Beyond Non-Payment: How Are Credit Agreements Impacted by COVID 19 measures?
09.04.2020 – Authors: Alina Radu, Valentin Voinescu, Stefan Ionescu, Catalina Dan
As the coronavirus pandemic takes its toll on every economic sector, both companies and banks are revisiting their credit agreements in order to identify key next steps.
One obvious impact relates to companies having difficulties fulfilling their payment obligations under loans and under instruments creating financial indebtedness. This is temporarily addressed partly by the moratorium measures enacted by the Emergency Government Ordinance no. 37/2020 and its Implementation Norms, which essentially requires banks to delay payment of principal (and capitalize interest as far as companies are concerned) for a period of up to 9 months, upon borrower request. There is also a competing Parliament adopted law, which is not yet in force at the time of this writing that provides a similar approach, though diverging in certain key areas. You can read more about these measures and keep yourself updated on developments by accessing our main article on this topic here.
While these measures essentially address non-payment risks, credit agreements often include a variety of provisions which may still render the borrower in default even if regular payments are being covered – the so called “event of default” clauses, which often extend beyond just non-payment.
This article includes a selection of key areas to look for in credit agreements, and also look at the legal position regarding other available reliefs such as force majeure and hardship.
I. Key Events of Default to look for
These provisions are not relevant only for companies facing the prospect of acceleration but also for companies having a undrawn portions of available facilities, or open revolving credit lines, as technical events of default may entitle the bank to cease financing, When it comes to acceleration, Romanian courts might be more sympathetic to a borrower where the event of default is not non-payment – but when it comes to closing the tap on financing, the court will have less leeway and is more likely to rule in favour of the creditor.
The occurrence of other events of default depends, mostly, on the description and the wording of the relevant clauses. Therefore, borrowers should maintain a close communication with lenders and should take into consideration revising their agreements in order to assess whether an event of default can be avoided by submitting waivers/consent letters with the lenders or even commence negotiation to amend the loan documentation. Syndication financing should be given particular attention, as there are certain requirements to the level of the lenders’ consent on certain aspects.
a) Financial covenants
Most commercial credit agreements include financial covenants which need to be met by the debtor. These essentially prescribe economic formulas to measure the health of the borrower looking at accounting data (value of assets, earnings, liabilities, etc.).
Borrowers should check their credit agreements to verify:
- when is the testing date for these covenants, and by reference to what data – it will be key to verify when exactly the performance for the second quarter of 2020 will be assessed according to the covenant calendar; and
- what ratios are applicable and whether based on the information at hand, these are likely to be breached;
Most loan agreements cover a variety of legal and factual issues. If any representation is untrue or misleading, an event of default might occur. As well, borrowers may be mindful of the fact that sometimes there might be a condition precedent to any utilisation request that the representations are true – meaning that if there are available amounts in credit facilities not yet drawn, these may blocked until the misrepresentation is remedied.
In the context of the coronavirus pandemic, certain representations (such as the no default representations or the financial statements representations) may become untrue.
The borrower should carefully asses these clauses and timely inform the lender in order to find a solution.
Many loan agreements provide that an event of default occurs whenever the borrower breaches or is in default under contracts it has in place with other parties. Usually, these clauses cover financial arrangements borrowers may have with other lenders, but more strongly worded clauses can even cover defaults with key commercial partners.
It is important that borrowers review their cross-default provisions to map out any risk of contamination of defaults from one contract to another. Equally, lenders should consider the extent to which other financial indebtedness of the borrower or other key members of that group may be impacted by a default.
A prevalent event of default included in credit agreements relates to so called “insolvency events”.
Romanian insolvency laws, a contractual provision stating the “termination” (in Romanian: desfiinţarea) of an agreement due to the opening of insolvency proceedings may be considered null and void. Accordingly, an acceleration under the facility agreement due to the opening of insolvency proceedings against the borrower may be in certain circumstances considered invalid, to the extent such acceleration would be construed by the insolvency court as a form of “termination” of an agreement.
But credit agreements provisions may not necessarily link these “insolvency events” to actual opening of insolvency procedures – some standard language used also covers instances where a borrower “admits inability to pay its debts as they fall due” – which arguably occurs when a debtor applies, for instance, for the moratorium regime implemented as a result of COVID-19 measures.
Events of default linked to the existence of litigation proceedings should be reviewed. In certain situations, the borrower does not have to actually have litigation proceedings commenced against it in order for the event of default to apply – for instance: (i) certain agreements do not refer only to actually commenced litigation but also “threatened” litigation; and (ii) certain agreements provide that litigation commenced against another member of the group can trigger a default on the borrower.
f) Clauses regarding Material Agreements or Key Contracting Parties
Some credit agreements include clauses according to which termination or alteration of certain significant commercial agreements of the borrower without lender consent is an event of default. Sometimes these are singled out in the contract and other times they are identifiable by the amount of revenue regularly obtained through them (e.g. all agreements generating more than 10,000 Euros annually).
This exposes borrowers whenever key partners face difficulty themselves and seek to re-negotiate or terminate these arrangements, but is also very relevant when taking pro-active strategy decisions concerning ongoing contracts.
Borrowers should therefore urgently scan their credit agreements to identify and interpret this type of clauses and ideally consult with lenders where it is necessary.
g) Cessation of business
Most commercial credit agreements provide that the suspension or cessation of all (and sometimes even part) of their business is in itself an event of default, exposing the borrower to the risk of lender acceleration of the debt.
Borrowers who have seen their activities grounded to a halt during this period are likely already in default on their credit agreements as a result of this clause and should seek to consult with lenders on next steps.
h) Material adverse change clauses (“MACs”)
It is fairly common for financing agreements to provide an event on default or a representation on MACs. Such clauses are usually included to protect against unexpected changes to the borrower’s financial situation or market fluctuations, which could not have been duly anticipated in the representations/events of default clauses at the date of drafting the agreement.
More often than not, these clauses are subject to multiple interpretations, due to the fact that contracts do not provide for specific events that may trigger a material adverse change, but rather use general and sometimes even ambiguous language. The assessment whether the coronavirus outbreak can be viewed as an event triggering such clauses must be made on a case-by-case basis and it must take into consideration each agreement’s specific language.
Therefore, the impact on the material adverse change clauses is ultimately to be determined by a court of law. What is more, there seems to be very little to no legal practice (both in Romania and other jurisdictions) with regard to triggering such clauses in the context of major adverse global political and economic events, and consequently one should be mindful when it comes to invoking MACs to accelerate the loans.
Additionally, the party relying on these clauses has to meet a high burden of proof and that is why parties may view calling a MAC as a last resort, encouraging them to negotiate and amend the loan documentation, rather than terminate the agreements.
i) Other clauses
It is important for the parties of the loan agreements to ensure that their obligations (such as making payments and serving notices) are not affected by state measures affecting business continuity. Therefore, definitions of terms such as “Business Day” may be revisited, as the parties may not have taken into consideration ad hoc holidays that are the consequence of a global pandemic when defining such terms.
Furthermore, it is also important for Borrowers to review the deadlines they assume(d) under their loan documentations in order to deliver financial statements, valuation reports etc, as they may be impacted due to the state of emergency measures taken following the military ordinances.
II. Considering force majeure
Unlike other jurisdictions, under Romanian law, force majeure may be invoked by the parties, even though they have not included such clauses in their agreements, but only to the extent they have not expressly waived their right to do so.
On the other hand, certain finance documents may provide that the occurrence of a force majeure cause would contractually entitle the finance parties to invoke the acceleration of the loan agreements. This is particularly prevalent in the case of development financings or project financings.
An event may be viewed as a force majeure if it fulfills the following conditions: (i) it is an external event, beyond the control of the party invoking it, (ii) inevitable, (iii) that could not have been foreseen, and (iv) whose effects could not have been avoided in any way.
We note that generally speaking, the issue with respect to the force majeure and/or of casus fortuitous being invoked by a borrower as a reason for not fulfilling its obligations (in particular its payment obligations) is a controversial one.
According to the Civil Code, this may not be possible, as the Civil Code states that when an obligation has an object fungible assets (such as money), the debtor may not invoke a fortuitous impossibility of fulfilling its obligation.
It is worth noting that the GEO 29/2020 did set out a rebuttable presumption of force majeure for small and medium sized enterprises, where a state of emergency certificate has been issued.
However, it remains to be determined by a Romanian court, on a case-by-case basis, if the event invoked by the parties can be seen as a force majeure, especially in the current context.
Romanian legal practice has stated many times that force majeure must be an event that could not have been foreseen by any person and not particularly by the debtor invoking it. However, courts seem to be divided with respect to the possibility of an economic crisis to be viewed as a force majeure event.
As the coronavirus crisis is a first for Romania, there is no legal practice when it comes to epidemics being considered a force majeure. Although other jurisdictions are not way too far ahead when it comes to this matter, there still are some French cases worth mentioning.
French courts considered that an epidemic is not sufficient to invoke force majeure in several cases, for example:
(i) A Nancy court ruled that Dengue fever epidemic could not be invoked as force majeure as this is an event that has been recurrent every year since 1980 – moreover, even though in 2007 there has been an unusual number of cases, this is not an event to be deemed unforeseeable;
(ii) Another court ruled that the H1N1 virus is not a force majeure event since it has been foreseen, largely announced and even health measures have been taken;
(iii) The Paris Court of Appeal ruled that the Ebola virus did not in fact make the party’s obligations impossible to perform and therefore this cannot be viewed as a force majeure event;
(iv) Furthermore, the same Court of Appeal ruled that the SARS epidemic was not a force majeure event due to the fact that at the date in question there were not cases of SARS in Thailand, even though measures have been taken by Thai authorities to avoid the spread of the virus.
Of course, none of these events have caused such an intense change in our day-to-day lives as the coronavirus. Therefore, depending on the measures taken by authorities, courts may have a different approach this time around. Nonetheless, it remains to be seen on a case-by-case basis (and even on a court-by-court basis) how the coronavirus pandemic will stand the test of the force majeure conditions.
[For more information with respect to the applicability of force majeure, please read the following article. Moreover, with respect to the approval of the force majeure during emergency state, please see our colleague’s article here.
III. Is hardship an option?
Should the performance of an agreement become excessively onerous, hardship may be considered. However, in order to invoke hardship, the following conditions should be fulfilled:
(i) a change in the contractual circumstances has occurred after signing and it is not/could not have been reasonably foreseen at the date of signing the agreement – if the signing date is relatively distant from the date of the virus outbreak, this condition is likely to be easily fulfilled;
(ii) the party invoking hardship did not assume/cannot be considered to have accepted the risk brought by the change of circumstances – this will largely depend on the terms of the contract because some “standard” contracts include a waiver of hardship for the debtors; unless the debtors contracted out of such a waiver in the negotiation of the contract, than hardship will likely be excluded;
(iii) the party claiming hardship reasonably and in good faith attempted a fair and reasonable revision of the agreement – this is why conduct during this phase, and especially cooperation and negociation with creditors is essential for the prospect of a successful hardship claim.
Nevertheless, given the current situation, hardship is deeply dependent on the parties’ negotiation, as failure of such negotiation will require a claim before a court of law.
Some credit agreements include provisions excluding the application of the Civil Code’s hardship provisions. If adequately worded and enforceable, these exclusions are likely to be upheld in a court of law on the basis that the Civil Code provides that the hardship regime only applies if the debtor has not undertaken the risk of change in circumstances and could not reasonably have been deemed to undertake such risk.
 Nancy Court of Appeal, 1st Civil Chamber, Judgment of 22 November 2010, n° 09/00003
 Besançon Court of Appeal, 2nd Commercial Chamber, Judgment of 8 January 2014, n° 12/02291
 Paris Court of Appeal, Judgement of 29 March 2016, n° 15/12113
 Paris Court of Appeal, Judgment of 29 June 2006, n° 04/09052