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Mishcon Academy Digital Sessions - Reshaping Businesses: The challenges and opportunities for banks

Posted on 29 March 2021

Mishcon Academy: Digital Sessions is a series of online events, videos and podcasts looking at the biggest issues faced by businesses and individuals today.

In this session our panel gave a practical overview of the opportunities and pitfalls for banks whose clients are facing financial distress during these unprecedented times. The topics included:

  • ESG: the opportunity for differentiation
  • Dealing with distressed borrowers
  • Non-performing loan sales
  • Transition from LIBOR
  • Perfecting and enforcing security 

The Mishcon de Reya panel, moderated by Head of Debt Advisory Omega Poole comprised: Insolvency Partners Paul McLoughlin and David Leibowitz and Real Estate Finance Legal Director Sarah Spurling.

This live session was held on 23 March 2021. All information was correct at time of recording.

Omega Poole 

Welcome to this digital session on Reshaping Business: Options for Banks.  My name is Omega Poole and I’m a Partner in our Real Estate Finance Team and Head of the Debt Advisory Service.  I’m joined today by my colleague, Sarah Spurling who’s a Legal Director in our Real Estate Finance Team; David Leibowitz, who’s a Partner in our Dispute Resolution Practice with a particular focus on insolvency matters and Paul McLoughlin, a Partner in our Dispute Resolution and Corporate Rescue Team.  In this session, we’ll be touching on some of the challenges facing banks dealing with stressed and distressed loans, including what signposts they should look out for to indicate there may be problems; different options for enforcement and some recent changes to the restructuring playbook, introduced by the new Corporate Insolvency and Governance Act last year.  In addition, we’ll touch upon the transition away from LIBOR and how this can be dealt with as part of an amendment to an existing facility as well as briefly talking through another topic which is increasingly top of the agenda for many of the lenders we speak with, which is sustainable or green financing. 

What factors should lenders in particular take into account when they know or suspect that their borrower is distressed?

Sarah Spurling

In any event, at the first sign of trouble there are certain procedural steps that, from a lender perspective, should be considered immediately.  The first is, where problems have reached the level of an event of default under the facility agreement or an event of defaults reasonably believed to have occurred, a prompt reservation of rights letter is usually going to be a very sensible first step, so that they don’t compromise their potential rights while their investigations are ongoing.  Alongside a reservation of rights letter, we’d always advise, even at this early stage, commissioning a law firm to conduct a security review.  But at an early stage, lenders need to have a keen eye on, what are the significant assets in a business? What is the lender’s recourse to those assets in a worst-case scenario?  And to what extent is there anyone else with competing security rights potentially conflicting interests that might need to be considered.  If lenders do conclude that there’s an event of default which has occurred, they’ll need to decide what action to take.  In the past year we found most lenders have started being fairly amenable to temporary measures to try and support their borrowers through a difficult period in the hope of better times to come.  An important point for some waivers, they should always be in a formal document and specify exactly what reach has been waived and for how long and often, it’s an opportunity to bake in additional appropriate requirements and further controls, at least for so long as that problem period persists.  We might expect lenders to consider a standstill agreement over a waiver letter.  We tend to see that where parties need a bit more time and space to assess the financial information, whether there’s enough value to justify a more involved restructuring and what the best exit route might be.  So, if waiver letters and standstill agreements are a temporary measure while parties take stock, what happens next?  The question will be whether to restructure, with the view to making a more viable project, or to proceed to enforcement and fundamentally, each lender will be assessing the best option to maximise its return.  Nine times out of ten, any kind of restructuring by amending terms of the existing finance are going to include some combination of sharing or rescheduling debt obligations, often with an increased margin or some other sort of compensation and also tightening up of controls.  There are some pitfalls which lenders need to be mindful of and I’m going to hand over to Paul now to just run through those in a little bit more detail. 

Paul McLoughlin

The two that are most relevant are probably shadow directing and the risks around taking new security.  In terms of shadow directing, it’s one of those risks that most lenders are warned about.  It’s a situation where the directors or a majority of the directors become accustomed to acting on the instructions of a third party and so the third party becomes effectively a director.  If your borrower becomes insolvent and an administrator or liquidator is appointed, they will certainly be looking back at the activities of directors and whether there could have been shadow directors.  It’s really not one of those risks with is readily seen, but it’s certainly one of those risks which if it does materialise it’s very significant and it’s a personal liability.  The risk with new security, is either that if it isn’t hardened, it won’t be enforceable or if the company goes into an insolvency process within the hardening period, your security won’t bite and your debt would be unsecured.  The three risk areas for new security in English law are; avoidance of floating charges, preferences and transactions and then the value.  The prevailing view is that it probably couldn’t be a transaction at an under value and so the two that are left are avoidance of floating charges and preference.  Of those two, the floating charge is really the most significant where a company is insolvent at the time it creates a floating charge.  That floating charge will not be valid at all, except to the extent of any new money provided at the time of the charge or afterwards and the real significance of that for secured creditors is that the floating charge is a pre-requisite to appointing an administrator.  The difference with a preference is it’s actually quite easy to manage that risk from a lender’s perspective, so that when you’re seeking new or enhanced security if you make that a condition of any waiver, of any relaxation of a draw stop or of any new facilities, then by definition it can’t be a desire on the part of a company to prefer, it’s a condition imposed by the lender. 

Omega Poole

If a bank decides it no longer wants to work with a debtor in providing continuing support, what the suggested next steps that it should think about?

David Leibowitz

The platform for a successful strategy in relation to enforcement is going to be the security review.  I think we’d always suggest that it would be sensible to do that security review at a relatively early stage.  You don’t want any surprises down the line.  Enforcement can be – if that is the route you’re going to go down – that can sometimes be a very hostile environment to go into.  If you’ve either managed to sort them out in advance, or at least you know they’re coming down the line, that will inform your strategy going forward.  I just wanted to say a word about guarantees.  In some respects that may seem to be a more straightforward way and very often is a more straightforward way than having to enforce your security.  Often guarantees are not actually in standard form, they are one of the documents in the finance suite that tends to be quite heavily negotiated and therefore you need to look at the particular terms of any particular guarantee.  What are the sort of usual challenges beyond the matters that I’ve already discussed?  No surprises really, the ones for example where the guarantor comes forward and says, “Look, you asked me to sign this guarantee.  The bank said to me they’d never call on it, it was just one of those sort of checklist matters, they required it going forward but the relationship manager said you don’t need to worry about it.”  I mean, even if these are poor arguments, they’re arguments which we see run on a regular basis as they’re a nuisance value sometimes for the bank.  And finally, is there some underlying problem with the debt in relation – as between borrower and lender – which means the guarantor can say, “Well, actually there is no underlying debt here on which you can claim under the guarantee.”

Just moving onto the next step is, you need an event of default.  You need a hook to hang your enforcement on.  You would always want on an enforcement situation to go under, if possible, a hard default.  One where there is really no room for argument that there has been an event of default.  If you’re in the unfortunate situation of getting the event of default wrong, i.e. you call an event of default, which could for example have effective triggering cross default under other finance documentation, then you as the lender could find yourself on the wrong end of a damages claim.  When you’ve got your event of default, you’re effectively going to be looking at the final getting to the cliff edge as it were by serving your demand.  The most common type of enforcement that we see is administration, as Paul mentioned, by far the most common, but also the appointment of a fixed charge receiver. 

Omega Poole

So, David if receivership and administration are both options, which should a bank go for?

David Leibowitz

The fixed charge receiver is in a sense the most straightforward of the two.  If you’ve got a simple scenario where maybe you’ve got a fixed charge over a special purpose vehicle that has got a property in there, that might be a perfect opportunity to effectively say, “Well, I want that property sold and that’s going to pay me back in full or it’s going to be the best there can be in the circumstances,” but frankly anything more complex than that and it doesn’t need to be particularly complex but it just needs to be a business that’s operating, it’s got staff, it’s got trade creditors, it’s got contracts going in and out, in that type of situation, the lender really should not be looking at the fixed charge receivership route and should be looking at administration.  And fundamentally the reason there is that the most likely exit is going to be probably a sale of the business and assets of the company into a new vehicle. 

Omega Poole

We’ve seen numerous legal developments over the past twelve months in response to the pandemic in particular.  How do you think they will impact lenders going forward?

Paul McLoughlin

The general trend is that the Government wants to create a more business-friendly rescue regime.  I think the two that I would just pick out at the minute would be the use or potentially the use of moratoria by borrowers.  Where it does become relevant to banks is that in the event of a moratorium, a bank is prevented from enforcing its security whilst the moratorium is in force and that’s fairly significant.  They much prefer a scenario where the borrower effectively says, “We appreciate there are no options and we will invite the bank to enforce its security,” and so you know, that kind of conversation may be a bit more difficult with this new regime in place. I think the other thing that is worth mentioning is simply the reform to prepacks.  Prepacks have been a staple of UK restructuring for 20-25 years.  The reforms that are currently going through the legislative process are designed to create transparency for the benefit of unsecured creditors.  The process, I would imagine, will adapt to reflect those new regimes.  I can’t imagine that it is going to have a hugely significant impact on the use of Prepacks going forwards. 

Omega Poole

We also do a lot of work for overseas banks.  Have there been any developments that relate specifically to overseas banks or indeed, their borrowers when dealing with distressed loans?

Paul McLoughlin

The UK ceased to be a member state for the purpose of the EU insolvency regulation.  That is very significant for, particularly overseas banks, but also borrowers, debtors with pan European operations and assets.  That is definitely going to be more challenging, in a nutshell the tried and tested concepts of centre of main interest and establishment is now not as relevant to the UK.  It’s still very relevant to the EU 27 but for UK companies it’s going to be a different regime. 

Omega Poole

Sarah, another topical legal change that applies to new loans that I know we’ve both been having many discussions with our lender contacts and clients about is the transition from LIBOR.  How are we seeing market participants approach the upcoming changes?

Sarah Spurling

Lenders are… should be and are offering using the opportunity of waivers and amendments to replace the LIBOR references in their loan terms so they don’t end up revisiting terms on a facility twice in a twelve month period when they do get round to replacing LIBOR.  Most market participants now that are using SONIA have adopted a five business day look-back, or lag, to calculation of SONIA to enable all parties to have a degree of visibility on the interest that will be paid on an interest payment date.  The drafting is quite complicated, it’s quite complex and it’s not yet comfortably familiar to many lenders or indeed borrowers, particularly where lenders are based outside of their standard large, UK-based clearing banks and institutional lenders who’ve had teams looking at this for quite some time.  Particularly for smaller loans, or where the residual term is fairly short or based on standard form documents, many lenders are actually choosing to switch, not to SONIA, but from LIBOR to a fixed-rate approach and to a certain extent that has an advantage of simplicity, but it can create a mismatch with hedging products and own-rule is unlikely to be the preferred approach long-term. 

Omega Poole

So, how could writing sustainable loans be beneficial to lenders?  What are you seeing in your discussions, Sarah?

Sarah Spurling

There is an increasing view that increasing exposure to ESG more often than not does outperform the market especially in the last few years.  Regulatory requirements are likely to increase over the next few years in this space.  Almost all stakeholders that we’re speaking to are seeing increasing demand from their end investors and from society at large to take into account ESG considerations.  So, I think a lot of lenders taking all of that into account are starting to see it as important to bake into the thinking, covenants, reporting and everything else within their loan documents. 

Omega Poole

And I think that brings us very neatly to the end of our slot.  So, it just leaves me to say thank you to my colleagues, very much, for sharing all of their thoughts.  Thank you very much to you, our audience, for joining us today and we hope that you’ll attend another one of these events very soon. 

The Mishcon Academy Digital Sessions.  To access advice for businesses that is regularly updated, please visit mishcon.com. 

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