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Banking & financial disputes

Bank/borrower negotiations in the post-Covid world

As a result of the Covid crisis we are currently in businesses, which would normally be in no danger of defaulting on their bank loans, will need additional support from their banks. Recognising the devastating impact that mass defaults will have on their own businesses, banks will be looking to work closely with companies to support them through the crisis. Robin Henry explores bank and borrower negotiations in a post-Covid world.

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In the current Covid-19 crisis, thousands of businesses which in normal times would be in no danger of defaulting on their bank loans will need additional support from their banks in the coming weeks and months. Banks also recognise the devastating effect that mass defaults will have on their own businesses and the priority for them must be to help as many businesses as possible to survive this crisis. It is therefore vital that both borrowers and lenders work together to avoid unnecessary loan defaults and it is expected that there will be intensive negotiations between them to find a way through threatened or actual defaults.

The scale of the task facing lenders to continue to support businesses is even greater than that faced in the wake of the 2008 Financial Crisis. At that time, banks faced a great deal of criticism for failing customers, particularly SMEs, and this resulted in FCA schemes being set up to compensate customers who had been missold interest rate hedging products or who had been badly treated by RBS’ Global Restructuring Group. Today the FCA and PRA are keen to ensure that banks take more socially responsible actions with a view to avoiding loan defaults on a nationwide scale. To that end, the regulators have been providing advice to banks and other lenders.

On 26 March 2020, the PRA and FCA advised financial firms that they expect lenders to consider carefully their responses to potential breaches of covenants arising directly from Covid-19. Where problems which arise are of a general nature or are firm-specific but unrelated to the solvency or liquidity of the borrower, the regulators expect lenders to treat them differently from uncertainties that arise because of borrower-specific issues and to consider waiving the resultant covenant breach. Firms are expected to consider such potential breaches of covenant in good faith and not to impose new charges or restrictions on customers following a covenant breach that is unrelated to the facts and circumstances that led to that breach.

On 15 April 2020, the FCA issued a Dear CEO letter to firms lending to small businesses. Although the regulator said that, technically, lending to SMEs is mostly outside the FCA’s scope, it intended to rely on the Senior Managers and Certification Regime (“SMCR”) to ensure that banks acted responsibly in this area. The SMCR makes senior managers of banks accountable for all activities whether regulated or not. The FCA therefore expects lenders to ensure senior managers with clear responsibility for small business lending are discharging their responsibilities suitably. Boards will need to collect information on the bank’s treatment of SMEs and, where appropriate, to challenge the relevant senior manager.

The FCA has also announced that, in order to supervise the actions of lenders, it is creating a small business unit to co-ordinate the activities of the FCA across small business issues. These FCA activities include ensuring its regulated firms are supported through the challenges posed by the current Covid-19 crisis, gathering intelligence about the treatment of small businesses by financial services firms during the crisis and ensuring a co-ordinated response by the FCA to any issues identified. Concerns about poor conduct and/or customer outcomes can be raised with this small business unit. Looking back on the fallout from the Financial Crisis, there was much criticism of the failures of the FCA to respond to the concerns of SME bank customers and the lack of legal recourse available to them. The regulator seems intent on taking a pro-active role in this crisis but questions still remain as to whether SMEs’ legal remedies have increased in any material way. The best hope for all concerned must be to avoid defaults in the first place.

How to avoid defaults?

In order to avoid unnecessary defaults, a borrower first needs a clear understanding of its financial position and what financial covenants are included in its lending agreements so that it can monitor which potential defaults may exist.

Borrowers need to know the dates on which financial covenants will be tested and be aware of whether it is likely that such covenants will be breached on those test dates. In the current crisis, covenants which test whether there is sufficient profit and/or cashflow to cover the interest payments on the debt, such as cashflow cover, interest cover and debt service cover, will be particularly important.

Once a borrower becomes aware that one or more financial covenants is in danger of being breached, it is advisable to speak to its lenders and legal advisers as soon as possible and ideally before any covenants are actually breached in order to avoid a default. The terms of the covenant may provide for a grace period to allow time for the breach to be cured. If no such provision exists, it may be possible to negotiate with the lender to agree to waive the breaches to allow compliance with the covenants. Other steps may be possible to avoid events of default and maintain a functioning relationship between the company and its bankers but it will be important to think ahead and identify potential flashpoints contained in the loan documentation. In that way, it may be possible for both borrowers and lenders to survive the crisis with as little damage as possible.

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Robin Henry

Partner - Head of Dispute Resolution Services

robin.henry@collyerbristow.com