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Funding: what happens when things go wrong?

A sudden change in circumstances such as a loss of a key contract or unexpected poor cash flow could result in an event of default being triggered under your facility agreement.

Following an event of default, your lender will have a number of options available and which one it will exercise will depend on a number of factors including:

  • The nature of the event of default and the background to how it arose.
  • Your relationship with your lender.
  • Your financial conditions.
  • General market conditions.

The main options available to your lender, in ascending order of severity, are:

Reservation of Rights Letter
If your lender needs time to consider what its next steps are, or wishes to appoint experts (such as lawyers or valuers) to help it understand its options, then in order to protect its position it may issue a reservation of rights letter.  In this letter it will reserve its rights under the facility agreement to take action against you.

Waiver Letter
It may be that following discussions your lender becomes comfortable with the situation and it agrees to waive the event of default.  This should be formally documented in writing so that both parties have certainty as to what has been waived and what conditions, if any, need to be satisfied before the waiver is effective.

Amendment or Amendment and Restatement Agreement
If, following an event of default, the parties agree that a permanent change is needed to the terms of the facility agreement, for example a change to the financial covenants, then this will need to be documented in an amendment agreement to the facility agreement.

If more extensive amendments are needed, then more typically an amendment and restatement agreement will be entered into by the parties under which all the new amendments are incorporated into an amended and restated facility agreement, making it easier for both parties to be clear as to the terms of the facility.

Debt Restructuring
If the event of default is financial and you are in financial distress then it may be necessary for you and all your creditors, including your lenders, to restructure all your debts and liabilities, so that your business can continue to operate on a solvent basis.  This can be done contractually or it may involve a statutory process such as administration.

Enforcement of Security
This is the ultimate sanction available to a secured lender and generally a lender would only go down this route after exhausting all other options available to it.

Before enforcing security a lender will usually make a formal written demand for repayment, which must be issued in accordance with the provisions in the facility agreement.  The issue of the default notice will generally entitle the lender to:

  • Cancel any further commitments to the borrower.
  • Demand repayment of all outstanding loans, any accrued interest and any and all other amounts accrued or outstanding under the facility agreement.
  • Charge default interest on the amounts outstanding.
  • Enforce its security, which includes any guarantees given (both personal and corporate).

If your lender serves a default notice it may also trigger events of default under facilities with other creditors, under hedging documentation and/or under other commercial contracts that you are party to.  So the consequences of a lender serving a default notice are potentially very far reaching.

The documentation will normally set out a detailed process that your lender has to adhere to in exercising its enforcement rights and there a number of ways it can go about this. If you would like information or advice on formal insolvency procedures please contact Elizabeth Boyes

How to avoid these things happening

  • Be familiar with what you can and cannot do under your facility documentation so that you do not inadvertently breach your obligations.
  • If you want to do something that does not accord with the terms of the facility documentation then obtain your lender’s consent up front and as soon as possible.
  • If you think you may be in breach of financial covenants then speak to your lender immediately so you have the best possible opportunity to rectify the situation before the doomsday scenario of your lender looking to enforce its security arises.
This information is intended as a general discussion surrounding the topics covered and is for guidance purposes only. It does not constitute legal advice and should not be regarded as a substitute for taking legal advice. DWF is not responsible for any activity undertaken based on this information.

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Helen Corner

Partner

I am a partner specialising in corporate banking and a leading member of the firm’s national banking team.