Industries and businesses have been hit hard by COVID-19, many have temporarily shut down and furloughed employees. With job loss comes reduced income and decreased financial stability. Many households will struggle to meet their obligations, including loan obligations. It is important to review and understand your loan documents – covenants, representations, warranties and your obligations as a borrower. Individuals and businesses should assess their assets and take preemptive measures to avoid a breach for non-payment.
A covenant is a promise to do something under a contract. In a loan document, they will often pertain to the repayment of the loan, but may also involve other obligations. Breaching one or more covenants in a loan agreement generally results in a default on the loan. Most agreements contain an “acceleration clause” which allows the lender to demand early and full repayment on a defaulted loan.
No one knows for certain how long the pandemic economy will impact our daily lives. It is critical you are aware of your loan covenants. Pre-emptively contact your lender and ask to amend or waive some at-risk covenants prior to a breach. It is always best to act early. If this is not an option, liquidation of assets may become necessary while the business is inactive. It is always important to remain candid and honest, especially when reporting your financial picture. Most loans have covenants related directly to financial disclosures and these are also subject to breach.
Representations are assertion of fact and warranties are promises the asserted fact is true. Most loan documents have standard representations and warranties worthy of examination in the current economic climate. Examples of a few include:
“Material Adverse Effect”: – This representation states that there will be no or there are no expected circumstances that will have a material adverse effect on the financial condition of the borrowing party since a specified prior date. It is up to interpretation and depends heavily on how the individual document is drafted, but an economic downturn and pause on business activity may constitute a “materially adverse event” impacting the business.
Disputes– Provisions for dispute settlement, outlining forced arbitration, waiver of a jury trial, or litigation can be invoked to determine force majeure or even materially adverse events.
Contacting your lender ahead of a potential of breach and obtaining either a waiver or amendment to financial obligations under the loan documents might be a short-term fix, but many business may need a long-term solution if the economic downturn is prolonged.
If your business is struggling to navigate the changes caused by COVID-19, the attorneys at Kendrick Law Group may be able to help you. We are well versed in both contract and business law and can help advise, interpret, or even amend your outstanding obligations. Contact us today for a complimentary consultation.
Co-written by Spenser Nampon, law clerk