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COVID-19’s Impact on German Corporate and Acquisition Loans30 March 2020

The spread of COVID-19 has caused concerns among borrowers, sponsors, investors as well as lenders in view of the potential effect on facility agreements. While the expectation is largely that the effect of the pandemic will be temporary, there is likely to be an increased need for liquidity in an environment where new loans will be difficult to obtain.

We have received numerous queries as to the potential effect of the crisis on their facility agreements and the following is intended to address at least some of these concerns. However, each facility agreement is different and, as with any contract, the devil is in the detail, so a review of the relevant agreements is vital before any action should be taken.

"While German legislation provides for a moratorium on payment obligations under consumer loan agreements and a consequential suspension of acceleration rights, corporate borrowers will not benefit from this legislation."

Events of default

Understandably, the primary concern of borrowers at this stage is that their loan facilities could be accelerated. Obviously, where there are concerns about compliance, which were already in place prior to the outbreak of the coronavirus, that will not change. It is also important to note that events of default may be caused by the pandemic and its economic and other consequences. However, in many cases, the concerns are premature:

  • Financial covenants, if they trigger an Event of Default, will usually be determined based on historic accounting data. That information will often not yet reflect the impact of the coronavirus. But this is clearly an event of default that may arise in future.
  • The occurrence of a material adverse change usually depends on the impact of circumstances on the financial, assets and business condition of the borrower’s group or the ability of the borrower to perform its obligations under the facility agreement. So, the test is individualised and not based on the global effect of the pandemic. In many cases, it is very difficult to understand the impact the crisis will have on the business and finances of the borrower as such, not least since certain negative effects may be alleviated by government support. Also, given the uncertainty of this provision, lenders will often be reluctant to rely on this event of default alone.
  • Some facility agreements also contain events of default caused by the cessation or abandonment of the business. However, the temporary shutdown of operations by government action, will not usually constitute such a cessation or abandonment. That may change, if the shutdown continues uninterrupted for a lengthy period.
  • Under some contracts, contractors are arguing that force majeure events have occurred that permit them to discontinue performing their obligations. Force majeure as such is neither a defence nor an event of default under the usual facility agreements. However, the occurrence of a force majeure event under material supply contracts can have a material adverse effect or otherwise constitute an event of default under facility agreements.
  • Finally, some group companies may eventually be subject to insolvency proceedings or party to a litigation or similar disputes or they may be in default of payment obligations as a result of the coronavirus epidemic. But again, we expect that such events will take their time, not least in such countries (as in Germany), where insolvency requirements have been or are expected to be loosened.

We would like to clarify that while German legislation is being implemented that provides for a moratorium on payment obligations under consumer loan agreements and a consequential suspension of acceleration rights, corporate borrowers will not benefit from this legislation.

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"Borrowers may consider utilising undrawn facilities, in particular working capital and revolving facilities."

Liquidity

At this stage, the focus of many companies is on maintaining liquidity. To achieve this result, borrowers may consider the following steps:

  • Utilisation of undrawn facilities: Borrowers may consider utilising undrawn facilities, in particular working capital and revolving facilities, even if at this time the funds are not yet required, even at the expense of having to pay interest.
  • Obtaining external financing: To the extent additional financial indebtedness is possible, borrowers may consider such funding. In particular, the borrower may benefit from subsidised loans from government agencies, such as KfW guaranteed facilities, which have been introduced / expanded to address the impact of the coronavirus epidemic. Borrowers may apply for such support through their principle lenders.
  • Clean down: Where facility agreements require a clean down of working capital facilities, borrowers may use available liquidity earlier so as to have a longer break before the next clean down becomes due.

Financial covenants

Where facility agreements have financial covenants and are not covenant-lite, it is important to manage processes to avoid a breach. Of course, financial covenants are usually tailored to the financing and borrower. On that basis, the specific provisions of the facility agreement will need to be analysed.

  • Equity injection. Financial covenants often allow for an equity cure, in a limited number of cases and usually not on immediately following test dates. Where the borrower expects to breach financial covenants, injection of equity may be considered prior to the lapse of the relevant period. Such equity injection prior to the default may mean that sponsors have more opportunity for cures at a later stage.

"We would expect appetite of lenders for new or increased financings to be limited and pricing to be higher."

  • Borrower may also need to review whether the effects of the coronavirus epidemic can be added back to EBITDA definitions.
  • More generally, financial covenants and in particular the definition of EBITDA should be analysed to see whether the impact of the coronavirus can be mitigated.

Market Volatility

We would expect the markets to be volatile until the impact of the coronavirus pandemic can be better priced. Until then, we would expect appetite of lenders for new or increased financings to be limited and pricing to be higher. We would expect to see a rise in market flex-provisions.

Existing lenders may be willing to divest loans. Certain restrictions may apply to such divestments under the terms of facility agreements, e.g. consent requirements, unless in case of a (material) event of default. This may be an opportunity for sponsors may step in to acquire debt at discounted rates, albeit usually defranchised from the lenders’ syndicate.

Should you seek assistance in planning further steps or would like to discuss your options out of precaution, please do not hesitate to contact Watson Farley & Williams. We gladly offer our support in these complicated times.

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