As the Coronavirus pandemic has progressed, it has become increasingly clear we are on the brink of a very serious recession. Pledges of government support are larger than those following the post-2010 financial crisis but cases of default and insolvency are still expected to be significant. Recent first-quarter earnings show banks reporting loan loss provisioning at five times those of previous quarters.
While the length and severity of the pending economic pain is still uncertain, financial services companies can prepare by taking the vital first step to assess the provisions in legal agreements which will dictate what steps you can take when your customers start to feel the pressure.
Find out how Factor’s technology-assisted review can answer these and other questions quickly and cost-effectively.
What to look out for
Pre-default rights: As the old joke goes, when asked how I went bankrupt, the answer is gradually and then suddenly. But in the joke is a truth that financial problems become visible early, and visibility of those problems needs to be shared with lenders early:
- What financial covenants does the contract contain which might indicate the borrower is in financial distress?
- What are the disclosure obligations on the counterparty?
- Does the contract allow for waiver requests?
- Does the contract allow for an acceleration or demand for repayment prior to a pre-defined event of default or breach in a financial covenant?
- What events of default can you rely on?
- Failure to pay or deliver is the strongest ground for default, but what grace periods or carve-outs have you agreed to in the past?
- Are there any provisions which limit your rights to declare an event of default such as an Illegality?
Default notification: The law requires strict adherence to formal notices sent under a contract, particularly in the case of a default:
- How do you send notice? Can you accelerate or close-out without an affirmation of notice?
- When is the notice deemed effective?
- Are you entitled to cease your performance obligations under a conditions precedent clause
Default calculations and final demand:
- What does your legal agreement say about how you arrive at the final amount due and when does it need to be paid?
- Can you charge default interest and at what rate? Can you recover additional costs incurred such as legal fees?
Security and guarantees: These are not difficult questions to answer for an individual default, but in stressed markets you may need to act quickly across a significant amount of defaults:
- Are you a secured creditor and how do you rank with other secured creditors?
- Can you appoint receivers or similar officers?
- Is there a third-party guarantee and what can you recover under it?
How is your loan exposure connected to other exposures?
- Is the default linked to other exposures that your customer has with your institution or group, such as hedging agreements?
- Is your default likely to trigger a cross default against your customer by other third-party institutions?
- Can you rely on a right to set-off for any amounts you owe the customer or their affiliates?
Forbearance, restructuring, or assignment?
- If you are minded to work with a customer in difficulty, what provisions of your contract apply?
- If you are in a loan syndicate, how does the syndicate reach a decision?
- If you are waiving compliance with a borrower’s obligations, how do you safeguard your continuing rights?
- If transfer or assignment is an option, what rights or conditions apply under the agreement?
While it is still too early to see how the next few months and years will play out, being in a position to answer these questions will enable you to make informed and effective decisions in a timely manner as market disruption develops.