is there an incremental facility that can be established? Would establishing/ increasing the facilities require other lenders to consent? What is the related documentation process?

    • Is the Sponsor going to help with any liquidity issues – and does this assistance come with certain conditions or limitations?

    • What existing permissions does your borrower have for it to access other financial indebtedness – can that debt be drawn, and do you want it to be drawn?

  • Financial Covenants

    • What is the likelihood of your borrower’s continued compliance with its financial covenants in light of:

      • Any projected decrease in EBITDA – either through projected loss of revenue or increased operational costs (or both)?

      • Incurrence of additional debt?

    • Are any “springing” covenants exercised by the drawing of the revolving facility, and as such, certain additional super senior lender rights?

    • Are there any adjustments to EBITDA contained in the loan agreement that could be utilised (or argued for) to mask the real impact that the pandemic is having on your borrower’s business (remembering that these adjustments will be relevant both for the purposes of financial covenant compliance and any leverage-related incurrence tests in the loan agreement)?:

      • Could any coronavirus-related costs be classified or loss in revenue be classified as "Exceptional Items" in the loan agreement and treated as an add-back to EBITDA on an uncapped basis?

      • Could the borrower point to its COVID-19 response as falling within certain cost savings and synergies or other initiatives that can be added back to EBITDA?

      • How are the proceeds from any insurance claims, government funding1 or grants treated?

      • How are rent-free periods, VAT holidays and PAYE wage support to be accounted for?

      • In recent years, for certain businesses, EBITDA "shock" adjustment concepts have been included in loan agreements to offer "one-off" relief to borrowers in the testing of compliance with financial covenants. Whilst these types of adjustments have focused more on acts of terrorism, could the language in your loan agreement be broad enough to also cover a pandemic of this type?

    • Equity Cure:

      • What ability does the Sponsor have to inject equity into the borrower group to avoid/cure a financial covenants breach? Is there any EBITDA cure provision? Any deemed cure?

      • Given the uncertainty around the ongoing impact of this pandemic, what are the over-cure provisions contained in the loan agreement that could be exercised by the Sponsor to aid your borrower with sufficient cushion with respect to upcoming tests?

    • It is also worth remembering that financial covenants are tested on a "last twelve months" basis and, as such, even if the impact of COVID-19 transpires to be short-term on businesses, the impact on financial covenants testing will continue for a much longer period of time. This will be important to note in any discussions around financial covenant resets.

  • Information Rights

    • Is your borrower anticipating issues with delivery of financial information due to interruptions with its business – e.g. accounts, compliance certificates – and if this is the case, how will you monitor its financial wellbeing? Typically your loan agreement will give lenders access rights or additional information rights if a default or event default is suspected under the loan agreement.

    • In most cases, your borrower will be required to notify you of any defaults/events of default under the loan agreement, however, placing reliance on such provisions in the current environment is not necessarily recommended.

  • Representations and Warranties/Undertaking/Events of Default

    • A number of customary representation and warranties, undertakings and events of default in loan agreements are qualified by "Material Adverse Effect/Change" (“MAE”), meaning that these provisions are only breached where an MAE has, or is likely, to occur. Depending on the drafting of that provision, the ability of your borrower to confirm certain (repeating) representations because of the impact of COVID-19 on its business may be impeded, and consequently the facilities may be “drawstopped”, adding to its liquidity concerns.2

    • Almost all loan agreements will contain a specific MAE event of default, which will not attach to a particular action of the borrower group, but applies on a generic basis to the business of the borrower. Again, depending on the drafting of that provision, the event of default may be trigered.3

    • Due to liquidity issues and/or business disruption, your borrower may not be meeting its obligations under certain of its contracts, as a consequence:

      • Depending on the materiality thresholds contained in the loan agreement, cross-default provisions may be triggered.

      • The loan agreement may contain specific non-performance events of default in relation to certain material contracts, which will not necessarily have materiality thresholds applicable, and may be breached as a result of the issues it is facing.

      • Insolvency events of default should be reviewed as there are certain circumstances outside of an actual insolvency event which may trigger these provisions, in particular for overseas subsidiaries.

    • Any failure to pay upcoming interest payment or principal payments will likely trigger an immediate event of default under the loan agreement.

    • If your borrower’s audited accounts need to be qualified as a consequence of the impact of COVID-19 on its business or because there has been a “drawstop” on its facilities, leading to its auditors not being able to sign it off as a “going concern”, this will also likely trigger an event of default under the loan agreement.

    • If your borrower’s businesses has ceased completely as a consequence of COVID-19, then this will likely trigger a cessation of business event of default in your loan agreement.

  • Other Issues

    • In more complex capital structures, certain distinct groups of lenders will have an independent set of consent rights and events of default giving rise to independent acceleration rights for them; and/ or there may be subordinated or holdco financing arrangements in place which are governed by a separate loan agreement, and as such having a separate set of covenants, consent rights and events of default. Any consideration of the above items should therefore not be confined to a senior lender’s rights under a senior facilities agreement only.

    • It should also be remembered that the consequence of an event of default is not only that it gives rise to acceleration rights for the lenders, but in the interim, will also act as a “drawstop” on the facilities and increase the pricing of the facilities (for those facilities with a margin ratchet).

    • You may also want to review the transfer provisions in your loan agreements to understand what restrictions apply, should you now be considering transferring your debt.

Whilst the list above is not exhaustive, it serves to illustrate the multitude of issues that COVID-19 may give rise to for borrowers and lenders under their loan agreements. These are the issues to be discussing with your borrower, its stakeholders and your advisors so that necessary action can be taken, and unnecessary action ruled out.


1) For further commentary on government loans in the UK please see separate Dechert note entitled "COVID-19 Government Funding and other liquidity options" (which will be published on 25 March 2020)

2) For further commentary on MAE please see separate Dechert note entitled "COVID -19 as an MAE in Loan Agreements".

3) For further commentary on MAE please see separate Dechert note entitled "COVID -19 as an MAE in Loan Agreements".

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