Update--What To Expect in the Days to Come – Top Lender Issues re COVID-19
Compliance Certificates are Due—Compliance certificates for Q1 have become or will soon become due (generally on either April 30 or May 15). Lenders should be on the lookout for EBITDA Stuffing (aggressive use of addbacks) and should be prepared to push back when Borrowers do so inappropriately in order to avoid any argument that the Lenders concur with those add-backs. Discussion to date has focused on Borrowers proposing addbacks based on:
Middle Market Lenders Buy Pieces of Large Market Deals—Given the scarcity of new deals, we have seen middle market lenders purchasing pieces of large market deals in order to generate revenue. While cov-lite, generous baskets and opportunity for leakage are no stranger to middle market deals, those provisions are more prevalent in larger market deals. Lenders going up market should be cognizant of those looser terms.
To Keep or Not to Keep Proceeds of Paycheck Protection Program Loans?—The FAQs issued by the SBA and the Treasury Department now include a question focusing on other sources of borrower liquidity as a component of the required certification that the loan request is "necessary to support … ongoing operations". The answer provided requires applicants to take into account, among other things, the "ability to access other sources of liquidity sufficient to support … ongoing operations in a manner that is not significantly detrimental to the business". While the FAQ answer specifically references public company access to capital markets, the guidance is not expressly limited to public companies. The response also establishes a May 7 outside "safe harbor" date for prior recipients to repay PPP funds, should they determine that the new certification gloss would prompt a decision to decline the funds. The Fed announced that it will publish the names of all companies receiving Federal assistance, and the Treasury Department announced that it will audit all recipients of PPP loans in excess of $2MM. All of this, of course, is on the heels of the public’s reaction to companies such as Ruth’s Chris and Shake Shack (companies that can seemingly access the public markets for cash), accessing PPP loans. In response, we've seen a number of Borrowers return PPP loan money and a number of private equity firms return PPP loan money across their entire portfolio of investments.
Bankruptcy—Some parties are seeking chapter 11 relief and blaming the filing on COVID-19, with a quick 363 sale to the lenders; others recognize that filing at this time may result in even more lost value; still others are struggling with committing the incremental capital necessary these days for chapter 11. In many ways it feels like 2009, but because the valuation swings are so massive given current EBITDA and an unknown future, filing chapter 11 may give out-of-the-money constituents a platform to make arguments that would otherwise have been unavailable. Chapter 11 outcomes remain opaque, perhaps even more so today.
Audits—Lenders are approving, for many credits, extensions of the due date for the delivery of 2019 audited financial statements. Most loan agreements require the delivery of unqualified audit opinions. We’ve seen very few 2019 audits thus far, but a few contained, within the audit opinion, an “Emphasis of Matter” paragraph, which (a) assumes that the Borrower will continue as a going concern and (b) states that the Borrower anticipates that COVID-19 will have a material adverse effect on its business, financial condition and cash flows, and has caused the Borrower to have "substantial doubt" about its ability to continue as a going concern. While this paragraph falls short of being a standard, express “Going Concern Qualification”, which in most cases would result in an Event of Default, the substance of the paragraph certainly looks and smells like a “Going Concern Qualification”. Can going concern or emphasis qualifiers be used as evidence that an MAE has occurred for purposes of revolving loan funding conditions?
Tax Issues-- Loan amendments and forbearance agreements can create tax consequences for borrowers and lenders if such amendments or forbearance agreements cause a "significant modification" of the debt instrument. A significant modification of a debt instrument results in a debt instrument or loan being treated as exchanged for a new loan for income tax purposes and such exchange may cause tax consequences to both borrowers and lenders, including cancellation of debt income, acquisition premium, restarting of AHYDO clocks for borrowers, gain, loss, and restarting of holding period for lenders who hold debt instruments as capital gain investments, and conversion of market discount into OID and other phantom income for lenders. Lenders and borrowers should discuss with their legal and tax advisors proposed modifications and workout terms to make sure such terms do not cause unexpected tax consequences.
New News for Payroll Protection Program Loans
Consents to Paycheck Protection Program Loans—See our Client Alert dated April 21, 2020, which can be found on our website and our LinkedIn page, for details about the terms of the loan agreement consents that we’ve prepared over the last few weeks. New PPP loan applications are tapering off, and so are the related Consents.
Mid-and Long-Term Solutions—After addressing Q1 2020 principal and interest payments, Borrowers and Lenders turned their attention to longer term fixes. Some fixes are addressing Q2 and Q3, others are addressing the remainder of 2020 and into 2021. See our Client Alert dated April 21, 2020, which can be found on our website and our LinkedIn page, for details about the terms of such fixes. It is these fixes where we’ve spent most of our time the past week or so, and is likely where we will be spending most of our time for the weeks ahead.
Additional Government Support— Our Client Alert of April 21 introduced the Fed's "Main Street Lending Program", which at the time consisted of two government released term sheets. After receiving public comment, the Fed issued revised term sheets (3 instead of 2) and related FAQs. Even as revised, we expect that the Program will be of limited use for many of our clients
The Program has evolved from two components to three: the Main Street New Loan Facility (MSNLF), for new loans up to $25 million; the Main Street Expanded Loan Facility (MSELF), for upsizing existing loan tranches by up to $200 million; and a new facility, the Main Street Priority Loan Facility (MSPLF), for new loans up to $25 million at a higher leverage point than is permitted under the MSELF. The terms for each of the three programs are set forth on the comparative table below. Loans must be funded prior to September 30, 2020 (unless extended by the Fed). Participation in any of the three programs is limited to "Eligible Lenders" and "Eligible Borrowers", each of which is designed to meet certain "American First" provisions of the CARES Act. Importantly, non-bank lenders do not qualify as "Eligible Lenders", though the Fed has indicated that they may be added in the future. Criteria for "Eligible Borrowers" remain little changed as compared to the initial Fed formulation, though the cap on employees has been increased from 10,000 to 15,000, and the cap on 2019 annual revenues has increased from $2.5 billion to $5 billion. For each of these caps, the Fed requires aggregation of all Eligible Borrower "affiliates" in accordance with the affiliate test set forth in federal regulations; the result being that all companies under common equity-sponsor ownership will be aggregated for these purposes. Unlike PPP loans, loans under the Main Street Lending Program are not forgivable.
Leverage restrictions will likely make the Program inaccessible for many of our clients, though on this topic the Fed has made some positive strides. First, higher levered facilities are allowed under the MSPLF, which allows for newly originated loans capping at 6x EBITDA for 2019, as compared to the 4x cap under the MSNLF program. The trade-off is the required higher hold position for the originating lender (15% under MSPLF as compared to 5% under MSNLF). Importantly, EBITDA may be calculated using the same methodology that the Eligible Lender used when extending credit to the Eligible Borrower or similarly situated borrowers, providing more latitude as compared to a strict EBITDA formulation many feared would apply. All leverage caps under the Program are determined on an "all debt" basis, including all undrawn available debt (such as under untapped revolvers), with only limited exclusions, including for undrawn commitments no longer available due to changed circumstances, or for facilities that cannot be drawn without additional collateral. For our ABL clients, the Fed acknowledges in the FAQ that asset-based underwriting does not typically revolve around EBITDA, and that the Fed and Treasury Department "will be evaluating the feasibility of adjusting the loan eligibility metrics" for asset-based borrowers.
Pricing has shifted under the Program from SOFR to LIBOR. The Fed had wanted to encourage Eligible Lenders to adopt SOFR pricing now (ahead of the anticipated market shift to SOFR by the end of 2021), but apparently realized that banks have enough headaches as it is, without having to re-engineer systems immediately for SOFR pricing purposes.
Program loans come with certain borrower restrictions. Borrowers are required to use commercially reasonable efforts to maintain payroll and retain employees while the loans are outstanding. While the loans are outstanding, and for a year thereafter, borrowers are barred from stock buybacks, distributions (limited tax distributions are accommodated) and excessive executive bonuses. The Program also entails certain lender attestations to the Fed that will need to be carefully reviewed based on the financial position of each Eligible Borrower.
The Last Dance—This Chicago law firm has enjoyed the first six episodes of the documentary on Michael Jordan's final season with the Bulls, and is looking forward to the next four. We (at least the older ones among us) can remember fondly, attending Bulls games during the heyday with many of our long time clients.
MAIN STREET LENDING PROGRAM
COMPARISON OF LOAN ATTRIBUTES
AMONG PROGRAM FACILITIES
 EBITDA will be calculated using the methodology used by the Eligible Lender for credit extended to the Eligible Borrower or similarly situated borrowers prior to April 24, 2020.
 SPV means an entity to be formed by the Federal Reserve Bank of Boston to acquire the participations referenced above.
55 East Monroe Street, Suite 3300, Chicago, Illinois 60603-5792
The material in this client alert is based on information existing at that time. It should not be construed as legal advice or legal opinions based on any specific set of facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, an attorney-client relationship.
If you do not wish to receive information from Goldberg Kohn, please reply to this email with "REMOVE" in the subject line.