It is still too early to predict the full impact of COVID-19, but it is clear that we are faced with a period of major disruption for which there is no precedent. Alongside the immense human cost, businesses are suffering sudden and unanticipated loss of revenues as a result of the virus and the measures designed to slow its spread and seeing their finances severely tested.
Governments are making an immense effort to maintain confidence through the provision of financial support for businesses, but not every business, however deserving, will be able to benefit. Against this backdrop, it is inevitable that corporate trustees will be at the heart of some very difficult decisions.
This note is the first of a short series in which we consider the role of the trustee in the context of COVID-19.
Impact on New Transactions
Uncertainty in the markets makes raising capital much more challenging, but more than ever companies will need to finance their day to day activities. Some companies will need to raise emergency funding to stave off financial difficulties caused by the crisis, others may be looking to re-finance existing debt that is about to mature. Closing transactions in the current environment will be challenging, and there are a number of commercial, practical and legal issues that corporate trustees need to consider:
- Signing/closing - there is typically a short period between signing and closing a finance transaction. Given the constantly evolving impact of COVID-19, the traditional "no material adverse change" clause will be severely tested. Markets are so volatile that we are arguably seeing a "material adverse change" on a daily basis, even before taking into account the financial health of the underlying corporate. Corporate trustees should aim to distance themselves from any obligation to determine whether or not there has been a "material adverse change".
- Operational closures - as governments attempt to control the spread of COVID-19 it is possible that there will be closures of some of the entities that can be critical for closing and the perfection of security e.g. Companies House or the Land Registry. Whilst not their direct responsibility, trustees should be alive to the role played by such bodies in order to avoid any unwanted issues at closing and immediately after (particularly given such issues may themselves lead to difficult decisions on the part of the trustee).
- Corporate authorisations and execution - with increased home working and the potential for directors to be unable to fulfil their duties due to illness, market participants will need to ensure that their constitution allows them to meet the operational challenges that arise. For example it may be necessary to re-visit existing signing authorities to ensure that they are fully equipped to execute documents - see our separate note on Execution of Documents - issues for trustees.
- Risk profile - while a trustee has only limited duties to diligence the transaction or property of which it is trustee, there is now an increased risk of potential transactions failing to complete and of those that have completed running into distress. Corporate trustees must carefully consider new mandates to ensure they are comfortable with any commercial risks arising from the transaction (including which jurisdictions are relevant to that transaction).
- Trustee protections - when economic conditions are difficult, it is even more important that transaction documents contain suitable protections for the trustee and are carefully reviewed. The trustee should not be exposed to any risks in the underlying transaction. It must have the right to be indemnified, prefunded and/or secured to its satisfaction prior to taking action and should ensure that its rights and protections remove any potential liability. Legal counsel should be engaged to check that such protections are suitably robust.
Impact on Existing Transactions
Trustees are under no duty to monitor a transaction - it is the Issuer's obligation to notify the trustee of any potential covenant default or event of default. As such, the trustee will not be expected to monitor any approval, consent, termination or default provisions to ensure compliance in light of COVID-19.
However, given the current environment and the constant news cycle, it is possible that trustees are made aware of facts or circumstances relevant to an issuance, requiring action to be taken or a determination made. We set out below some key considerations in respect of existing transactions:
- Trustee as a fiduciary - the fallout from COVID-19 has led to pressure on liquidity and cash flows. Debt service covenants will be severely tested. Inevitably some issuers will struggle to make payments on their underlying debt whilst others will find themselves in breach of their covenants. Issuers and borrowers will be closely reviewing their finance documentation for some form of forbearance on the grounds of extraordinary circumstances (most likely in vain) at the same time that lenders will be looking closely at material adverse change clauses. We anticipate trustees facing pressure from borrowers to take steps to help mitigate financial impact of the crisis through the relaxation of covenants or waiver of events of default and pressure from lenders to enforce.
There may be fully justifiable reasons for making such a request, such as the practical impossibility of convening a meeting to pass a suitable resolution in the time available, particularly in the context of the rapidly deteriorating economic environment. However, the trustee is a fiduciary for the Noteholders and other secured parties, not the borrower. As such, it can only exercise a discretion if it is confident that the exercise of the discretion is not materially prejudicial to Noteholders.
This creates a dilemma for the trustee, who will be reluctant to accelerate and enforce security unless instructed to do so by Noteholders and indemnified, prefunded and/or secured to its satisfaction before doing so. Faced with a potentially rapid deterioration in business as a consequence of cross defaulting the borrower's other obligations and without clear instructions from Noteholders to accelerate a company's debt, could this be the rare situation where a trustee can step in to help preserve the status quo to grant a waiver, pending formal instructions from Noteholders as to whether to confirm the waiver or accelerate? What is the trustee to do if the only way that an issuer can access any of the government backed funding schemes is if the trustee waives a covenant in an existing financing? Every case will have to be examined on its facts and the trustee needs to ensure that if has a suitably robust process in place before reaching its determination.
It is generally accepted that the standard applicable to the trustee's performance of its duties is the "standard duty of care". A trustee might be open to challenge on grounds of negligence if it takes a decision as a result of which Noteholders suffer loss and has failed to take reasonable steps to place itself in a fully informed and proper position to take that decision. However assuming that the duty of care has been satisfied, the trustee’s actual decision can only be challenged on grounds of 'Wednesbury unreasonableness' (Associated Provincial Picture Houses Ltd v Wednesbury Corporation (1948) 1 KB 223); e.g. perversity or capriciousness. In other words, the trustee has taken a decision that no reasonable trustee could make. So the trustee needs to be certain that in reaching its decision, it has taken all material considerations into account and has reached a decision that any reasonable trustee would make.
- Interpretation - transaction documents come under no closer scrutiny than when an issuer is financially distressed. Where there is disagreement as to interpretation, it is often the trustee who is brought in to make that determination. Simple cases may be resolved by the trustee taking legal advice, while the more complex may be settled by obtaining the advice of leading counsel. However if the parties are unable to reach agreement, an application may have be made to court under Part 8 of the Civil Procedure Rules. We can expect to see an increase in disputes as transactions become stressed. In normal circumstances, it can take time to make an application to court under Part 8 and for the Court to make its determination. With the additional pressures caused by COVID-19, it will be increasingly difficult to run an expedited process, with any delay potentially exacerbating existing difficulties.
- Certificates - corporate trustees will want to ensure that any decision taken is based on facts. Underlying bond or loan documentation typically contain a provision allowing a corporate trustee to rely (without liability) on a certification provided by transaction parties as to a particular set of facts or circumstances if such confirmation is provided in the form of a "certificate". Corporate trustees should therefore ensure that information provided to it is provided by way of a certificate which specifically references the relevant clause in the trust documentation.
- Force majeure/frustration/material adverse effect - as economic conditions deteriorate, we expect market participants will have to consider the impact of force majeure and material adverse effect clauses, which could result in an event of default or a party being unable (or unwilling) to fulfil its contractual obligations in the manner originally anticipated. Careful consideration will be required to determine whether COVID-19 would trigger these provisions. Transaction parties may also attempt to rely on the legal doctrine of frustration, as grounds for non-performance. This is much more difficult to demonstrate than force majeure, requiring that the performance of the contract is impossible, illegal or radically different from what was contemplated when the contract was made.
- Business Days - unscheduled operational shutdowns may be relevant in the context of "Business Day" definitions. This may impact settlements, valuations or payment dates, and potentially trigger a disruption event (which in itself may require the exercise of trustee consent). If there are any embedded financial instruments (for example, derivatives), any mismatch arsing as a result may require the trustee to exercise its discretion to make a determination.
- Notice provisions - notice provisions are often over-looked when negotiating documents, but the importance of these provisions should not be under-estimated in the current environment. Many standard form notice provisions do not envisage a situation where there may be a delay in receipt of the notice, whether because of travel restrictions, office closures or otherwise. In order to avoid any possible dispute as to the valid delivery of notice, these clauses must be adhered to. We would also recommend following up with the recipient of any notice to obtain written confirmation of receipt (even if that receipt is through electronic means).
- Noteholder meetings - the government has made clear that social distancing is required and, where feasible, employees should be working from home. Even though Noteholder meetings are rarely crowded, it may nevertheless be difficult to comply with the highly prescriptive mechanics for noteholder meetings embedded in the note documentation. This may lead to difficulties where a trustee determines that it is right and proper to seek noteholder consent to any waiver, amendment or other event, but its ability to hold a meeting in the prescribed form is limited. Careful consideration will need to be given as to whether it is prudent to hold the meeting by other means (and risk a challenge to the validity of such meeting) or delay the holding of that meeting.
There are testing times ahead. Trustees will have a valuable role to play in helping issuers and borrowers to navigate the complexities. It is inevitable that trustees will be required to make some very challenging decisions and will be under unique pressure to accommodate both noteholders and borrowers.
Coronavirus Resource Center
For more content addressing the multidisciplinary business and legal implications of COVID-19, please visit Baker McKenzie's Coronavirus Resource Center. The information is split between regions/countries, as well as across four key issues (addressing Workforce (including privacy); Risk and Disputes; Supply Chain; and Investment and Deal Activity). There are also details of upcoming webinars that we will be hosting.