Coronavirus vs. relations with financial creditors and restructuring

COVID-19 epidemic threat has a huge impact on many industries and will certainly affect the relations of entrepreneurs affected by the current situation with entities providing external financing. It should be remembered that especially in the conditions of increased risk throughout the market, financing entities may take actions to secure their interests not only in the event of the next loan instalment or the bond coupon not being paid, but also at an earlier stage.

Loan agreements

With the exception of the simplest revolving loan agreements, each loan agreement contains financial covenants, i.e. levels of financial ratios tested at specified intervals (monthly, quarterly, annually) that should be maintained by the borrower during the financing period. The most common covenants are leverage ratios (most often in the form of net debt/EBITDA) and debt service ratios (DSCR – ratio of free cash flow to the sum of payments to creditors, or ICR, where only interest payments are taken into account). In a situation where there is a sharp decline in revenues and the inability to reduce costs at the same pace, entrepreneurs will face the risk of breach of financial covenants, especially in the case of shorter testing periods.

Falling asset prices may also affect the valuation of collaterals. Many loan agreements (especially in the case of financing in the real estate industry) include an obligation to maintain a certain ratio of loan to the value of the collateral (LtV). Particularly in the case of non-amortizing loans or loans with a very long amortization period, a drop in tangible asset prices may lead to difficulties in maintaining the level of LtV expected by the bank.

Rapid deterioration of market conditions favours also the occurrence of other states considered to be a breach of the loan agreement (so-called events of default). An event of default may include:

delay in payments to the bank,
suspension or closure of a significant part of operations,
undertaking enforcement by other creditors,
termination or withdrawal from contracts by significant contractors,
delay in payment of taxes,
disposal of significant assets,
failure to comply with the agreed business plan,
incurring additional external financing.

It is worth remembering that most loan agreements contain cross-default clauses – the occurrence of a default regarding one loan agreement results in a default on other agreements. Therefore, the difficulty in meeting the conditions of one loan agreement may result in negative consequences in the entire external financing base.

In the event of a breach of the financing conditions, the financing bank may have the right to:

terminate the loan agreement,
demand early repayment of the loan,
request an additional collateral,
undertake enforcement of security,
request implementation of a recovery plan,
transfer the receivable to any entity.

In order to prepare for possible market scenarios, we recommend to:

update financial projections and analyse the possibility of violating financial covenants in the nearest testing periods,
conduct a reliable analysis of the possibility of occurrence of events of default in connection with the deteriorating market situation,
consider applying to financing banks for consents (so-called waivers) for the occurrence of defaults, suspending the testing of financial covenants, or deferring the nearest payments to banks,
consider starting talks with banks regarding a comprehensive amendment of financing conditions,
analyse possible restructuring scenarios (more on this below).

Bonds

Deterioration of market conditions related to the epidemic threat may also affect the perception of bondholders and potential investors of the bonds issuers’ ability pay interest coupons or repay bonds on time. As in the case of bank loans, it is crucial from the perspective of the issuer of bonds to analyse the impact of the current economic situation on the possibility of occurrence of situations giving bondholders the right to demand early redemption of bonds (so-called events of default or grounds for early redemption of bonds).

Violations of financial covenants constitute an important part of the grounds for early redemption of bonds. In the case of terms and conditions of the bonds (WEO), as in loan agreements, issuer’s obligations are introduced to maintain specific financial ratios at the level specified in WEO. Regardless of the financial covenants, WEOs contain a number of other events of default, which may potentially occur due to deterioration of market conditions (as in the case of loan agreements).

The occurrence of event of default may cause the bondholders to be entitled to additional rights (depending on WEO provisions), apart from the early redemption of bonds, including, i.a., the right to demand a higher interest coupon on the bonds or to establish additional bonds security.

What is more, it should be noted that the occurrence of event of default (constituting the ground for early redemption) does not necessarily cause an earlier redemption of bonds – depending on WEO provisions, it may be obligatory to adopt a prior resolution of the bondholders’ meeting on the early redemption of bonds.

WEO may also contain provisions pursuant to which the issuer is obliged to establish additional collateral if the ratio of the value of debt under the bonds to the value of the collateral falls below a certain level.

Preparation of bonds issuers for potential effects related to the current market situation should include, among others:

verification of the issuer’s situation and assessment of the possibility of occurrence of events of default indicated in WEO,
estimation of the issuer’s financial ratios in the near future,
consideration of the possibility of starting the WEO amendment procedure as regards the issuer’s obligations, depending on the specific case,
analysis of possible restructuring scenarios.

Restructuring and bankruptcy proceedings

Polish restructuring and bankruptcy law gives debtors with or at risk of problems with meeting their current liabilities (including financial liabilities) a number of possibilities to save their enterprises. It should also be remembered that the provisions of the insolvency law impose on managers of enterprises also an obligation to take action within the statutor deadlines.

Observing the current economic situation as of today, it can be said with certainty that the effects of the pandemic will affect all branches of the economy. Due to the spectacular declines on stock exchanges around the world, the economic consequences of the spreading coronavirus will also affect all investors, regardless of the industry in which their businesses operate. Therefore, the situation in macro- and microeconomic terms allows us to assume at the moment that the vast majority of entrepreneurs – in the face of the pandemic – may be considered threatened with insolvency.

Therefore, if your company has a standstill, there are payment backlogs, you have lost the ability to perform the concluded contracts, in the consistent assessment of SSW experts it is necessary for you to take immediate action.

In the first place, we recommend making a professional and comprehensive assessment of the state of the enterprise, in the course of which we will determine whether its current situation allows restructuring measures to be taken or whether the focus should be on protecting the interests of managers.

Restructuring

In the event of a crisis, in addition to ongoing operational activities undertaken as part of operations, immediate implementation of restructuring measures contained in the Restructuring Law should be considered.

Such actions will help to effectively avoid the risk of falling into insolvency.

As part of the restructuring activities, in cooperation with SSW experts, it is possible to:

perform flexible employment reduction,
withdraw from contracts which are unfavourable or currently impossible to fulfil,
liquidate unnecessary assets,
suspend and prevent enforcement proceedings.

The opening of the restructuring procedure gives also the opportunity to refrain from paying certain liabilities on an ongoing basis, which will have a very positive impact on the company’s financial liquidity and allow it to conduct operational restructuring and rebuild its market position.

Restructuring also protects against termination of contracts which are significant from the company’s point of view, including lease contracts or bank guarantees.

Bankruptcy

However, if the current slump in the markets has affected the enterprise to such an extent that its further functioning is not possible even following restructuring measures, it should be remembered that persons who act as members of the management board have a legal obligation to file a bankruptcy petition in a timely manner.

The provisions of the Bankruptcy Law impose this obligation individually on each member of the management board, irrespective of the rules of representation in force in a given company and require its effective submission within 30 days from the date of insolvency. At the same time, the provisions introduce a presumption that the state of insolvency arises in the event of the suspension of settlement of current payment obligations to two or more creditors in 3 months. Failure to comply with the obligation to file for bankruptcy in a timely manner may result in a personal liability of the management board member for the company’s obligations and a ban on undertaking certain business activities and acting as a member of statutory bodies of companies for a period of one to ten years.

The current situation is a particularly difficult time for entrepreneurs. We recommend that you monitor the company’s financial liquidity on an ongoing basis. Your decisions regarding restructuring measures should take into account the above obligations.

It should also be remembered that the fulfilment of the obligation to submit a bankruptcy petition in a timely manner may also be accomplished by opening restructuring proceedings within that period.

Therefore, as part of support for entrepreneurs, SSW experts will perform a comprehensive audit of the company’s situation and choose appropriate ways of restructuring it, taking into account the interests of the company, its creditors and the board members.

PRE-PACK

The occurrence of insolvency and lack of chances for successful restructuring of the company does not necessarily mean the definitive end of the enterprise’s operation. It often happens that economic relations are shaped in such a way that the value of debt makes it impossible to effectively manage and repay the debt, even on very preferential terms. Then, if the debtor owns assets with actual operational value, a pre-pack procedure should be considered.

The pre-pack application form constitutes a part of the bankruptcy petition, and thus filing it complements the obligations of board members.

At the same time, as part of the pre-pack procedure, the entire debtor’s enterprise or its selected components are purchased for the price specified in the application by an indicated buyer. It should be noted that the purchase of assets under this procedure involves the so-called enforcement effect, which in practice means that they are free of encumbrances.

An outline of the procedure is included in the presentation.

We invite you to contact us and take the first diagnostic actions.

Our team, consisting of both restructuring experts and experts dedicated to each of the majority of specialist industries, will conduct a professional audit of the company’s situation and propose an optimal strategy for its restructuring.