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Key Considerations for Commercial Lenders

March 23, 2020

Chad Porter is a partner in the Burns & Levinson’s Finance, Middle-Market M&A and Private Equity, Securities Law, and Business & Transactions groups. He specializes in mergers and acquisitions, commercial financing arrangements, private equity investments and transactions, securities transactions and compliance, general business affairs, and business disputes. He can be reached at cporter@burnslev.com or 617.345.3686. Frank Segall leads Burns & Levinson as part of its Executive Committee and as Chair of the firm’s Business, Finance, Restructuring and Venture Capital & Private Equity groups. Known for his business savvy, thoughtfulness and legal expertise, Frank has helped build the firm’s practice and focus on the needs of growing companies. Highly networked and capitalizing on his business acumen along with lawyering skills, Frank has helped his clients create, develop, and build synergies, negotiated highly complex and sophisticated transactions, secured billions of dollars of financing, brokered strategic partnerships and expanded revenues for his clients. He can be reached at fsegall@burnslev.com or 617.345.3684.

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The economic effect of measures taken to control the spread of COVID-19 is going to have an adverse effect on many commercial borrowers. The magnitude of such effect will depend on the nature of the borrower’s business and how it is affected by the material disruption of supply chains, softening demand for goods and services, non-payment of receivables, and non-performance under contracts as the borrower or third parties may be unable or unwilling to fulfill obligations. Borrowers are reassessing budgets and forecasts, and actively seeking access to available debt capital.

This distressing and unfortunate situation will provide lenders with a number of potential concerns to assess, including:

• Borrowing Base. For borrowers with revolving lines based on a borrowing base (including accounts receivable, inventory, etc.), COVID-19-related disruptions will likely have an impact the borrowing base. Such impact could include eligibility reductions due to customer cancellations and disputes, stretching of payment terms, and supply chain disruptions. Implementation of borrowing base reserves may be advisable to the extent appropriate in relation to specific COVID-19 disruptions. 

• Overadvances and Cash Management Triggers. Decreases in the borrowing base may create overadvances and trigger related payment requirements as well as more stringent controls on cash management.

• Financial Covenants. Financial covenants andrelated definitions may be affected by the COVID-19 disruption, including prospective covenant compliance issues as well as EBITDA add-backs in relation to extraordinary and non-recurring losses and expenses. 

• Funding conditions. With respect to advance requests, funding conditions typically include a bring-down of representations and warranties, no default or event of default, and sometimes no material adverse change/effect. Each of these requirements will need careful consideration to determine effects of COVID-19. A variety of events of default may have occurred or are likely to occur, including as to financial covenants, cross-defaults, payment defaults, material adverse effects, insolvency, or deterioration in financial condition.

• Additional and Enhanced Reporting. Loandocumentprovisions typically permit the lender to require enhanced reporting and obtain additional information, including as to:
  • accelerated reporting deadlines for financial reporting and borrowing base certifications;
  • ensuring cash management processes are enhanced as to control of cash and accounts;
  • updated cash flow budgets and other projections;
  • prompt notices of disputes or claims, changes to material agreements or commercial relationships; and
  • copies of board/equity holder presentations.

• Modifications, Forbearances, and New Regulations. Many borrowers are or will soon be in default of their loan documents. Lenders will be hard pressed to call defaults and enforce their rights during one of the most catastrophic events in history. Lenders need to protect their positons and will need to structure modifications to the loan documents or enter into forbearance agreements that will enable borrowers to recover and stay in business. Since there is so much uncertainty as to when things will be normalized, it will be difficult to determine how long a forbearance or temporary modification should last. Therefore it will most likely be advisable to structure flexible agreements that have short terms that can be extended as more certainty returns to the markets. Lenders must also be aware of new regulations that are being adopted to protect borrowers that might restrict a lender’s enforcement rights.   

• Lender Liability. In assessing the borrower’s situation and the loan documentation requirements, lenders should exercise prudence and consider the potential for lender liability claims. Common areas of concern in this regard pertain to the implementation of changes to the borrowing base, as well as determinations that a material adverse change/effect has occurred. A lender’s decisions to mitigate risks, including as to borrowing base reserves, funding requests, and calling events of default among others, are subject to contractual and statutory obligations to act reasonably and in good faith. Decisions should be measured and defensible, and it is best to clearly notify the borrower, reasonably in advance when possible, of such anticipated changes. 

Our finance team is available to assist lenders with understanding the loan document provisions and applicable legal regimes to properly navigate today’s turbulent economic environment. Please do not hesitate to reach out with any questions.