The outbreak of Covid-19 has undeniably affected both borrowers and
lenders negatively, with the exception of a few players such as those in
medical supplies, basic food stuffs and certain technology, e-commerce
and entertainment providers.
The outbreak of Covid-19 has undeniably affected both borrowers
and lenders negatively, with the exception of a few players such as
those in medical supplies, basic food stuffs and certain technology,
e-commerce and entertainment providers.
Businesses have
been forced to confront the hard questions about how to continue
running their operations seamlessly and keep afloat in the current
global crisis. As the impact of the pandemic continues to unfold, almost
all businesses have been forced to review their cash flow and liquidity
positions to address a sudden and significant reduction in revenues.
The
unforeseen and dramatic fall in revenues and available cashflows will
inevitably put borrowers under significant stress, particularly where
substantial repayments are due in the next couple of months.
To
compound the situation, continued access to funds under revolving
working capital facilities or other sources is also likely to be
challenging if there is potential for or actual default under the
facilities. Ironically therefore, some businesses may be unable to
access new funding or further drawdowns of their loans just when they
need them most.
Borrowers should take proactive steps
at this time including reviewing the terms of their existing facilities
and where possible, engage with lenders at the earliest opportunity, to
discuss the potential implications of the pandemic on their loans,
particularly because it is difficult to predict with any precision how
long the effects of the pandemic are likely to last.
As
the situation evolves, one of the questions that corporate borrowers
and their boards of directors continue to grapple with is whether a
borrower’s obligation to comply with payment terms under its loan
agreements can automatically fall away or be excused in view of the
pandemic. The answer to this question is examined below.
FORCE MAJEURE
In the absence of any specific contractual provision allowing a
borrower to defer repayment, a borrower’s obligation to make scheduled
loan repayments as they fall due is not exonerated by events outside its
reasonable control, which cause it cash flow difficulties.
Many
loan agreements will not have any provisions excusing a borrower from
its obligations if an event beyond its control were to occur (i.e. force
majeure) and borrowers will therefore need to seek alternative forms of
relief.
On the contrary, Covid-19 may instead lead to
what is in effect a ‘material adverse change’ to the borrower’s
financial position and ability to perform its obligations, which may
qualify as an event of default under the loan agreement.
This
could in turn trigger a demand from the lender for accelerated
repayment of the loan by the borrower. Acceleration when a borrower is
struggling to pay even the ordinary scheduled amounts, could put the
survival of many businesses at risk.
OTHER OPTIONS
All
is not doom and gloom however, as each case will need to be considered
on its own merits, including the wording of the loan agreement and the
context in which the loan was made. Clauses that may be relevant include
grace periods, disruption events, non-business days among others.
None
of the above clauses would provide a defence for non-payment by the
borrower for an irresolute or indefinite period, but a borrower faced
with financial difficulties may seek some leniency from the lender under
such provisions and in the current circumstances, most lenders may be
willing to provide it.
This is especially so,
taking into account the measures announced by the Central Bank of Kenya
which are aimed at cushioning borrowers and the wider economy against
the external shocks of Covid-19 and maintaining financial stability in
the country.
Borrowers must, however, initiate this
process by approaching their lenders, who will consider the respective
circumstances of each arising from the pandemic. Parties should ensure
to properly document any waivers or amendments to the terms of the
existing loan agreements arising from their discussions, for future
reference.
It is important to bear in mind that
lenders also have their own financial obligations to meet and if their
loan assets become non-performing on a large scale, then the very fabric
of our financial markets is at risk.
It is with
this risk in mind that policymakers and banking regulators in countries
like Singapore are considering lightening the burden on banks by
temporarily lowering the thresholds or measurements for capital adequacy
and loss provisioning for non-performing loans.
In
a similar vein, the Central Bank of Kenya has lowered the Cash Reserve
Ratio and provided flexibility in respect of loan classification and
provisioning for loans which were performing before the pandemic.
TEMPORARY INSOLVENCY MEASURES
In
addition to the measures mentioned above, the government is also
proposing emergency funding and relief from taxes, among other
initiatives. Notwithstanding the raft of measures introduced, some
borrowers may regard Covid-19 as being so adversely disruptive to their
immediate operational survival that they are unable to recover in the
short-term, leading them into some form of insolvency process.
In
such cases, the government should consider temporary measures that can
help borrowers weather the storm, without placing themselves prematurely
or unnecessarily into insolvency.
This is
especially pertinent considering the duties of directors and their
potential liability in relation to companies in financial difficulty —
case in point being liability for wrongful trading.
Under
existing laws, a director of a company may be held liable for wrongful
trading if he knew or ought to have known that there was no reasonable
prospect of the company avoiding insolvent liquidation or insolvent
administration and, despite this, failed to take every step to minimise
the loss to creditors.
If found guilty, such a
director may be required to contribute to the company’s assets, as the
court may consider proper, for distribution to creditors. It should be
noted that there are instances where continuing to trade may actually
reduce the losses to creditors and as such, closing the doors once a
company is in financial distress may not be the optimal solution either.
It
is for this very reason that directors should seek legal and financial
advice which is tailored to their particular circumstances, to make an
informed decision on the best approach.
Given the
challenges above, the government should consider temporarily suspending
the wrongful trading provisions for company directors to provide comfort
to those who may be reluctant to continue acting for firms experiencing
financial difficulties or who might otherwise file for insolvency,
perhaps unnecessarily or prematurely, as a result of temporary
challenges arising from Covid-19.
Precipitate
action may in itself be more damaging to creditors in some circumstances
than waiting until the situation becomes clearer.
In
addition, putting a company into insolvency may put it beyond all hope
of recovery due to the reputational damage suffered, when the company’s
financial distress would have been reversed within a reasonable period
post-pandemic.
Crucially, given that other
creditors (apart from lenders like banks and financial companies) also
have a right to commence insolvency proceedings against borrowers in
financial distress, a temporary measure such as provision for
restructuring plans that bind dissenting creditors should be considered.
Under
current laws, company voluntary arrangements and schemes of arrangement
must be approved by a majority of the unsecured creditors and meeting
the approval threshold can be a real challenge.
PRE-INSOLVENCY MORATORIUM
A
pre-insolvency moratorium (similar to one available to a company in
administration) may also be useful as it would prevent such creditors
from taking enforcement action against a company while it considers
options for its rescue.
Other temporary measures
that are worth considering include increasing the statutory minimum
amount of debt owed before a creditor can initiate insolvency
proceedings (the current amount being Sh100,000) and the time required
to comply with a statutory demand.
Under the current laws, a debtor is required to comply within 21 days, failing which insolvency can be initiated.
Granting
greater latitude to borrowers during this time by temporarily
increasing the amount and period mentioned above may forestall the
potential harm to the economy should many businesses satisfy the current
legal criteria for insolvency as a consequence of the pandemic.
Similar
measures have been announced or proposed in other countries such as the
UK, Australia, Germany and Spain and perhaps Kenya should consider
borrowing a leaf from their book.
Nyabira is a
partner, Muigai is a director and Murangi is a Senior Associate in the
Projects, Energy & Restructuring practice of DLA Piper Africa, IKM
Advocates
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