COVID-19: redefining lender and debtor relationships

COVID-19 RESOURCE HUB | Financier Worldwide

BANKRUPTCY & RESTRUCTURING

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The coronavirus (COVID-19) pandemic has affected every company in different ways and to widely differing extents. A minority have benefited, having seen an uptick in demand for their products and services, while others have been much less fortunate, experiencing a drastic nosedive in business.

For those companies on the precipice, there are options available. However many of these – including government-backed business interruption loan schemes, commercial loans and overdrafts, invoice-based funding, asset refinance and peer-to-peer funding – involve incurring considerable debt.

“While some may be able to borrow additional money, others may not or may not want to,” says Angela Stallard, a partner at Penningtons Manches Cooper. “The idea of borrowing to repay existing borrowing in the current circumstances will be anathema to some, and so default and the risk of potential enforcement action for default will be inevitable for many.”

To aid affected companies, many national governments and international organisations, including the European Bank for Reconstruction and Development (EBRD), the European Investment Bank (EIB), the International Monetary Fund (IMF) and the World Bank Group (WBG), have implemented a range of COVID-19 emergency financial assistance packages.

In its ‘EBRD Covid-19 Response: Financial Restructuring and Insolvency Discussion Paper’, the EBRD outlines a number of financial restructuring and insolvency policy initiatives which complement the emergency financial assistance already being provided by national governments and the international community, as described below.

First, immediate initiatives to support new financing and co-financing by international financial institutions and national banks through secured transaction reforms that recognise the validity of intercreditor and security agent structures and ringfence COVID-19 and other new financing from insolvency avoidance provisions.

Second, short-term initiatives to help small and medium-sized enterprises (SMEs) through the particularly challenging period of financial and operational distress caused by COVID-19. These initiatives will include the provision of integrated legal, business and financial guidance tailored for smaller businesses, including generic advice on how to restructure operations and adapt to remote working and web-based trading.

Third, medium to long-term initiatives to strengthen insolvency and pre-insolvency restructuring procedures for all stakeholders, including SMEs, improve the efficiency of general insolvency (including liquidation) procedures and the enforcement and sale of secured assets, and build stronger bank resolution regimes in countries where these are inadequate to meet the challenge of a future banking crisis.

In the US, COVID-19 has had a profound impact on the US economy, disrupting the operations of virtually every industry, with retail, energy, real estate, financial services, hospitality and transportation having been hit particularly hard. As a result, many companies are engaging in negotiations with their lenders and investors on a revised capital structure.

In response, the US government introduced a historically-large stimulus bill: the Coronavirus Aid, Relief and Economic Security (CARES) Act. This legislation authorises a total of $500bn to provide liquidity to businesses that are suffering most from the pandemic. Of these funds, $46bn is allocated for direct lending through the Treasury Department for certain industries, while the balance of $454bn is allocated to support programmes established by the Board of Governors of the Federal Reserve System for lending to and investment in eligible US businesses.

“The legislation prohibits the principal amount of a loan from being reduced through loan forgiveness,” explains Keith M. Rosen, US head of risk advisory at Norton Rose Fulbright. “It also specifies that the loans and loan guarantees issued under this programme are to be treated as debt for federal income tax purposes, and that ownership interests arising from these transactions will not result in a change in ownership.”

In terms of UK lending initiatives, the government introduced a £330bn stimulus to support the UK economy through the pandemic, with banks and other lenders also implementing a range of financial support to help companies. Additional lending initiatives include the $1 trillion in lending capacity secured by the IMF in response to funding requests from more than 100 countries, as well as stimulus from the World Bank Group, including an economic programme that will provide up to $160bn over the next 15 months.

Alongside such initiatives, debtors, according to Penningtons Manches Cooper, need to: (i) be proactive and contact their lenders in the event that they are or will have difficulty meeting their contractual payments; (ii) be mindful that interest continues to accrue on the debt and that a moratorium does not constitute a waiver, meaning their debt will be bigger at the end of the moratorium period; and (iii) be aware that recovery and bankruptcy proceedings are not the subject of a blanket prohibition and that these routes remain open to lenders in appropriate circumstances.

At the same time, lenders will need to carefully consider instituting any proceedings against debtors, especially bankruptcy proceedings, constantly review their practices and consider their own cash flow and monitor their ability to service any debt of their own.

Across the globe, the debt companies have incurred throughout the COVID-19 crisis is in danger of becoming unaffordable – a scenario that lenders, as well as regulators, will need to tackle in order to prevent the pandemic becoming a major drag on economies.

In a recent speech, and with one eye on the past, Charles Randell, chair of the UK’s Financial Conduct Authority (FCA), stated that “the industry could not repeat the events of the 2008 crisis”, where the treatment of some SMEs customers caused “serious damage to the trust in financial services” institutions and, in some cases, to customers themselves.

Going forward, all lenders will be looking to avoid repeating the costly financial and reputational damage of 2008. Similarly, the fallout from COVID-19 means that lenders can expect to see a significant number of SME customers defaulting or showing signs of financial difficulty.

“The challenges of the pandemic are daunting, but this crisis presents us with opportunities too,” concluded Mr Randell. “Opportunities to reshape our financial system to make it fit for the recovery and provide more sustainable investment and credit in the years beyond.”

Fraser Tennant