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The covid19 global crisis and the relating lockdown measures will strongly impact the activity of borrowers and the value of their assets. Their repayment capacity and their liquidity needs will also be affected.
The crisis also impacts lenders and the operation of financial markets.
We outline advice to meet the difficulties that may arise in the implementation and negotiation of financing agreements.
1. MONITORING THE DEFAULT RISK FOR THE BORROWER
In addition to the risk of payment default due to cash flow shortage which would enable the lender to accelerate the loan and enforce securities, the debtor must focus on the following clauses, the breach of which constitutes an event of default.
Information undertaking
Credit agreements generally contain information undertakings of the debtor, in particular the undertaking to update any information provided to the lenders which would have become inaccurate and, at their request to inform the lender or the agent, of any changes in the borrower’s financial and operational situation. Borrowers should therefore be prepared to provide adequate and detailed information and, given the evolving nature of the coronavirus crisis, periodically update such with respect to the practical effects of the disruptions on their business activity and forecasts.
Top-up provisions in security documents
Top-up provisions create an obligationfor the pledgor , in the event of a decrease in the value of the asset granted as security below a certain threshold set out in the agreement, to provide new security interests over assets acceptable to the creditors in order to compensate for such decrease in value. Due to the considerable decrease of stock market prices in the past month, this clause finds an immediate and harsh application in the case of pledge over listed securities, putting the debtor at risk if it does not have sufficient new assets to offer.
Breach of covenant
The abruptness of lock down measures and the disruption of supply chains can quickly lead to the breach of ratio covenants, in particular the leverage ratio (consolidated net debt divided by consolidated operating income), on the next test date.
Assets disposal undertaking
When the borrower has agreed to implement an asset disposal plan within a certain timeframe to reduce its indebtedness, the strong plunge of the stock market, the uncertainty over global activity and the suspension of negotiations caused by the Covid 19 crisis for example may call into question the respect of the borrower’s commitments, .
Can the creditor rely on a Material Adverse Change or Event?
The Material Adverse Change (MAC) or Material Adverse Event (MAE) clauses allow the lender to suspend, terminate or renegotiate the credit agreement in case of occurrence of a significant event that affects immediately or in the future the borrower’s business, assets or financial situation and consequently its ability to meet its repayment obligations.
This change or event does not need to be temporary or known to the lender prior to the conclusion of the contract, but it may be an event of a systemic nature and it is not required that it is unpredictable and irresistible. The lender may then accelerate the loan or at least refuse any new drawdown.
To date, the Covid19 crisis seems too recent and the persistence of the disruptions it causes far too uncertain for a lender to be able to decide to accelerate or to refuse a drawdown for this very reason without taking the risk to pay damages.
The risk of cross-default
Cross-default clauses, when stipulated, allow creditors to accelerate in the event of a default under another credit, bond or derivative agreement. Their implementation can have a domino effect on the borrower. Contracts affected by such a cross-default clause must also be audited.
2. WHAT PROTECTION CLAUSES AND TOOLS CAN BE ACTIVATED BY THE BORROWER AGAINST THE EFFECTS OF THE COVID-19 CRISIS?
Faced with the risk of default caused by disruptions linked to the Covid 19, many protection mechanisms are available to the borrower.
Contractual cure
Credit agreements may grant borrowers a cure period in the event of the occurrence of a contractual event of default. These contractual provisions will have to be verified. This cure period (being usually fairly short) will probably be insufficient to allow for full remediation of defaults that may arise from a strong and evolving crisis such as the Covid 19 pandemic.
Waiver / amendment
If the cure period is insufficient or not adapted, the debtor may request a waiver of an event of default. It should be recalled that lenders are in principle allowed to request for a waiver fee.
Depending on the impact of the Covid 19 on its repayment capacity, the borrower may ask for the postponement of one or more instalments, an extension of the credit period, an extension of the covenant test period, or a waiver of any top-up provisions.
ForceMajeure
Could a borrower rely on Force Majeure to suspend repayment under its loan for the duration of the Covid 19 crisis?
If the contract contains a Force Majeure clause, one shall refer to it. Under French law, Force Majeure is not of public order and the parties are free to agree on its definition and its consequences or even to exclude it.
The legal regime of Force Majeure set out under Article 1218 of the French Civil Code has been amended in 2016. Force Majeure occurs only if the event (i) is beyond the control of the debtor, (ii) could not reasonably have been foreseen at the time of the conclusion of the contract, (iii) has effects that cannot be avoided by appropriate measures and (iv) prevents the performance of the obligation by the debtor.
This regime applies only to contracts entered into or modified since April 2, 2017. For earlier contracts, the old regime remains applicable. The latter requires that the event be unforeseeable, irresistible and external.
In all cases, if the impossibility to perform the obligations under the contract is temporary, the contract is not terminated but only suspended, whereas if the impossibility to perform the contract is permanent, the contract is automatically terminated and the parties are definitively released from their obligations.
As for contracts subject to the new regime, three conditions must be satisfied for the debtor to be relieved from its obligations:
- The health crisis is beyond its control. This is not disputable in terms of the effect of the crisis on its order book and the disruption of its supply-chain, as well as the disorganization caused by the legal closure measures. The illness of the debtor’s employees may also taken into account if it is not the result of the debtor’s risky conduct.
- The health crisis is reasonably unforeseeable at the time of the entry into of the contract. Otherwise, the debtor shall be deemed to have agreed to bear this risk. In the case of a viral epidemic, it has been held that Force Majeure is not characterized when the epidemic existed prior to the contract (Saint-Denis de la Réunion, 29 Dec.2009, No. 08/02114 – in the case of chikungunya). This condition will be satisfied except for contracts concluded since the appearance or spread of Covid 19 i.e. end of February or beginning of March 2020.
- Finally, the effects of the event cannot be avoided by appropriate measures, i.e. the debtor must first take appropriate measures to try to limit the effects of the crisis and fulfil its repayment obligations or mitigate its default. It is therefore not sufficient for the debtor to have little control over the direct effects of the Covid 19 crisis on its business stemming from the mandatory lock-down and deferral measures, but the debtor must reasonably attempt to mitigate the effects on its payment obligations. Certain sectors (luxury, event industry, hotel and catering, tourism, transport, energy) are very affected by the crisis, but the debtor’s actual situation and the effect of the aid measures enacted by the government (postponement of payment of social security charges, unemployment compnesation, etc.) must also be taken into account.
In the light of the case law which has clarified the criteria for the application of Force Majeure in the previous regime and the characteristics of the Covid 19 crisis, those conditions would in substance also apply to previous contracts.
The notification of a Force Majeure event might prove to be a useful defensive weapon for certain debtors wishing to have the performance of their payment obligations suspended and to negotiate as best as they can an adjustment to their contract without waiver fees (suspension of repayment obligations, provision of new security, release of interests, etc.). The notification made to the lender should seek to identify the concrete effects of the Covid 19 crisis on the debtor and their impact on its contractual obligations despite reasonable efforts. However, the temporary and evolving nature of the crisis does not currently allow to invoke it to terminate a credit agreement.
Can the Covid 19 crisis be invoked to trigger hardship?
Since 2016, Article 1195 of the French Civil Code allows for renegotiation of the contract in the event of a change in circumstances which could not have been foreseen at the time the contract was entered into and rendering the performance of the contract excessively onerous for a party who had not agreed to assume the risk.
Could a party to a loan agreement request renegotiation of the contract from its co-contractor (in particular if that party has to implement particularly onerous measures to face the epidemic)?
In practice, the question does not arise in credit and security agreements, as such clause does not apply to contracts prior to the 2016 reform of the French Civil Code and is generally set aside in those concluded since its entry into force.
Legal grace period
The judge may grant a delay or reschedule, within a limit of two years, the payment of sums due or to be due by a debtor, taking into account the situation of the debtor and the needs of the creditors (Article 1343-5 of the Civil Code), even after the opening of proceedings.
Preventive and safeguard procedures
If the Covid 19 crisis causes insurmountable difficulties for certain debtors despite the temporary suspension of their obligations, it could be considered to resort to preventive procedures of ad hoc mandate and conciliation or even to safeguard.
3. IMPACT OF THE COVID-19 CRISIS ON THE FINANCING OF RENEWABLE ENERGY PROJECTS - by Christophe Jacomin
The COVID-19 crisis is likely to significantly disrupt financing operations for renewable energy infrastructure. Indeed, the equipment needed to build this infrastructure is produced in Asia, which has been largely affected by this new virus, and this could have several consequences for current financing contracts.
Firstly, in so-called ‘greenfield’ financing (i.e. financing the construction of infrastructure), delays in supply can lead developers to fail to meet the consolidation date set by the debt documentation. Second, some lenders may consider the Coronavirus outbreak as a “Material Adverse Effect” (MEA), the definition of which is often broadly defined in credit agreements. This qualification would lead to an event of default under the terms of the credit documentation, which would be likely to result in the early repayment of the entire debt and the realisation of the collateral. Finally, some may consider the Covid epidemic19 to be a case of force majeure, exempting the co-contractors from the consequences in terms of the performance of the said contracts.
In this respect, it would appear that the players involved in these financings must show anticipation. When a supply or scheduling difficulty is identified, it seems useful to discuss and conclude a waiver or an amendment adjusting the contractual situation of the parties to the new circumstances. It is also possible to negotiate a moratorium on interest on the debt.
4. WHAT PROTECTION FOR CREDITORS?
The Covid crisis19 also impacts creditors. Exceptional measures are expected to be taken in order to lighten their obligations with respect tocapital adequacy or stress testing, and enable them to assist companies with dealing to the crisis.
Certain provisions instated to protect their interests could also be activated depending on the impact of the Covid crisis19 on the financial markets. In particular, the following should be mentioned:
Market flex/Market Mac/Market Disruption clauses
These clauses, common under underwriting and syndication agreements, allow the financial party to renegotiate the terms of an offer, or cancel or modify its commitment in the event of a major event affecting the financial markets.
Credit Default Swaps
Credit default swap contracts allow the lender to protect himself against the borrower’s credit risk. In case of CDSs governed by the International Swaps and Derivatives Association (ISDA) master agreement, it is the ISDA itself that will decide whether an event of default has occurred, allowing the swap to be applied or not. The conditions for enforcement of CDSs in connection with the Covid 19 crisis will have to be closely followed.
5. PRACTICAL RECOMMANDATIONS
The fast and brutal spread of the Covid19 crisis requires parties to assess its potential effects on their obligations under their financing agreements. They need without delay to start auditing their contracts and anticipate the enforcement of adequate protection provisions.
For contracts under negotiation, we will recall that as the parties as now aware of the crisis, protection provisions will not be able to be applied as such. It could be contemplated to strengthen them.
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