In the current economic climate, there are a number of key issues facing borrowers in the event of lender insolvency or default.
Committed facilities/term loans
Provided they are fully drawn and the borrower is not in breach itself, the impact in the short term may not be too severe.
Where borrowers are planning to make further draw-downs under a committed facility however, they need to put in place a contingency plan if the lender is insolvent. Unless the commitments of the lender are transferred to another solvent bank, further draw-down requests will almost certainly not be met.
The situation here may be far more critical for the borrower. Further draw-down requests may not be met – starving the business of working capital. At the extreme, this may force the borrower to cease trading if it cannot pay its debts as they fall due. Borrowers should review their cash flow forecasts carefully and consider alternative sources of finance. They should look for alternative lenders as a matter of urgency - even if this may mean higher borrowing costs. The directors should consider carefully whether or not the company can continue to trade and seek appropriate professional advice.
Invoice discounting factoring facilities
The situation can be even more acute where a borrower has financed its receivables. Advances are typically made on a daily basis against invoices raised, and the borrower may be very dependent on this source of working capital for liquidity. A failure by a lender to make an advance may lead to critical liquidity issues very quickly indeed. Urgent steps may need to be taken to ensure that unfunded invoices are not paid into frozen trust accounts. However, great care needs to be taken as these facilities typically provide for the sale of all approved invoices to the lender. Specialist advice should therefore be sought immediately in the event of insolvency of a receivables finance lender.
These present particular difficulties. First, if the Agent Bank is insolvent it may be financially risky to continue making payments to the syndicate via the Agent, unless it is clear that these monies are segregated. Interim arrangements may need to be agreed with syndicate members as a matter of urgency in order to safeguard payments to ensure the borrower does not end up in breach.
Secondly, syndicate participants are usually liable only for their own commitments. So, further draw-down requests may not be met in full if one of the syndicate members is unable to perform its obligations to participate in an advance. Borrowers in this situation should factor this into their cash flow forecasts and seek urgent meetings with the Agent or other syndicate members to see what alternative arrangements might be put in place.
Market disruption and material adverse change
Many facilities entitle a lender to change the pricing in the event of market disruption – particularly where loans are London interbank offered rate "LIBOR"– linked. They may be entitled to substitute alternative higher funding costs or not fund at all.
Equally, facility documentation may contain a "material adverse change" default enabling the lender to cease funding if they believe a material adverse change has occurred. Lenders may be more likely to invoke either or both provisions in the current climate. Borrowers will need to consider their position very carefully and take early advice if potentially significant damage to their business is to be avoided.
International Swaps and Derivatives Association documentation
Many facilities require a borrower to enter into a hedging arrangement using International Swaps and Derivatives Association (ISDA) documentation. The insolvency of one of the parties to an ISDA Agreement may (depending on what is specified in the schedule to that agreement) give rise to automatic early termination of the ISDA Agreement or a right to terminate the agreement in favour of the borrower. In addition, the termination of a hedging arrangement may amount to a default under the loan documentation.
In the event that one of the parties to an ISDA Agreement begins to encounter financial difficulties it is advisable to have the ISDA Agreement and related documentation reviewed by a specialist lawyer.