Loan and contract financial covenants

Many commercial contracts and loans include financial covenants for parties to meet after the dotted line has been signed. These might be banking type covenants such as financial performance, earn-out provisions, milestones for payment of deferred consideration, warranties provided by sellers or any number of other financial covenants.

We look at what options are open to parties who end up in technical default of their financial covenants in contracts.

Loan agreement financial covenants

Borrowers should carefully consider whether they are at risk of breaching any terms in their loan agreements. Reduced cash-flow might mean they miss a repayment date or breach a financial covenant. The loan agreement may also require the borrower to report material adverse changes to the lender. Where a borrower is in breach of a loan agreement, the loan may become repayable on demand.

Borrowers must carefully consider the loan agreement itself to determine a course of action. The best course may be to negotiate with lenders based on early disclosure and open and frank communication. After all, it is usually in the lender’s interest that a borrower is able to repay its loan and interest over time, rather than being forced to repay a loan early as a result of a technical breach.

Another possibility where a financial covenant has been breached and the borrower is likely to be in serious default, is some form of business restructuring or sale of parts of your business.

Breach of contractual warranties about performance

Warranties are statements of fact given by one party to another, and are common in commercial contracts. If a warranty turns out to be false, the innocent party may have a right to claim damages or seek an indemnity for loss that they have suffered, or potentially they may be able to terminate the contract.

A warranty to the effect that there has been no material change to the business since the date of the last accounts or which mention known or threatened breaches of material contracts by the company or its customers and suppliers can prove problematic in a recession.

Potential for renegotiation

Where possible, parties negatively impacted by financial covenants should seek to renegotiate.

While counterparties may not be under any legal obligation to agree to amend a contract, they may take a commercial decision to do so, especially where the alternative means an increased chance of recovering money.

In the context of forward looking financial covenants, a lender or contract party may be willing to make adjustments to target levels set by the contract and/or extending or adjusting other aspects pf performance based covenants.

This is a challenging time for businesses of all types. At Gannons we have experience of commercial deals and disputes, and are ready to guide you though. Please do call us on 0207 438 1060.