Introduction
The Asian debt markets are currently being buffeted by unusual conditions – COVID 19 and its aftermath; multiple signs of stress in many sections of the economy and, the general hammering of the credit, fixed income and equity markets. If ever there were a time for safe havens and for Asian corporates to gain access to reserve funding and general liquidity, it is now.
As a parallel dynamic, these market circumstances themselves are all the more likely to result in borrower default – payment or otherwise – precipitating, at least initially, consensual restructuring discussions. Well-advised lenders and borrowers alike should therefore consider afresh how their finance documentation may permit potential and actual defaults to be remedied.
Reserve Funding
Quite apart from any cost savings or commercial arrangements borrowers are able to put in place at this time which strengthen liquidity, reserve funding will usually take one of three forms: (i) using headroom in existing commitments (among others, unutilised term and revolving facilities, overdraft and green-shoe facilities); (ii) making use of additional permitted indebtedness from third parties, to the extent achievable under current senior financings; and (iii) renegotiation of senior facilities themselves so as to obtain additional senior debt.
One of the key factors for borrowers to consider when assessing how to achieve better liquidity and access reserve funding is the extent to which their internal checks and audits show that they are currently in compliance with the provisions of, and in particular the events of default set out in, their existing finance documentation. This is critical. Borrowers must approach existing lenders or new financiers with clean hands.
Drawdown Requirements
A basic requirement likely to arise is that borrowers must be able to certify within drawdown requests that there are no Defaults in existence (i.e. no actual or potential events of default).
Furthermore, drawdown conditions are likely to require borrowers to certify they are in compliance with their representations and warranties – depending on the circumstances, either so-called “repeating representations” – this being the shorter subset of representations set out in the original credit agreement which are required to be true and correct as at the date of drawdown and the date of submission of a drawdown certificate – or, potentially, with weaker borrowers or in leveraged situations, they will need to be in compliance with all representations set out in the credit agreement, by reference to the facts and circumstances existing at the date such representations are made.
Other Notice Requirements
In addition to certifying “no Default” at the time of drawdown, borrowers are usually required as an ongoing obligation to notify the agent if they become aware of a Default and to notify any steps being taken to remedy the situation. Whilst this is sometimes negotiated out of original documentation, failure to make such notifications would typically lead to an event of default.
Consequences of a Default
Default provisions are a structural feature of virtually all loan documentation and their significance for borrowers can be drastic in several different ways:
(i) Perhaps the most obvious consequence of a lender being entitled to call an event of default is that it is then able to accelerate debts owed to it and, potentially, to make demands under any guarantee and enforce any security of which it has the benefit.
(ii) Another consequence of an event of default occurring is that this will generally function as a draw-stop for new utilisations (for term facilities) or for any increase in the amount outstanding (for revolving facilities). As described above, this is usually tested by way of the certification requirement in a drawdown certificate to be signed by a director.
(iii) An event of default may permit lenders to compel renegotiation of the terms of finance documents; such terms may be less commercially favourable to a borrower on the basis that the lender considers the risk profile to have changed. These may include any number of matters such as, classically, changes to increase margin and fees or tightening or other flex to key commercial terms, such as permitting fewer carve outs and exceptions to the package of restrictive covenants.
(iv) Continuance of an event of default may also cause other downsides for borrowers such as, restricting the payment of dividends or repayment of intergroup loans, restricting permitted disposals or, in loan agreements with margin ratchets, impacting the calculation of margin.
When is an event of default “continuing”?
Whilst the circumstances which constitute an event of default are often heavily negotiated, especially where lenders seek to introduce deal-specific events of default, the mechanics surrounding calling an event of default and lenders’ access to remedies after an event of default are typically those already included in template documentation and are often not the subject of such close scrutiny. Nevertheless, the manner in which they are drafted can have major practical consequences and we consider these are worthy of closer examination, in particular, what it means for a Default to be “continuing”.
The position of the Loan Market Association (LMA) leveraged facilities agreement – which is widely adopted in English law governed acquisition and leveraged financings – is that a lender will be entitled to call an event of default and thereafter have multiple remedies:
“on and at any time after the occurrence of an Event of Default [which is continuing]’”.
This model form facility agreement leaves it up to the parties to negotiate and agree whether or not to include the phrase “which is continuing”. Clearly, where this phrase is included, it will be advantageous for the borrower as it imposes an additional threshold for the lender to satisfy before becoming entitled to exercise remedies.
But the key to this requirement lies virtually hidden within the LMA interpretive provisions which are set out in clause 1.2 of the template facilities agreement. This section interprets the word “continuing” as follows:
“A Default (other than an Event of Default) is “continuing” if it has not been remedied or waived and an Event of Default is “continuing” if it has not been [remedied or waived]/[waived].”
As regards a potential event of default, the interpretation provision is rarely amended and the position is quite straightforward. To give an example: if the borrower fails to deliver a notice to the agent on behalf of the lenders before a specified date but the facility agreement provides that the borrower has a grace period before this amounts to an event of default, so long as the borrower delivers the notice during the grace period, it will have remedied the potential event of default and, as such, it would no longer be “continuing”. In this way, many of the operative consequences of a potential event of default hinge on it being continuing.
However, the position with respect to an actual event of default is not so simple. If the borrower does not deliver the notice by the end of the grace period, the question then arises as to whether the event of default is capable of remedy if the borrower delivers the notice at some stage after the end of the grace period.
In this example, the square bracketed language within the interpretation of the word “continuing” will be pivotal. Must a lender expressly waive the event of default, or, does the borrower still have the power to remedy the breach ? If the interpretation of “continuing” includes the wording in the first square brackets set out above, such that an event of default may be “remedied or waived”, the borrower should be able to remedy the breach by its own accord, without requiring an express waiver from the lenders. Alternatively, if the formulation in the second square brackets is used, so as merely to include the word “waived”, a borrower will be unable to remedy an event of default after the end of the grace period, without the express agreement of the lenders.
Given the importance of the word “continuing” and the tremendous power it can present to lenders with respect to draw-stops, acceleration of indebtedness and potentially, renegotiating borrowing terms, it is surprising that parties to loan agreements do not spend more time negotiating and agonising over agreement of how this word should be interpreted. Parties would be well advised to double-check which formulation their existing finance documentation contains.
Who dictates whether it is possible to remedy an event of default ?
On many occasions, borrowers and lenders end up agreeing alternative formulations for interpretation of the word “continuing” within facility agreements. To the extent the parties arrive at a stalemate in such negotiations, both lenders and borrowers sometimes take comfort in bifurcating the different types of actual events of default, as follows:
“An Event of Default relating to default in payment is “continuing” if it has not been waived.
An Event of Default relating to a circumstance other than a default in payment is “continuing” if it has not been remedied or waived.”
This formulation provides that:
(i) a payment default which becomes an actual event of default should only be capable of being remedied by way of an express written waiver from the lenders, whereas,
(ii) any other event of default is capable of being remedied by the borrower acting on its own.
Whilst this appears to be a reasonable compromise, from a lender point of view, it is not always such a recommendable solution. The reason is that just at the time of heightened stress or distress, when lenders expect real clarity on whether or not they can access remedies, they will effectively have passed control to the borrower so that it can decide whether or not an event of default (other than with respect to payment) is capable of remedy and has in fact been remedied. The concern is that, even the well-intentioned borrower acting in good faith, may be able to reach a subjective view on the nature of the remedy, perhaps because the event of default has only been substantially remedied or perhaps, only remedied temporarily.
Cautionary tales for lenders
At this stage, it will be helpful to provide examples of how borrowers may be able to re-assert control in an event of default scenario by maneuvering around the definition of “continuing”, potentially to the detriment of lenders:
(i) Negative pledge provisions and other types of undertakings which restrict granting of security are some of the most technical areas of a facility agreement. Experienced lawyers from reputable law firms can disagree on the operation of the detail of these provisions. This is also patently relevant to liquidity as new creditors and other liquidity providers may require borrowers to grant security. Non-compliance with the restrictions may take place in an obvious manner (such as by way of the borrower simply entering into a security agreement so as to grant security in favour of a new creditor). Presumably, if this type of restriction is breached, an appropriate remedy would be release of the new security. However, negative pledge provisions may also be breached in more subtle ways, such as by borrowers factoring debts on terms which are contingently, or in some other way, arguably, recourse in nature, perhaps outside of agreed parameters. Lenders’ counsels can quickly get in to trouble in these areas where they agree exceptions to what is known as “quasi-security” outside of well-trodden drafting recommended by the LMA template documentation. Where-ever there is a lack of clarity around whether or not a provision has been breached – or where reasonable lawyers can hold differing views – it goes almost without saying that there may also be confusion around how any such breach might be capable of remedy. The fact is that if the interpretation of “continuing” after an event of default is left for the borrower to reach its own view, some of the negotiating strength may have passed to the borrower and, perhaps, the practical burden of establishing breach of the underlying provision will have passed to the lenders.
(ii) Debt incurrence restrictions are also classic areas where lenders’ and borrower’s counsels can reasonably disagree. Restrictions on incurring financial indebtedness centre around the customary, lengthy definition of “Financial Indebtedness”. There is a technical “story” behind almost every line of this definition – it is surprising that disputes do not arise more commonly over the debt incurrence provisions of finance documentation. Some parts of the definition almost seem to hint at the ability of the borrower conveniently to arrange its liabilities in a way so as not to be caught by the restrictions. Consider, for example, the reference to “deferred payment arrangements” for which, to be classified as debt for these purposes, it is usually required that one of the primary reasons for entering into the transaction will have been to raise finance for the borrower. From time to time, borrowers may have multiple reasons for deferred payment arrangements – there may genuinely be several primary reasons for agreeing to such arrangements: it may suit their supply chain logistics; it may help their treasury function and other internal processes or, it may help their own counterparty risk assessments. This is the kind of detailed area where borrowers may be grateful of being able, virtually, to swing in and out of compliance with the technical details of the restrictive undertakings in a facility agreement by being able to decide what was and what was not a primary reason for entering in to a transaction.
It would be possible to list out a great many other examples whereby borrowers would find it helpful to have control over whether or not a particular provision of the facility agreement has been breached or remedied at any particular time. From the point of view of lenders, they should think carefully before agreeing arrangements whereby borrower can remedy events of default – however, lenders and their counsels can take comfort in the fact that the risk profile for agreeing how the word “continuing” is interpreted is greatly reduced if there is proper clarity around how the underlying provisions of facility agreements might be capable of being breached in the first place.
Liability of agents and lenders
Against this background of borrowers under financial distress and finely balanced questions of interpretation, lenders and agents are faced with some potential liability, notwithstanding that disclaimers of their liability are included in the finance documentation. If lenders call an event of default and the borrower has a basis to contend that no event of default has in fact occurred or that any such default has been remedied – i.e. it is no longer continuing - lenders risk incurring liability in damages for breach of contract where this is used as a draw-stop and the borrower suffers loss as a result. Wrongful enforcement of security may also result in a lender or agent being liable in trespass or conversion and this is compounded where this causes cross default under the borrower’s other contractual arrangements.
Conclusion
Current market conditions may become increasingly fraught, both for borrowers seeking liquidity and lenders seeking simultaneously to manage their customer relationships, credit committees and increasingly, the views of regulators. Borrowers can potentially avail themselves of many sources of reserve funding but as a practical matter, they should review their existing facility agreements and determine whether or not an event of default needs to be “continuing” before lenders can trigger remedies, and if so, whether it is possible for them to remedy defaults without obtaining express waivers from lenders. Lenders too should consider these default and remedy arrangements and determine where they can and should take back control of the situation from borrowers. Experience shows that where both borrower and lenders are well informed of the default mechanics, discussions and negotiations for any required amendments or restructurings are likely to be more fruitful.
