Now’s the time to check out your cash flow challenges – Stuart Fitzsimmons

Covid crisis means failing to comply with loan terms could be unavoidable for some firms, warns Stuart Fitzsimmons

Stuart Fitzsimmons is a Partner, Dentons

The coronavirus (Covid-19) pandemic has led to unprecedented business interruption and an urgent need for many Scottish businesses to review the terms of their current financing arrangements.

The immediate issue facing many businesses is to assess their short and medium-term cash flow challenges together with seeking any necessary amendments or waivers to loan arrangements where failure to comply with some of the terms may become unavoidable.

Increasing access to working capital through this uncertain period is vital. Many businesses have drawn any available loans in full to maximise flexibility, and some private equity sponsors have instructed portfolio companies to do this as policy. As conditions to drawing on a loan will typically require a confirmation that there has been no default against the loan agreement terms, there has been a perceived benefit for some borrowers in drawing available headroom in existing loans now ahead of any potential further business deterioration caused by the Covid-19 crisis when the ability to draw their loans could be blocked by failure to meet the conditions. In a sense, it is best to draw loans now and have the cash available.

Other businesses are looking at new or increased loan facilities. Corporate banking facilities can sometimes contain options to increase the loan amount, should this become desirable for the borrower in the future. As this will often be a request made of an existing lender/lenders, borrowers can sometimes falsely assume that because the “option” is documented in current loan paperwork, an increase will be obtained as a matter of course. However, increase options are often explicitly stated to be subject to further credit approval, provision of satisfactory financial information and other conditions, so borrowers should not treat an increase option as an absolute commitment of additional future funding.

The new government lending schemes are intended to provide access to additional finance to businesses at this time. We have advised both banks and borrower companies on transactions through these programmes in recent weeks including the Bank of England Corporate Covid Financing Facility (CCFF) aimed at large “investment grade” companies and coronavirus business interruption loan schemes aimed at SMEs and mid-market corporate businesses. The Chancellor has tinkered with the conditions of these schemes several times and the extent of their effectiveness remains to be seen. Speed of execution of lending through the schemes will be important and they offer businesses a potential sticking plaster for immediate working capital issues ahead of perhaps broader refinancing or review of loan arrangements over the next 12 months when the market position is clearer.

Together with reviewing working capital and access to additional finance, companies must carefully assess existing loan arrangements and any potential to breach the terms as a consequence of Covid-19 impacts. Financial covenants appear in loan agreements as regular health checks on the financial performance of a business and inevitably fall under increased scrutiny at a time when profits might be declining for many companies and borrowings increasing to help with working capital. Tests focused on debt service, cash flow or leverage would be good examples of where this squeeze can be felt. The crucial assessment for borrowers will be whether to approach lenders with a request for a complete holiday from the testing (we are seeing requests to cease testing for between 1 and 4 quarters) or an adjustment to the covenant test calculations to account for the Covid-19 impact.

Our experience is that adjustments are viewed more favourably than outright financial covenant testing holidays and lenders may well need something in return through increased financial information requests to give a better view inside the four walls of a business. Depending on the precise circumstances this may extend from requests for 13 week cash flows and updated business plans, through to controls on dividends or acquisitions and more opportunistic business activities.

As the business impact of Covid-19 continues to change on a daily basis, we recommend that lenders and borrowers review the terms of their loan agreements as an essential part of contingency planning and navigating through the storm.

Stuart Fitzsimmons is a partner, Dentons