In the face of these unprecedented and uncertain days of COVID-19, financially stressed borrowers are expected to take every measure available to them to keep their businesses afloat. For borrowers with revolving credit lines, this has included drawing down unused availability to ensure immediate, and sometimes future, access to needed liquidity. In ordinary circumstances, a revolver provides a borrower flexibility to address changing cash flow needs on a cyclical or seasonal basis. Today, an untapped revolver may be a lifeline for a business struggling with the loss of cash flow.
In such times of crisis, maintaining cash on hand, whether for immediate needs or as security to better protect against unknown future consequences of the virus, may be a good business strategy. While such a borrowing, whether protective or not, triggers interest expense on these new advances, today’s extreme interest rate environment minimizes those additional costs (indeed, in certain cases, interest expense may not be much more than unused commitment fees). Lenders will certainly see this differently, and will often want to avoid further exposure in times of crisis. As a result of conflicting interests, we expect to see more tension between borrowers and their lenders as pre-emptive revolver draws become ever more frequent.
In virtually all instances, a condition precedent to any such draw will include the absence of any defaults in the governing loan documents. A borrower considering a pre-emptive draw must act before any financial covenant or other default is triggered under its credit facility. Given the toll that the virus is sure to take on the quarterly earnings of borrowers in many sectors, dramatic swings in fixed charge, interest coverage and other financial covenants are expected. Of course, borrowers are also cautioned to consider the implications of any such a draw on their ongoing relationships with their lenders. Whether faced with a draw request or not, lenders with revolving credit exposure will want to carefully review their credit agreements to determine their obligations to advance funds under these unprecedented conditions. This will include carefully analyzing the impact of any “material adverse change” or “material adverse effect” in the loan documents (a MAC or MAE clause). Such clauses are often highly negotiated and may be structured to encompass the reasonably anticipated future consequences of an event. Others may be drafted in a manner that limits their scope to the immediate, knowable effects of an event. These clauses are also often interpreted on a subjective basis given the import of “materiality” a bright line may be difficult to find.
Careful attention to applicable MAC or MAE clauses is required from both the borrower and the lender. From the borrower’s perspective, a draw will likely be conditioned on an affirmative representation from a qualified financial officer that no default exists at the time of the draw (or will exist as a result of such draw). This includes any breach of a MAC or MAE clause and a borrower (and the signatory) will want to carefully review the documents and circumstances before making such representation. From a lender’s perspective, a material adverse change may be its only opportunity to prevent further exposure to a troubled borrower but withholding a draw on that basis alone might also lead to future litigation and limited opportunities for repayment of existing debt.
The trend is picking up steam. Very recently, L Brands Inc., the owners of Bath and Body Works and other brands, drew $950 million on its $1 billion revolving credit line to provide liquidity during the crisis. Faced with closing all stores during coronavirus crisis, the company described the move as a “proactive measure” which would, among other things, allow it to continue to pay employees during the store closures. Earlier in March, casino operators Caesars Entertainment, MGM Resorts and Wynn Resorts, among others, announced that they were drawing on their revolving credit lines to help weather the temporary closures of their casinos. Hilton and other hospitality companies have also drawn on their revolvers as their occupancy rates have plummeted. Proactive draws have not been limited to industries taking the direct hit from the crisis. Anheuser-Busch InBev, for example, recently drew down $9 billion to help it navigate a global downturn if necessary. We expect that this trend will only accelerate in coming days and weeks.
While the circumstances were different, we have seen this phenomenon of pre-emptive draws before, most recently during the height of the oil and gas crisis in 2016-17. At the time, many E&P companies began drawing their RBL (or reserve based loan) facilities in advance of bi-annual redeterminations which were expected to dramatically reduce the value their reserves. Many E&P borrowers maximized their borrowings before redeterminations reduced the value of their reserves and therefor their ability to draw. In many cases, these proactive draws allowed the borrowers to enter bankruptcy flush with cash, and without the need for debtor-in-possession financing. Given the current and anticipated volume of draws, we may soon revisit some of the fact patterns of the 2016-2017 oil patch Chapter 11 cases.