August 2020, Diagoe Plc’s Nigerian entity announced that it was struggling to
refinance a $23 million debt and trim costs following a shortage of dollars in
the local-foreign exchange market. While the lack of access to greenback (dollar)
remains a growing concern for borrowers in Africa, the downturn in the revenue
and profits as a result of COVID-19 has recently become a more prevalent cause
for the inability of many borrowers to fulfill their contractual obligations.
disruption of supply chains, compulsory quarantine, and social distancing
regulations are a few examples of the effect of COVID-19 which in turn have materially
caused economic instability and affected the ability of borrowers to meet their
financial obligations. There is therefore a need for lenders and borrowers to critically
consider the implications of the current economy on their financial obligations.
article highlights some key implications the current financial terrain may have
on borrowers’ businesses and their ability to comply with their contractual obligations.
The article further sets out recommendations for lenders and borrowers who are faced
with the task of funding and repaying loans under respective financing
arrangements. While there are numerous impacts of the resultant effect of
COVID-19 on covenants in finance documents, this article highlights only a few of
such key legal consequences on financial obligations.
Conditions and their Implication on Covenants in Finance Documents
Generally, financial covenants in a loan agreement are undertakings given by the borrower to test the performance of the business servicing the loan and to help the lender ensure that the risk attached to the loan does not unexpectedly deteriorate prior to maturity. These performance covenants may cover the borrower’s business both back or forward to assess whether the business is showing any signs of distress that could potentially affect its financial obligations under the finance documents.
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However, as a result of the steps taken to
combat the COVID-19 pandemic, many businesses have seen a severe and abrupt
drop in income which has affected the ability of businesses to meet some
these covenants have been breached as a result of the pandemic, the lenders may
declare a default under loan documents and demand early payments of loan which
acts as a drawstop, such that the borrowers will not have access to their
facilities. A drawstop event means a breach by the borrower of a financial
covenant which gives the lender the right to refuse to make further loan
advances under a facility agreement.
In light of the foregoing difficulties that both
lenders and borrowers may face in these uncertain times, the following
paragraph sets out practical solutions that may be explored by the
Considerations for Borrowers and Lenders
the current unpredictability of the financial markets, it is important that
borrowers and lenders conduct a critical review of their current loan documents
to verify the implications of COVID-19 on their rights and obligations. Most
importantly, borrowers have to fully disclose to their lenders the current
situation of their businesses, highlighting any potential breach before it
happens helps to build trust and to enable the lenders to have a clear picture when deciding if they
will be willing to adjust financial obligations in line with the current
realities of the economy and take into consideration some practical solutions
set out below.
First, parties may agree to re-negotiate and subsequently amend their financial covenants, taking into consideration the impact of COVID-19 on the borrower’s ability to comply with their financial covenants. For instance, certain definitions in the finance documents may no longer reflect the current realities of the borrower’s business, such as EBITDA which is used as a metric for thelast four fiscal quarter periods of earnings before interest, taxes, depreciation, and amortization to measure the company’s financial performance.
Thus, where the EBITDA has been affected as a result of the pandemic an amendment to its substance will be an appropriate step in order to reflect the current financial condition of the borrower. Other re-negotiation may be in relation to compliance with certain conditions provided under the finance documents.For example, a facility agreement may include provisions requiring the borrower to fulfil certain further conditions precedent before it can access additional funding under the relevant facility.
It usually includes confirmation that:
(i) no Event of Default or a potential Event of Default has occurred and is continuing; and
(ii) the repeating representations are true in all material
respects, in each case, as at the date of the utilisation request and the proposed utilisation date.
In such instances, parties may either amend the provisions or the borrower may request that the lender grant waivers in the event that such conditions will not be fulfilled.
Another consideration that the borrower may
explore (subject to the fulfillment of any available conditions or if waivers
are granted by the lender) is utilizing any undrawn commitment under its
existing facilities. Although, it has been highlighted above that material breaches
of covenants may give right to the lender torefuse to provide additional
funding, it may be in the interest of lenders to provide same. This is because additional
funding may positively impact the borrower’s business and in turn improve the
lender’s chances of full debt recovery.
Finally, parties may consider undertaking a full
restructuring of the financing by re-negotiating substantial terms and entering
into restructured facility documentation which may capture relaxation of
financial covenants, obtaining a moratorium on interest payment obligations, all
necessary requirements, amendments, waivers, and consents required by the
borrower. Essentially, the restructured facility documentation is drafted on
much better terms that reflect the current financial conditions and commercial
needs of the borrower.
The global COVID-19 pandemic
has no doubt placed a strain on the ability of some businesses to service their
debts under finance documents. While many governments especially in developed
countries have granted some aids, this may not be enough especially for
companies in certain industries that have been seriously hit by the pandemic. The
situation is even worse in undeveloped markets where there is little or no
support from government. Thus, it is unavoidable that re-negotiation and
restructuring are considerations that will likely be put forward by borrowers
to avoid triggering defaults under their finance document during these
It is advisable that lenders
on the other hand, are more flexible with their approach with their borrowers and
are willing to work around re-negotiating the financial covenants with the
borrowers given the current uncertainties arising in the economy.
Written By: Bukola Adelusi recently completed her LL.M in corporate law at Western University, Ontario. Prior to her LL.M, she practiced with a top-tier law firm in Nigeria, where she specialized in banking and finance, M & A and private equity.