COVID-19 Impact on Loan and Credit Agreements
The ongoing spread of the COVID-19 coronavirus and “social distancing” (the “COVID-19 crisis”) will have widespread impact on the financial industry and those that rely on products and services provided by banks, other lenders and services providers. The extent of that impact cannot be known with any certainty, but past downturns and recently publically announced legislative agendas offer insight into the potential impact (both macro-and micro-economic), its aftermath and the role of government.
COVID-19 and potential impact on Commercial Lending
The COVID-19 crisis could potentially serve as the basis for a lender to refuse to make a loan or refuse to fund further advances under a committed loan (e.g., a line of credit or a construction loan) or serve as the basis for a lender to declare an event of default under existing loans. The ability of the lender to refuse a loan or advance or call a loan is heavily dependent on the terms of the specific agreements between the parties and could potentially be impacted by government intervention. The following types of provisions should be reviewed to determine if a borrower’s access to credit could be limited by the COVID-19 crisis:
Commitment letters and loan documents often provide that a lender can refuse to make a loan or fund an advance if a material adverse change has occurred to the financial condition of the borrower or other loan parties. Material adverse change provisions can also extend to macro-economic events in some situations. To the extent the “material adverse change” concept is not objectively defined, borrowers should review those provisions in the context the borrower’s current circumstances to determine whether the COVID-19 crisis has resulted or could be excepted to result in a material adverse change in the condition of the borrower or other loan parties.
Borrowing Base Availability
Under asset-based lending structures, many borrowers should expect to experience a reduction in borrowing power due to slowing demand, resulting in a reduction in eligible accounts receivable. Borrowers should be especially careful to note that if the outstanding balance on a line of credit exceeds the borrowing base, a mandatory prepayment obligation could be triggered whereby the borrower would be required to make a principal payment to bring the balance of the line of credit in line with what the borrowing base permits.
The COVID-19 crisis could impact a Borrower’s ability to comply with several provisions of its loan documents including, but not limited to, the following provisions:
- The loan parties may be required to notify the lender of any material adverse change in financial condition and/or business;
- The loan parties may be required to notify lender of any event which constitutes an unmatured event of default (which is a default that will happen in the future) or event of default and steps being taken to cure the event;
- The loan parties may have an affirmative obligation to remain solvent while loan(s) are outstanding;
- The loan parties may be precluded from terminating or suspending business operations without lender consent;
- Financial covenant performance based on EBITDA, income or cash flow could be negatively impacted if the borrower’s business experiences any decline in any of those items;
- Financial reporting timelines might be missed due to business closures, employees working remotely or lack of availability of outside accountants;
- Defaults under certain material contracts identified in the loan documents or loans with third parties may trigger cross-default provisions; and
- Terminating or suspending business operations without lender consent may constitute an event of default.
Below is a brief overview of the current governmental response to COVID-19 as it specifically pertains to matters related to finance:
Local Level Foreclosure and Eviction Moratoriums
Numerous states, cities and counties across the country are implementing a temporary ban on evictions and foreclosures. The parameters of each eviction/foreclosure moratorium vary by jurisdiction. At least some jurisdictions have placed a moratorium on evictions of commercial tenants. The Mayor of Los Angeles, for instance, has put an order in place until March 31st (unless extended) stating, “no landlord shall evict a commercial tenant in the city of Los Angeles during this local emergency period if the tenant is able to show an inability to pay rent due to circumstances related to the COVID-19 pandemic.” A provision in the order also gives eligible tenants up to three months following the expiration of the local emergency period to repay any back due rent. The state of New York has taken similar measures stating, “all eviction proceedings and pending eviction orders shall be suspended statewide until further notice.” It can be expected that local jurisdictions across the country will take similar measures.
U.S. Small Business Association (SBA) Economic Injury Disaster Loan
The SBA is offering designated states low-interest federal disaster loans up to $2 million for working capital to small businesses to help overcome the temporary loss of revenue they are experiencing due to the COVID-19 crisis. The general process for accessing the SBA’s COVID-19 Disaster Relief Lending is as follows:
- Upon a request received from a state’s or territory’s Governor, SBA will issue under its own authority, as provided by the Coronavirus Preparedness and Response Supplemental Appropriations Act that was recently signed by the President, an Economic Injury Disaster Loan declaration.
- Any such Economic Injury Disaster Loan assistance declaration issued by the SBA makes loans available statewide to small businesses and private, non-profit organizations to help alleviate economic injury caused by the Coronavirus COVID-19.
- SBA’s Office of Disaster Assistance will coordinate with the state’s or territory’s Governor to submit the request for Economic Injury Disaster Loan assistance.
- Once a declaration is made, the information on the application process for Economic Injury Disaster Loan assistance will be made available to affected small businesses within the state.
- These loans may be used to pay fixed debts, payroll, accounts payable and other bills that can’t be paid because of the disaster’s impact. The interest rate is 3.75% for small businesses. The interest rate for non-profits is 2.75%.
- SBA offers loans with long-term repayments in order to keep payments affordable, up to a maximum of 30 years. Terms are determined on a case-by-case basis, based upon each borrower’s ability to repay.
For an updated list of counties eligible to apply for the SBA COVID-19 Economic Disaster Loan, you can go to: https://disasterloan.sba.gov/ela/Declarations/Index
If your area has been declared a designated area eligible for this program, information on the three-step application process can be found here: https://disasterloan.sba.gov/ela/Documents/Three_Step_Process_SBA_Disaster_Loans.pdf
The U.S. Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC) has released new guidance to financial institutions for working with commercial borrowers impacted by the COVID-19 crisis. The guidance encourages banks to use their resources to support their borrowers during their time of need and highlights areas where the FDIC and OCC will provide regulated institutions more flexibility with respect to compliance with regulatory requirements.
Federal Stimulus Measures
Congress is working to craft legislation that will have a meaningful economic impact to combat the COVID-19 crisis. Although negotiations on a final bill are ongoing and still subject to change, it is anticipated that an economic stimulus package will soon be passed to include direct relief for individuals, small businesses, financial institutions and highly distressed industries such as the airline and travel industry. The following initiatives have been proposed thus far:
- Nationwide moratorium on all individual and commercial foreclosures and evictions;
- Mandatory forbearance for mortgages on rental properties;
- Facility established by the Federal Reserve or Treasury to reimburse creditors and servicers for lost revenue and expenses, including payment advances;
- Direct payments from the Internal Revenue Service to individuals; and
- Small business relief in the form of streamlined SBA disaster lending programs.
Koley Jessen’s Banking and Finance Practice Group will provide updates on these and other governmental programs and issues as the details of those programs are further defined.
The COVID-19 crisis is a dynamic situation and the economic impact and government response will be ever-evolving. Koley Jessen continues to monitor the situation and stay current on the issues facing the financial industry and its participants and users in light of the COVID-19 crisis. If you have additional questions or concerns as the situation develops, please contact a member of the Koley Jessen Banking and Finance Practice Group.