16 March 2020

A simple question with a relatively simple answer.  

Businesses in sectors likely to be most acutely affected by COVID-19 (such as hospitality, transport, retail and labour intensive production), will undoubtedly experience reduced trading and profitability. If you exclude formal insolvency events and a total cessation of trading, the key question, from a financial perspective, is whether the impact of COVID-19 on trading could result in draw stop and/or an event of default under the business’s financial arrangements.


Let’s get the comparatively easy one out of the way to start with: Material Adverse Change (MAC) event of default.

Whilst the majority of investment grade facilities do not contain MAC clauses, they are common in midmarket documentation. These provisions can take a variety of different forms, however, the comfort for borrowers is that even in the Global Financial Crisis of 2007/2008 the majority of lenders did NOT rely on MAC clauses as either a draw stop or an event of default. Facilities were instead defaulted on specific events of default rather than the more general, and unspecific, nature of a MAC triggered by market-wide circumstances. As a matter affecting the Globe, as well as the global financial market, we see no reason why lenders would take a different approach in relation to COVID-19.

Financial Covenants

The more nuanced issue is that of a down-turn in trading and financial results adverse to expectations. If you ignore business fatalities, whether through cessation of trading or insolvency, you are then concerned with financial covenants and the extent to which a poorer than expected financial performance arising from COVID-19 will result in a breach of them. 

Key things to consider in this context:

  • Are the covenants calculated against historic performance or are they also look forward?
  • How much head room was built into the covenant levels as against expected financial performance at the time they were set?
  • Are there cure rights, and is the business, or are the owners or other stakeholders, in a position to exercise those?

For historic only covenants then any breach will only occur in the future when the relevant trading period has finished and the covenants are tested against the financial information for that period.

In terms of look forward covenants, these are normally only set where the business has a comparatively static income stream (such as rental income or some kind of payment under a PPI/PF contact). It should then be fairly clear whether or not the covenants will be complied with at the next test date, depending on the preservation of or disruption to that income stream. However, if set against a more dynamic income stream (i.e. a turnover rent or profit related income) then, given that no one at this time has a clear idea of the long term impact of COVID-19, we expect lenders to be reluctant to seek to exercise their rights, and to call default, on the basis of a breach of a covenant when the means of remedy is at best uncertain and at worst unknown.

Keep Calm, Carry On and…………Talk

COVID-19 in itself will not trigger a draw stop or constitute an event of default, but a significant deterioration in trading performance, affecting the business’s ability to meet its obligations under its financing arrangements, could. Whilst so much is still unknown, the key message is that borrowers and lenders need to “keep calm and carry on” while maintaining an open and continual dialogue between them.

If you would like to find out more about this topic, please contact Richard Leeming or Amy McVey.

Key contact

Richard Leeming

Richard Leeming Partner

  • Banking and Trade Finance
  • Derivatives, Debt Capital Markets and Securitisations
  • Real Estate Finance

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