Beyond PPP: Key Considerations for Corporate Borrowers in COVID-19 Era
With initial disbursements of Round 2 PPP loans being dispersed, businesses may want to consider additional liquidity-preservation options but should remain mindful of how their decisions could impact existing credit facilities.
With the news Tuesday that the Small Business Administration has approved more than 475,000 Paycheck Protection Program loans totaling more than $52 billion, it seems clear that the $320 billion in funding in round two will be dispersed quickly. After Monday morning’s website debacle, this is a welcome development for many businesses who desperately need the money.
However, once the second round of PPP money dries up, and as many businesses prepare for the specter of reopening in the near future, many businesses still face an uncertain financial future. In times like these, it is paramount that businesses preserve as much liquidity as they can and increase revenues in whatever way they can in the face of dramatically lowered consumer demand. Typically, this means reducing expenses and selling off any unnecessary assets, but it could also mean drawing down on available lines of credit or using smart money management techniques to weather storm.
No matter the course chosen though, if a business has any outstanding debt with a bank or another lender, the business’s actions (or inactions) could have a significant impact on the business’s operations and financial situation moving forward.
For example, a corporate borrower that seeks to preserve its cash on hand may choose to draw down on any existing lines of credit it has available to it. This has the advantage of increasing cash on hand to meet ongoing and/or reopening expenses and can be advantageous if credit markets tighten in the face of expected and unprecedented defaults which could exceed 10 percent of commercial borrowers this year.
However, most draw/advance requests also require borrowers to make certain representations and warranties to the lender about the condition of the business at the time of the draw/advance request (e.g. that there has been “no material adverse effect” on the business or operations of the borrower or that the business is in compliance with all of its important contracts). If these reps and warranties are false, this will be treated as a default under the loan documents and could subject the borrower to any remedies available to the lender including acceleration of the loan, default interest, and/or foreclosure.
Additionally, some corporate borrowers may seek to sell certain assets in order to make ends meet during this crisis. Beyond the obvious implications for the business if the asset is material to operating the business once it is reopened and/or operating a full capacity, selling assets may also trigger a default of a loan if the asset was part of the collateral secured by the loan. Further, selling the asset may trigger certain mandatory prepayment provisions under the loan documents and failing to sell the asset at fair market value may also be an event of default. Thus, at a minimum, corporate borrowers should consult with an attorney and/or their lenders to ensure that they obtain any collateral releases first and are able to handle any fallout as a result of selling the asset.
Some businesses may also want to turn to more frugal cash management techniques to preserve current liquidity. This can mean minimizing any voluntary prepayments of a loan or could include a delay in payment or reduction of any nonessential expenditures. Of course, lowering the number of voluntary prepayments may have the effect of causing more interest to be paid to the lender over the long haul, but this can be mitigated to the extent that such prepayments may trigger any prepayment penalties. Reducing or delaying the payment of certain nonessential expentures may help ends meet in the short term, but such tactics could further disrupt supply chains and could be seen as a default of the loan if the delay or disruption involves a material customer or contract.
No matter the tactic employed by a business though, corporate borrowers should always ensure to keep an open dialogue with their lenders to ensure that there are no hidden surprises either now or down the road. For most borrowers, if they are able to survive the intial disruption to their business, the next big milestone will come in the first quarter of 2020 when many of the financial and other annual reports (such as tax returns, financial statements, etc) are due to the lender. Since most loan agreements contain dozens of financial and other covenants a borrower is required to maintain for the life of the loan, a borrower may need to obtain the lender’s consent to waive certain covenants or agree to modify or amend the terms of the loan to accommodate the change in circumstances. A lender who has been kept in the loop throughout the process is much more likely to agree to accommodate the borrower’s requests with minimal or no adjustments to the loan documents.
For example, if a corporate borrower has to resort to selling some assets to increase its revenues, most loan agreements contain some sort of debt service coverage ratio that is tied to the business’s EBITDA. Whether or not the lender permits the business to include these so-called “extraordinary” revenues is typically a judgment call on the part of the bank and one that is much easier to make if the borrower has been transparent and communicative throughout the process.
For more extensive issues (say a reduction in the borrowing base due to lower accounts receivable from customers or lower inventory from suppliers), a lender is much more willing to make such accommodations if it can obtain more favorable terms elsewhere, whether it be in obtaining additional guarantees of the loan or obtaining a security interest in additional collateral securing the loan. What types of accommodations make sense and are reasonable under the circumstances is something that may be subject to negotiation, and corporate borrowers are advised to consult with counsel before proceeding with any modifications to existing loans.