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Loans at value; interest cover; debt service cover; leverage; gearing;

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Potential poisonous terms in credit contracts

Edward Smith and James Bell look at some important terms in credit contracts that should be known to the borrower in the present context. As a result, borrower have often been able to obtain credit with fewer or less credit or on a covenant-lite base.

However, borrower often ignore other, less advantageous regulations that may be difficult for them, even if they comply with their key financials. Risks of potentially "toxic" terms for borrower typically vary depending on whether the institutions follow the lender-friendly documentation produced by the Loan Market Association (LMA) unchanged.

Failure by a debtor to comply with one of these potentially difficult terms has the same effect as a violation of the FI covenants and may transfer such control to enemy counterparties. Here we consider some important terms that should be clear to our customers in the present context. Mortgagors should also be careful not to allow a lender to attempt to introduce such rules by means of a declaration of intent to waive a condition or a clean-up operation.

Will there be a look-forward test that takes into account adherence to current as well as deferred financing requirements? The aim of CFOs is to give creditors "early warnings". Although a debtor currently meets its key financials, it could still be in arrears if a worsening of its payment could lead to a violation at the next available review date.

Usually this point depends on the design of the Material Adverse Effect (MAE) item; the standard LA item contains this dual Look Forward test. The MAE should be defined, from the borrower's point of view, as applying only to any likely impact on debt and not to debt covenants. In the case of creditors, it is also to be preferred that the MAE's continued presence is established in an objective manner rather than in a subjective manner by the creditors.

Does a deficit in the accounts (i.e. obligations in excess of assets) lead to a loss? Occurrence of an accounting defect is often regarded as a standard and assessed by an entity at the enterprise level. It may be due to historical trade deficits or their funding structure, even if the entity itself is not in difficulties and can repay debt at maturity.

Recipients are very important not to go through this test. The initial situation of a creditor should be that the creditor is sufficiently protected in any case, since the effective opening of bankruptcy procedures (as distinct from a simple lack of financial assets) would represent a special case of failure of a traditional creditor.

Do you expect negotiation with bondholders to lead to outage? An attempt by a debtor to replan one of its obligations with its lenders (including lessors, contractors, etc., in excess of its lenders) due to real or expected difficulty is usually a failure. LMA's policy is that the start of such negotiation with a sole lender (regardless of the value of its liability) is a delay.

It is a genuine problem for financially troubled borrower (and business recovery consultant) as it is a failure that can be triggered at a very early juncture and it is ironic that the exposure of uncollateralised providers of credit could be precisely the measure that collateralised providers of credit want a business to act in this state.

Which is the utilisation limit for the utilisation of further credits (or the prolongation of already granted credits)? Utilization of financing in many schemes is an effective or prospective failure in the case of new lending and an effective failure in the case of prolongation of outstanding lending. For this reason, any failure of a loan will result in a draw stop for new financing or a prolongation of the loan (unless waived).

However, in some cases this draw stop may lead to a de facto speeding up of the facility without the lender being officially obliged to take further action. In particular, this can be a problem where the debtor has a working capacity requirement which makes it impossible for him to carry on working without them. Therefore, in the case of a roll-over of a facility (i.e. where creditors are essentially not invited to propose "new money"), the best place for beneficiaries is when the only suspensive requirement for roll-over is the lack of a "declared default".

A lot of borrower will not know that during the term of a credit line (on each interest date and when taking out a new loan) they give a series of explanations to the lender on a regular and automatic basis. Borrower should therefore be clear about which presentations are repeated among their institutions and whether they may be in arrears.

Does the cross-default provision multiply the impact of a given issue? A typical scenario is that a loss occurs when one of the Group's liabilities defaults (e.g. financial leasing), some of which may be on more stringent conditions than the principal facility. Therefore, the borrower should be aware of this correlation and the quanta of an appropriate trigger value.

Does a creditor have the right to cancel an advance on payment on demand even though there is no delay? Borrower's short-term solvency typically relies on an open line of credit provided by an "additional lender" under that lender's Revolving Loan Guarantee. What is the procedure for adjusting revving credits and overdrafts?

A number of borrower will be subjected to a "clean down" facility for their working capitals. In other words, for a one- to two-week per year horizon, they are obliged to scale back their working cap loans (potentially to zero) in order to prove to creditors that there are no structured loans under these arrangements.

Whereas most borrower usually have a length of time in each year in which they have a powerful working cap positions, the clear down is something that can readily be missed. Borrower should try to make sure that the cleared down collapses with a length of time in each year in which they have a solid working cap positions and are planning to break it.

Non-compliance usually leads to a outage. Is it possible to rectify technological failures without the explicit renunciation of the lender? In the event of a breakdown, a borrowing party should know whether this can be rectified without the lender's explicit renunciation in writ. However, in some cases, it may not be possible for beneficiaries to profit from it, and even if a delay may have been rectified, it is considered "ongoing" for the purposes of the credit contract until it is explicitly rejected in writing. However, in some cases, the creditor may not be able to recover the amount of the delay until it has been explicitly rejected in written form.

In other words, all the normal legal redress available to creditors in the case of delay (e.g. speeding up, enforcing collateral, withdrawing authorisation for certain "permitted" activities) will be available until the delay is explicitly forfeited. Borrower should try to arrange in new institutions that a failure or case of delay no longer'persists' once it has been repaired or cancelled.

Borrower should, for example, consider whether they would continue to profit from spin-offs that would allow them to carry out takeovers or takeovers in both the EU and the UK. It is also assumed that borrower declarations are repeatedly made, some of which concern adherence to EU-derived legislation. Additional changes to the current documents may be necessary as more details on the impact of Brexit on the lender and borrower become available.

Mortgagors should ensure that they have an understanding of their bank documentation and that they check on a regular basis that all their commitments, not just their key financials, are met. Although creditors do not wish to expedite or impose, they can take advantage of any persistent failure to compel a debtor to accept a reassessment of facility and fee payments as a precondition for forgoing.

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