Where Oh Where Has Our Borrower Gone? (by Vincent Pisano, Xtract Research)


A typical US credit agreement will require a borrower to provide the lenders with annual audited financial statements with a management’s discussion and analysis of results of operations and financial condition (“MD&A”) and a narrative description of the business, unaudited financial statements for the first three quarters of each fiscal year together with an MD&A, an annual budget, notices of the occurrence of specified events, and compliance certificates following the delivery of those financial statements. They also generally specify that the obligations may be fulfilled by delivering or filing reports with the Securities and Exchange Commission. Many also require quarterly or annual conference calls with lenders.

Compliance certificates are important because they may provide the only source of information as to how non GAAP adjustments to consolidated net income, EBITDA and excess cash flow permitted or required by the credit agreement are being applied. Agreements generally include an exhibit indicating how those items were calculated, as well as leverage and interest coverage ratios. How much detail is required is a function of the amount of detail included in the form of compliance certificate attached to a credit agreement as an exhibit.

When the borrower is a public company, there is generally no problem with the financial statement requirements. When the borrower is not a public company, however, there seem to be an increasing number of problems. Recent conversations with clients indicate that some borrowers have cut back on the information presented to lenders to a significant degree. In some cases, MD&A is not provided at all. Other borrowers are ignoring the requirements for conference calls. Compliance certificates are not presented with sufficient detail.

What can lenders do to get the information they need? The first approach is almost always to ask the Agent to intercede with the borrower. In some cases, however, particularly in sponsor financings, the Agent may be reluctant to that so as not to threaten future business or the borrower may summarily dismiss the Agent’s request. What then?

Look at the events of default section of the agreement. Failure to comply with covenants is a default and with the giving of notice, if required, and the passage of time becomes an Event of Default, allowing the Agent or Required Lenders to accelerate the loans. Borrowers obviously dislike allegations of an event of default, even when easily cured and acceleration is unlikely, because they trigger adverse publicity and may even allow other debt to be accelerated, the holders of which could have a greater motivation to accelerate.

One credit agreement we recently reviewed indicated that it was an Event of Default if “Any Loan Party fails to perform any other covenant or agreement not specified [in a different section] … and such failure continues for 30 days after the earlier of the date on which [borrower] becomes aware of any such failure and receipt by the borrower of written notice from the Administrative Agent or Required Lenders.” A borrower would obviously know if it failed to comply with its obligation to hold lender calls but may believe information delivered complied with the financial statement delivery requirements. Without the cooperation of the Agent or Required Lenders, a single lender could still provide a notice to the borrower that it is not in compliance with its obligations, eliminating the argument that the borrower lacks awareness of a default and starting the 30 day cure period.

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