While the COVID-19 pandemic is an unprecedented global crisis, the resurgence of the mentality that 'Cash is King' is all too familiar. In both the 2008 financial crisis and the downturn in the oil and gas industry beginning in 2014, borrowers sought to increase their liquidity by drawing on their existing credit facilities in an effort to stockpile cash to weather the economic slowdown. Amidst the COVID-19 pandemic, we are once again hearing about borrowers and sponsors who are fearful of a lack of liquidity and are considering drawing down the entire remaining balance of their facilities to address this fear.
This scenario, which is taking place around the world, presents a unique challenge for lenders in managing their own capital and leads to the question of what measures can be taken by lenders to prevent borrowers from drawing down their entire facilities and hoarding their cash. There are a few notable protections that may be available to lenders: (i) amend their credit agreements to add anti-hoarding provisions, (ii) enter into or exercise blocked account agreements, including in respect of disbursement accounts and not just deposit accounts, and (iii) adjust the borrowing base to reflect current asset values and limit draw downs.
Anti-Hoarding Provisions
Credit agreements can be amended to include anti-hoarding provisions to prevent a borrower from holding cash or cash equivalents in excess of a specified dollar amount. If the borrower reaches that specified threshold, they can be required to prepay or repay their line of credit by the amount of such excess.
Blocked Account Agreements
To the extent that lenders have not already done so, they can consider implementing and/or triggering full cash dominion over all applicable bank accounts including disbursement and deposit accounts. This will give the lender an element of control over the cash of the borrower. If a lender has a springing control agreement it may wish to deliver a notice of exclusive control to the applicable bank, assuming it has the right to do so under its credit agreement.
Borrowing Base Calculations
In the case of asset-based lending, lenders can consider their ability to recalculate the borrowing base to limit borrowings. A redetermination of the borrowing base will require re-evaluating asset values, which may include requesting fresh appraisals, and determining if going mark to market on asset values is a possibility.
Risks and Obligation to Fund
When considering any of the above-mentioned defensive tactics, lenders should carefully review their rights and obligations under their credit agreements and ensure that all of their actions are allowed and/or undertaken in good faith. These measures must also be assessed in the context of a lender's obligation to fund and to act in a commercially reasonable manner, which we will discuss further in subsequent client advisories.
If you have additional questions or would like more information, please feel free to contact any member of the Miller Thomson Financial Services Group to help you assess your risks and obligations and take proactive defensive actions.
March 30, 2020
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.