The economic challenges following from the outbreak of Covid-19 have, and will continue to have, a serious effect on the financial situation of many companies during the foreseeable future. Aside from day-to-day challenges such as liquidity issues and need for cost cutting, borrowers must be aware of their obligations in relation to their lenders under their financing arrangements.
You will find below a brief summary of certain common terms of financing agreements, the compliance with which borrowers should closely monitor. A challenging financial situation may furthermore entail the need for insolvency related steps to be taken in order to give the company breathing space (for example through corporate reconstruction (företagsrekonstruktion)) or in order to avoid personal liability for board members and CEOs.
Financial covenants are typically measured on quarterly or semi-annual test dates based on certain financial ratios by delivering a compliance certificate to the lenders. You may become aware of a breach of financial covenants before, on, or after the relevant test date. Financial covenants can either be maintenance covenants (i.e. apply all the time) or incurrence covenants (apply only upon the occurrence of a specific event, e.g. raising of additional financing). The latter are unusual in Swedish credit agreements but more common in bond terms.
Possible pro forma adjustments (which can be both negative and positive for the ability to meet the financial covenants) in relation to synergies, acquisitions, disposals etc. should be considered. Costs etc. incurred as a result of or to address Covid-19 effects could be deemed extraordinary items which can be added back to EBITDA. Be mindful that definitions can include caps and other restrictions in relation to extraordinary items.
Some financing arrangements include so called equity cure provisions, i.e. a pre-agreed manner for remedies of financial covenant breaches within a certain period of time after they occurred. These typically require additional equity or subordinated financing.
Other Events of Default (i.e. termination rights)
Material adverse change (“MAC”) clauses are common in financing agreements and generally aim to target the occurrence of an event or events which is/are likely to affect the ability to make payments when due or otherwise significantly deteriorate the financial condition of the borrower. MAC clauses have historically seldom been used to terminate loans but the effects of Covid-19 could potentially change this practice.
Financing arrangements often include termination events in relation to (i) insolvency and insolvency proceedings, which could apply not only to the borrower but also to other group companies and (ii) cessation of business meaning that if the borrower or a group company ceases to conduct business, it could constitute an Event of Default. This may be especially relevant for companies in certain business areas more affected by Covid-19, such as the travel or hospitality industry.
Cross default or cross acceleration clauses are common in financing agreements. In short a cross default clause means that if there is an Event of Default in another financing arrangement it triggers a termination right under the relevant agreement. A cross acceleration clause would require that the relevant other creditor has accelerated the other financing arrangement.
Other considerations and potential effects
Financing arrangements often contain clauses in relation to force majeure and market disruption which may need to be considered as these could affect the obligations of the lenders to provide the required services under the financing agreement.
Consensual restructuring outside of insolvency
A breach of the terms of a financing arrangement and any following negotiations with creditors may provide an opportunity to re-set covenants and postpone scheduled amortisations but may also, in more serious cases, entail the need for restructuring of the group, including the need for new equity injections and the sale of assets.
Insolvency and company reconstruction
Companies threatened by insolvency concerns should be mindful of complying with applicable insolvency legislation. For example, board members and CEOs can become personally liable for tax payments which are not made when due. A company facing balance sheet insolvency (kapitalbrist) may furthermore be obligated to draw up a control balance sheet (kontrollbalansräkning) and present it to the shareholders to avoid personal liability. Certain types of transactions with shareholders and affiliates may also have to be avoided as well as the granting of new security for old debt to any lender. In some cases, an application for company reconstruction may be the most efficient way of preserving the value of a company or to give the company the required breathing space to turn the business around. Also bankruptcy may serve this purpose.
First and foremost, borrowers must focus on securing sufficient liquidity, not only for the present situation but based on downside future scenarios and may consider drawing under their revolving or overdraft facilities as result thereof. The ability of lenders to refuse drawings under committed facilities is typically tied to Events of Default or Defaults, so absent any such events, lenders will normally be contractually obligated to accommodate drawings. However, to the extent that lenders are technically or administratively restricted from funding or paying out drawings, most financing agreements include force majeure clauses whereby lenders could avoid becoming liable for refusing drawings for as long as any such restrictions remain in place (and liability for any consequential damage is generally excluded entirely).
Borrowers should further closely evaluate and monitor their obligations under their financing arrangements, including if, and if so when, they are likely to default under any of them, creating the need for negotiations with its lenders. Borrowers should come well prepared into negotiations, including with updated models and with an as clear as possible picture of what changes are required (and for how long) and what lenders can be offered in return.
The Swedish state and its institutions have announced a number of initiatives, the purpose of which are to support Swedish businesses in these challenging times. Certain initiatives such as within the labour law sector have been aimed at cutting costs for companies . Others, such as Riksbanken’s initiative to lend up to SEK 500 billion to Swedish banks and the increased credit and guarantee frames of the Swedish Export Credit Corporation (SEK) and the Swedish Export Credit Agency (EKN) aim at securing the supply of financing for Swedish companies in a declining market.
The Swedish Government also proposes a possibility to defer payments of preliminary taxes on salary, employer’s social contributions and VAT. The extension includes tax payments for three months and can be granted for up to 12 months. The new rules are proposed to enter into force on 7 April 2020. To the extent a company applies for a retroactive period (ie. January - March), the tax amount will be credited to the tax payers’ tax account. Interest is levied on the amount. Please see link to Skatteverket>>
Companies may want to assess whether any such initiatives could be of interest.
As one of Sweden’s only true full-service firms, Vinge is constantly working on a very broad range of banking & finance matters, representing both lenders and borrowers on all types of financing deals in numerous important economic sectors. Vinge is the only large Swedish full-service law firm with both a strong banking and finance practice and a practice in bankruptcy receivership, in addition to the general insolvency and restructuring practice. This enables Vinge not only to give legal advice but also strategic advice as to how bankruptcy receivers and administrators (in case of a corporate reorganizations) are likely to act. Thanks to Vinge’s full service offering as a business law firm, we can execute complex renegotiations and reconstructions with expert support in e.g. M&A, labour law, tax, insolvency law and banking and finance.