By now, many businesses have weathered the initial operational changes required nationwide as a result of shelter in place orders, approached landlords and other vendors for initial concessions, and applied for and obtained any stimulus funds for which they are eligible. With those initial adjustments in place, businesses should consider assessing their existing credit facilities in light of those initial adjustments and to protect themselves from continued economic volatility.
In this alert, we will discuss the following credit facility modification considerations for borrowers:
- Timing and scope of credit modification requests.
- Liquidity and financial covenant considerations (including treatment of stimulus funds).
- Assignment and participation provision concerns.
Timing and Scope of Credit Modification Requests
Despite current market-wide economic distress, many businesses will not experience financial covenant compliance issues until the second and third quarter test dates due to first-quarter EBITDA benefitting from payment on previously accrued accounts receivable. If your business anticipates forthcoming financial covenant compliance issues, approaching your lender(s) now will permit agreed-upon changes to go into effect prior to upcoming test dates, avoiding a financial covenant default.
Acting proactively to avoid default will reduce lender fees and expenses by alleviating the requirement for waivers and forbearance agreements and, for businesses with credit facilities subject to intercreditor agreements, prevent protracted creditor negotiations to reset and resolve standstill and payment blockage period issues.
When approaching your lender(s), consider whether you should request the adjustments you expect to be necessary for the next year. For businesses with syndicated credit facilities, going back to the syndicate as infrequently as possible generally saves time and expense. Additionally, businesses that anticipate a particularly protracted recovery (whether due to geographic location of operations, industry or other considerations) that approach their lender(s) while TTM financials are still strong may get the benefit of negotiating leverage that will dissipate if they wait for further economic distress to materialize over the coming quarters.
Liquidity and Financial Covenant Considerations
When putting together a request for lender(s) to consider, you may want to address the following items:
- Liquidity Concerns. If a business anticipates potential liquidity issues, it may consider asking its lender(s) to permit an additional ABL credit facility (if not already in place) or a factoring transaction (even if for a finite period of time) to recoup value in accounts receivable with extended aging due to the pandemic. If a business already has an ABL in place, it may want to revisit the aging restrictions in its existing borrowing base. Lastly, businesses should consider whether lender(s) will accommodate a potential upsize transaction to see the business through the remainder of the current stretch of economic uncertainty.
- MAC Funding Conditions. In considering access to liquidity, businesses may wish to ask lender(s) for clarity around any material adverse change/effect funding conditions, including that the lender(s) agree to expressly exclude ramifications of market-wide economic distress that are not disproportionately affecting the business.
- Financial Covenant Considerations.
- Covenant Deferrals. Businesses should consider whether their lender(s) will forego or waive financial covenant compliance for the next year. Some non-traditional lenders are already getting comfortable with this construct.
- EBITDA Addbacks. Consider asking lender(s) for an additional addback or an increased cap, as applicable, to addback expenses and losses associated with the pandemic’s disruption to EBITDA. If a business can make a claim under its business interruption insurance related to pandemic disruption, to the extent not already included in net income, consider asking lender(s) to allow the proceeds of the insurance to be added back to EBITDA.
- Equity Cures. If lender(s) are not willing to defer financial covenant compliance, private-equity-backed businesses may want to negotiate for increased flexibility on the number of equity cures permitted for the next year. The business should also consider asking the lender(s) to waive any prepayments required in connection with the injection of equity to help with liquidity (provided the proceeds are applied to certain negotiated business expenses).
- Impact of Stimulus Funds. Businesses that received Paycheck Protection Program (PPP) loans may need lender(s) consent to permit the PPP debt and to waive prepayment obligations tied to the incurrence of debt for the PPP proceeds. Lender(s) are coalescing around excluding any forgiven amount of the PPP loan from EBITDA (which would likely occur pursuant to deductions for extraordinary gains in any event), but some borrowers have been successful in excluding the PPP loan from leverage covenants, in particular, if the leverage covenant is not a net leverage covenant such that the borrower does not get the benefit of the PPP proceeds.
Assignment and Participation Provision Concerns
In examining their credit facilities, businesses may also want to revisit their assignment and participation provisions to ensure they have sufficient protections in place. Typically, assignments and participations by lender(s) require borrower consent (not to be unreasonably withheld or delayed) provided no event of default exists. Some borrowers also negotiate a restriction on the right of lender(s) to assign or participate the loan to the borrower’s competitors even after an event of default.
With distress and compliance issues in the foreseeable future, businesses should be sure to understand the rights of their lender(s) to assign their debt to hedge funds and “loan-to-own” shops that may look for increased opportunities during economic downturns and which, absent a relationship with the borrower, may be less inclined to make concessions or grant waivers.
Businesses should consider assessing their credit documentation now to get ahead of these and similar potential issues and ensure they have adequate protections and flexibility in place to ride out the volatility resulting from the pandemic.
If you have any questions about credit facility options for your business, please contact the authors. Please join Bass, Berry & Sims attorneys on Thursday, April 30 for a webinar covering this and other topics, Managing Stimulus Funds and Third Party Debt + Related M&A Considerations During COVID-19. Details and registration information can be found here.