Coronavirus – What Cash-Strapped Businesses Should Know
The economic fallout of the Coronavirus/COVID-19 pandemic has only begun, and there is no sign of abatement in the near future. Because of the need for “social distancing,” many businesses that rely on in-person business from customers, such as gyms and bars, have been forced to close at least temporarily. Others, such as restaurants, continue to operate but must drastically curtail their business activities. Yet other businesses, such as hotels and airlines, do not operate under any mandatory restrictions, but have still seen a dramatic drop in customer traffic and revenue. To make matters worse, the massive presence of the virus in China and other countries has caused problems in international supply chains, which can bear enormous consequences for businesses that rely on these supply chains to get their goods to market.
Because of these sudden and massive economic dislocations, many companies suddenly lack sufficient cash to continue operating for more than a relatively short time. Additionally, companies that have borrowed money may end up defaulting under their loan documents, because of a breach of a financial covenant or for another reason.
In light of the current climate, it remains to be seen whether any bank or other lending institution will be willing to make any new loans to businesses, particularly to businesses that are suffering financial distress. To the extent that a lender considers your business to be a viable candidate for financing, your business should take particular care before entering into a term sheet or a full-fledged loan agreement. Before you even begin to negotiate the terms of new financing, you must carefully review your existing financial projections for 2020 and 2021, and make any necessary adjustments in light of their financial performance during the last few weeks.
Once your projections for the next couple of years are updated, you must pay even more attention than usual to the financing terms that the lender offers. In particular, you should carefully review any proposed financial covenants that the lender proposes, and compare those proposed covenants to your updated projections. Companies in industries that are most harshly affected by the Coronavirus crisis should consider requesting covenant “holidays,” so that compliance would not be required during the first several months of the loan.
Lenders may require the business’s principals to personally guarantee the business’s obligations under the loan agreement. Principals should not make the decision to enter into personal guarantees lightly, because the principals would become personally liable for the business’s obligations under the loan. If the principal pledges collateral (e.g., a mortgage on her house) to the lender to secure that personal guarantee, the lender may foreclose on that collateral if the business fails to perform under its loan obligations. This may require a bankruptcy filing not just by the business, but also by the principal personally.
Governments are actively considering fiscal stimulus packages, which may directly or indirectly benefit businesses that are affected by the virus. For example, earlier this month, the U.S. Small Business Administration (SBA) announced the creation of a new program to make “Economic Injury Disaster Loans” to impacted businesses. However, these loans are currently available only to businesses in states that are designated for this relief upon the request of those states’ governors.
At the time of this writing, the only counties in New York State in which these SBA loans are available are Dutchess, Putnam and Westchester counties. They are not presently available to businesses in New York City. Presumably, the SBA program will expand its reach shortly.
In New York City, Mayor de Blasio has announced that interest free loans up to $75,000 and grants for small businesses will be available, under the “NYC Small Business Continuity Fund.” Under this program, businesses in New York City with fewer than 100 employees that have experienced sales decreases of 25% or more will be eligible for zero interest loans of up to $75,000 to help mitigate losses in profit.
Business owners should stay aware of any new or existing government programs that could assist them during these trying times.
Compliance with the Terms of Existing Loans
If your business has already borrowed money, you should carefully review your business’s existing loan documents to determine whether the business can continue (a) to make the ongoing payments of interest and other amounts that become due, and (b) to comply with the business’s affirmative, negative and financial covenants in those loan documents. To the extent that your business has already fallen out of compliance, it will need to seek amendments or waivers from the lender.
In addition, in light of the ever-greater scope of travel restrictions and quarantine requirements, your business’s financial reporting to the lender may be impacted if your Board of Directors is required to reschedule meetings, or if your business’s accountants are unable to obtain necessary access to your business’s financial records. You should also carefully review your business’s “representations and warranties” under the loan documents, including any “material adverse effect” provisions. As a general matter, to constitute a material adverse effect, an event generally must be both significant and durational. However, the terms of the loan agreement itself will govern whether a material adverse effect has occurred with respect to that agreement. While the duration of the Coronavirus remains unknown, your business should continue to monitor its ability to perform under its existing loan documents.
If you have determined that your business has already breached, or is about to breach, one or more terms of its loan documents, consider engaging in discussions with your lender sooner rather than later. This is particularly the case if one or more principals have personally guaranteed the loan. As a general matter, lenders tend to be more willing to have constructive discussions when businesses are more proactive in reaching out to discuss the business’s financial situation. It is even better when the business is able to present a well-considered and factually accurate proposal to restructure the loan.
Because of the ongoing coronavirus crisis, affected businesses need to carefully consider their options if they need new infusions of cash, or if they are in danger of breaching the terms of their existing loan documents. These businesses should strongly consider retaining experienced advisors to assist them in navigating these treacherous waters.