Possible pandemic-related breaches of financial covenants in financing agreements
In Germany as well as other European and non-European economies, financing/facility/loan agreements often include certain financial covenants (including debt to equity ratios, interest and cash-flow covers, EBIT/EBITDA figures or margins etc.). This applies regardless of whether the underlying financing agreements are based on LMA standard documents or on internal bank templates.
It goes without saying that these covenants are heavily influenced by the operational performance of the company that acts as borrower and, under certain circumstances, the company or companies that act as guarantors.
If set correctly, tests undertaken with respect to covenants will indicate early signs that a business is not performing as planned. Breaches of objective covenants can therefore be a more comfortable default for lenders to rely on without risk of challenge or need to prove subjective elements, including materiality.
Given the financial character of the covenants, loss of income and deterioration in asset values are very likely to negatively affect financial covenant compliance.
Given the developments caused by the Pandemic and the impact that they have on the financial performance of many companies or businesses, covenant breaches have become much more likely.
The Deloitte Legal working paper (download) provides recommendations for dealing with potential Pandemic-induced breaches of financial covenants in financing agreements.