By John Archer and Scott Norcross
As measures to contain coronavirus expand, businesses in almost every industry sector are already experiencing the ripple effects of the global pandemic. With consumers staying home and employers limiting travel, there is significant pressure on revenues and operating margins, and there are rumors that the United States is on the brink of another economic recession. In addition to the health impact of this crisis, there are significant economic consequences that will likely only get worse before they get better. In light of this precarious economic environment, financial institutions are likely auditing their loan portfolios to assess risk.
The good news is that some lenders are working to provide relief for small businesses during these unprecedented times including 90 day payment deferrals and waiver of late fees. Businesses may want to check with their bank to see what specific relief is being offered. It is unclear, however, whether this may just be a temporary pause. At some point lenders will act to secure the highest value in any collateral and take other actions in accordance with their risk assessment. In this climate, businesses need to react and assess the pitfalls and triggers in their loans. Your legal and financial advisors can assist in this crucial review. For example, businesses should review their loan documents for potential default provisions that could trigger cash management or default—such as cash flow requirements, debt service coverage ratios, net income, annual financial reporting and other financial covenants. In some cases, the failure to report the temporary shut-down of your business may trigger a default. Knowing that such a trigger exists can ensure that the lender is properly notified and save businesses countless hours in these uncertain times.
Similarly, businesses should review the guarantees that their owners or key men have executed to secure the business’s debt. If there is a personal guaranty, it will be important to know whether that guarantee is non, partially or fully recourse and to review and understand the events that may trigger default in those agreements. Guarantors will need to determine their exposure as a viable source of collection for a creditor and take steps protect against that risk.
And if your business is served with a default notice, it is imperative to obtain legal advice and assess your options. Lenders must comply with loan obligations including notice requirements and cure periods. Failure to do so may result in potential claims against the lender. Additionally, business owners should work with their attorneys to analyze any business interruption and force majeure clauses in the loan documents. Depending on the loan provisions, these might be viable defenses to default claims.
One key clause to review in loan document agreements is whether the bank or creditor can seek to have a receiver appointed in the event of default. A receiver that is appointed by the court effectively becomes the custodian of the business assets, which could include real estate, inventory, equipment, accounts receivable and operating bank accounts. As a borrower, you may have agreed at the outset to have a receiver appointed in circumstances where there has been a default. It will be important to review these clauses carefully and assess your options moving forward.
Even though business is slowing in light of the spread of COVID-19, now is not the time to hesitate when it comes to protecting your financial well-being. Secured creditors will be vigilant to protect their interests in your businesses’ pledged collateral. Smart steps now in reviewing the terms of lines of credit and cash positions can hedge against these uncertain times. And subject to compliance with loan agreements, drawing additional cash from lines of credit may be an option to weather the storm.
If you have question regarding refinancing options, compliance with loan covenants, default risk or general management of your finance relationships during this turbulent time, please contact John Archer at jpa@kjk.com or 216.736.7224 or Scott Norcross at san@kjk.com or 216.736.7264.