Defaulting loans – helping borrowers negotiate the minefield

27 January 2017

In our latest blog, Eddie O'Hanrahan and Ned Beale, Partners at Trowers and Hamlins LLP provide guidance for when things go wrong under a financing arrangement.

When things go wrong under a financing arrangement, there is a considerable body of legal, commercial and practical guidance out there for lenders. By contrast, corporate borrowers are not so well catered for. 

Our short note is intended to fill this gap by providing borrower focused guidance in the unhappy event that a material breach has (or is alleged to have) occurred under a funding document, leading to a potential or actual event of default and enforcement action.

Legal concerns:

• Finance agreement terms – check what the document actually says.  If the agreement has been well negotiated, there may well be some saving provisions or qualifications which would pull the borrower out of an otherwise default situation.
• Grace periods – many finance agreements contain grace periods, i.e. an amount of agreed time in which the borrower can either remedy the breach or put together a proposal designed to remedy the breach in respect of which the financier has rights of approval.  The existence and duration of a grace period will depend on the nature of the breach alleged.  For example, a fundamental breach such as failure to pay will hardly ever enjoy a grace period, albeit there would be some allowance for disruption in payment systems.  However, if there is a breach of financial covenants, there may be an equity cure provision in the funding agreement to allow a borrower to remedy the default via support from a parent company or elsewhere in the group (such as fresh equity, prepaying the debt to an extent to bring the financial covenants back in line, providing additional collateral, etc).
• Cross default – if a breach has occurred, consider the impact on other agreements given cross default provisions and how other creditors may be affected.  Are you obliged under the terms of those other financing agreements to formally notify your other lenders, for example?
• Default interest – finance agreements typically provide that events of default (or certain events of default) trigger an entitlement by the lender to charge default interest, namely interest at the standard contractual rate plus an additional default rate.   You need to factor in this exposure if you know that an event of default will occur.  Where you anticipate that a 'technical' event of default will occur but hope that the facility will continue, it may be possible to agree in advance with your lender that the default interest will be waived, or at least organise for the event of default itself to be waived sooner rather than later, so that the default interest period is as short as possible.
• Intercreditor terms – as part of considering its wider suite of options, a lender will be reviewing any intercreditor terms to see if there are any restrictions around its options, priority of payment and enforcement rights.  A borrower should do likewise, again to help see the breach through the eyes of the lender and any particular drivers it may have.
• Notice – check if notice has been properly served in compliance with the finance agreement.  If not, that notice is defective.  In reality, notice defects can be easily corrected such that notice is served in compliance with the terms of the finance agreement.  Therefore this should not be relied upon for anything else save to buy time, but that itself can be important in a default scenario.

Commercial and other practical concerns:

• Involve your lawyers – it is a statement of the obvious but any borrower in potential distress should be speaking with its lawyers (both from a banking and litigation perspective) to ensure that its prospects of successfully getting beyond the breach are maximised.  It is also important to take legal advice on other aspects of those discussions, for example, putting in place confidentiality restrictions and negotiating standstill agreements.  Agreeing a strategy with your legal advisors and being extremely careful of what is said and put down in writing will be critical to reaching a safe and satisfactory outcome. 
• The drivers – linked to collaboration (see below), it is vital to understand your lender's drivers.  Are they effectively looking to re-price?  Are they being forced to move their debt book from a particular lending space in favour of another?  Do they consider that the loan terms are too competitive, such that the capital would be better deployed elsewhere?  What would be an ideal outcome as far as they are concerned?
• Collaboration – in our experience, the funders, for a variety of sensible commercial reasons, rarely look to enforce "out of the blue".  There tends to be quite a degree of pre-enforcement discussion.  Our advice would always be to keep those discussions as collaborative and as reasonably open as possible so as to keep the option of a negotiated settlement on the table.  Inevitably, as soon as the tone becomes contentious or litigious, that negotiated settlement becomes harder to achieve.
• Information – keeping everyone appraised of developments is critical.  As far as the funder is concerned, information is key so that it can record warning signs and monitor the situation.  Moreover, failure to do so is more likely than not going to result in an antagonistic response, undermining other attempts to be collaborative.
• Standstill – as part of a collaborative response to a breach, all parties should be encouraged in the strongest terms to sign up to a standstill agreement which would effectively put any potential enforcement action on hold up until such time as the picture is clearer and ideally a strategy has been agreed by key stakeholders.  Generally speaking, if other creditors have rights which may be triggered because of a cross default provision, your funder (like you) will want to put in place a standstill arrangement to prevent others from taking action which could otherwise frustrate an overall recovery strategy for your lender.
• Obtain independent financial advice – alongside the legal advice, independent financial advice is often very helpful.  For example, if you are facing solvency issues, having an insolvency practitioner produce options for administration whilst these are remedied will potentially give a lender comfort of your long term prospects, and encourage them to refrain from enforcing security. 
• Solutions – ultimately, enforcing loans is bad business (both from an economic and reputational point of view) as far as lenders are concerned.  Therefore, nine times out of ten, you can expect to find a reasonably willing ear and open mind to any feasible solutions.  Consider the options – does insurance have a role to play?  Can you introduce new money into the structure via equity cure or other funds to see off the problem in question?  Are there guarantees in place from the directors?
• Restructuring – could a restructuring in the widest sense, i.e. including pre-packs, be part of the solution?  If appropriate, conceding that some form of financial, operational and/or capital restructuring may be necessary is likely to result in a more supportive strategy from your lender.
• Redemption – if matters have reached an irretrievable state such that maintaining a relationship with the lender is not feasible, a redemption of the loan may be the only non-contentious route available.  In the (albeit unusual) event that the group has sufficient resources to repay the loan from its own proceeds, the problem goes away.  Otherwise, you, and probably with the help of a debt broker, would need to be tapping the refinance market as soon as possible to see if another lender will replace the existing lender.
• Litigation – litigation should never be entered into lightly, and is often particularly difficult for a borrower because the terms of finance agreements tend to provide lenders with extensive contractual protection.  Nevertheless, there may be circumstances where a robust recourse to the courts is the best option.  For example, there may be a dispute as to whether an event of default has actually occurred, or whether the lender has correctly exercised its contractual rights.  Generally speaking if an event of default has occurred you are stuck with the consequences. However, lenders are not entitled to exercise their rights in bad faith or capriciously or arbitrarily. In extraordinary circumstances, for example as has been alleged to have occurred in relation to RBS' Global Restructuring Group's treatment of some borrowers, it may be possible to argue that even where an event of default has occurred, lenders should not (because of their behaviour) be entitled to exercise their contractual rights. 

These are practical tips based on our extensive experience acting for corporate and public sector borrowers.  However, when an actual issue arises it is obviously important to obtain legal advice on the terms of the facility agreement in question - even market standard documents can contain variations which can have important consequences in a default scenario. 

Written by Eddie O'Hanrahan and Ned Beale, Partners at Trowers and Hamlins LLP