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COVID-19 in the Baltics: FAQ on Banking & Finance law issues due to COVID-19 outbreak

2020-03-17

1. Does the announcement of emergency situation and liquidity issues arising from the counterparties’ defaults or general economic downturn qualify as a Material Adverse Change (sometime also referred to as a Material Adverse Effect) (“MAC”) that may entitle the banks, bondholders or other debt financing providers to (i) accelerate the loans or demand extraordinary early redemption of debt financing instruments and enforce the collateral or (ii) refuse to disburse any part of any loan or committed debt financing?

The current COVID-19 outbreak is likely to have an adverse impact on a large number of financing transactions. A number of governmental restrictions imposed to combat the outbreak immediately induced lenders, bondholders and other debt financing providers to start considering whether the current situation allows invoking Material Adverse Change (MAC) clauses included in their financing agreements.

A typical MAC clause, routinely brought into financing agreements, entitles a lender to (i) refuse disbursement of (further tranches of) committed financing and/or (ii) accelerate (i.e. terminate and demand early repayment of) all disbursed financing if an unforeseen material adverse change occurs affecting a borrower or its group activities, their assets, business, financial standing, prospects, and etc. As a rule, MAC provisions tend to be general, broad and unqualified, encompassing all eventualities not otherwise foreseen in the contract. A typical MAC clause is either a borrower’s representation or an event of default clause. Depending on its language, the application of a MAC clause may be triggered by actual adverse effect on the borrower or only foreseen effect.

Is COVID-19 a MAC event? There are not many precedents whether a pandemic event could lead to the application of a MAC clause. However, it is a first time in history the world faces such large-scale restrictions and limitations. Thus, COVID-19 outbreak will form new practice in the field of the application of MAC provisions.

It goes without saying that due to distinct preventive measures introduced by governments towards various economic sectors some industries (transport, especially air transport, tourism, catering, conference organisation, education, beauty services, and etc.) will be more adversely affected. As such, ability of the lenders to invoke MAC clauses towards borrowers operating in such industries will be more realistic.

However, there is no “one size fits all” answer whether lenders may rely on MAC provisions in the current situation. Consideration should be paid to the following:

  1. Each MAC clause must be carefully examined and interpreted in the light of the situation of the particular borrower. It is the wording of a MAC clause that really matters. Such interpretation would also depend on the law governing the relevant financing arrangement;
  2. As in the case of force majeure, it is not the event itself (COVID-19 outbreak or governmental preventive restrictions) but the effect on a particular borrower and its business that matters. Governmental restrictions combating COVID-19 outbreak do not constitute a MAC per se;
  3. The effect resulting from the preventive measures must be adverse to the borrower in question;
  4. The outcome must be material. To be material, the effect brought by the circumstances must be substantially affect the borrower’s ability or expected ability to perform its obligations (usually meaning the borrower’s actual or expected inability to repay the loan or other financing);
  5. The effect brought by a MAC event must not be temporary. As for now, the governmental restrictions have been adopted for a couple of weeks. Thus, each lender must be well prepared to justify that effect on the borrower’s business is more of long-term than temporary nature;
  6. The lender’s attempt to rely on the negative effect on prospects or future earnings of the borrower will require very strong justification.

In the 2008 crisis lenders were reluctant to accelerate loans relying on the MAC clause before the actual delay of scheduled payments by the borrower. It must also be noted that each lender trying to rely on MAC clauses should evaluate whether such actions would not cause negative reputational risks.

While accelerating of the disbursed financing based merely on a MAC clause may not always be legally justified in respect of a specific borrower, stopping further disbursements based on that ground would likely be more easily justifiable in the light of current circumstances.

Notably, lenders proving new financing in the light of adopted restrictive measures affecting the borrower’s business will be less capable of relying on MAC clauses due to COVID-19 outbreak further in the future.

2. Does the announcement of emergency situation and liquidity issues arising from the counterparties’ defaults or general economic downturn (i) entitle the borrowers and issuers of debt instruments to demand extension or postponement of payment deadline for interest or principal payments or (ii) release the borrowers and issuers of debt instruments from the liability for any payment defaults caused by such circumstances?

It is untypical for financing agreements to include specific provisions entitling borrowers to stop, defer or delay payments scheduled under financing documents. However, each financing document must be carefully reviewed and interpreted whether there are such type of clauses or combination of clauses. As an option, borrowers could rely on force majeure clause if such is included in financing documents. However, to qualify as a force majeure event, there must be no objective opportunity to perform a contractual obligation and a particular financing document must not foresee that the obligation needs to be performed nevertheless. Governmental preventive measures adopted in the light of COVID-19 do not qualify as force majeure per se. It is the obligation of the borrower to prove that due to currently adopted preventive measures it is unable to perform the payment obligations to its lenders.

Further, a typical borrower’s remedy in a loan transaction in situations of financial distress is a limited grace payment or default period or a limited right of cure in accordance with the terms of the loan documents.

It should be further noted that, where the financing arrangement is governed by Estonian law, the failure by the borrower to duly and timely perform its payment and other obligations may not restrict, in the absence of a specific agreement to the contrary, the right of the lender to accelerate the financing and, in the case of corporate loans, to demand payment of late payment interest.

A separate note must be made with respect to debt instruments. It should be noted that most of these instruments are usually structured as bullet-payment instruments and, until the scheduled maturity, issuers will need to ensure liquidity necessary to meet their interest obligations only, which to an extent alleviates the concern.

3. What are the suggested steps for the borrowers and issuers of debt instruments anticipating liquidity issues or financial difficulties to occur as a consequences of the coronavirus outbreak towards the banks, bondholders or other debt financing providers?

If the borrower is facing or is about to face financial difficulties as a result of COVID-19 outbreak, we would recommend, firstly, proactively notifying its banks, bondholders and other debt financing providers of the current situation and, secondly, seeking to reach arrangements on grace periods or payment restructuring.

Notification. A loan document would typically have a borrower’s obligation in some form to notify the lender of a material adverse change or a new risk to the lender. Quite often that obligation could be an indirect obligation, like obligation to notify an event of default, obligation to notify changes in the asset values, etc. Representations made in the loan documents, including MAC clauses, often are self-repeating on certain dates or events, or are confirmed by delivery of a compliance certificate or similar document. Timely action is usually required to avoid automatic misrepresentations related to MAC. Thus, opening a dialogue with the lenders as soon as possible would be a necessary first step to find a solution.

Waiver requests. Each borrower has a generally accepted right to request a waiver of an obligation, as well as of an event of fault. Due to a number of legal, regulatory and contractual considerations, if a waiver is likely to be necessary, it should be requested a reasonable time prior to the breach of the affected obligation or the event of default occurring, understanding that its approval may involve new negotiations with the lender or that the lender may be willing to grant the waiver only subject to certain conditions.

While the general perception still is that a lender may grant or reject a waiver at its discretion, that right has ceased to be an absolute and unlimited right of the lender. When rejecting a waiver request, the lender should act reasonably and in a good faith. As a minimum, that obligation implies that the lender’s decision is motivated.

And finally, if the worst comes to the worst, consideration should be given to the feasibility of initiating insolvency or reorganisation proceedings as may be available to the borrower under the laws of the country of its incorporation.

Consumer loans

1. What differences apply to the above points in the case of consumer loans?

Remedies by lenders

It should be noted that, when it comes to consumer credit agreements, the right of the creditor to terminate the consumer credit due to delay in payment by the consumer may be restricted by mandatory provisions of applicable laws.

For instance, in Lithuania the Lithuanian Law on Consumer Credit establishes that the creditor shall have the right to terminate a credit agreement only provided that all of the following conditions are met:

  1. The consumer has been informed about overdue payment in writing on a durable medium;
  2. The payment is delayed for more than one month and the amount payable is not less than 10 percent of the outstanding amount of the credit or the payment is delayed for more than three consecutive months;
  3. The overdue payment was not covered within two weeks of service to the consumer of a repeat written notice on a durable medium.

Similarly, in Estonia the Law of Obligations Act sets forth that the creditor may cancel the consumer credit contract which is repayable in tranches due to a delay in payment by the consumer only if the following conditions are met:

  1. The consumer is wholly or partly in delay for at least three consecutive repayments; and
  2. The creditor has, without success, granted a cure period of at least two weeks to the consumer for the payment of the remaining amount together with notification that the creditor will cancel the contract upon failure to pay the tranches within the term and will claim for payment of the whole debt.

The creditor is also required, simultaneously with granting a cure period mentioned above, offer a consumer the opportunity to negotiate in order to reach an agreement.

No such restrictions are provided in Latvian law, and the creditor is allowed to terminate the agreement by notifying the consumer accordingly, provided that such right of termination is stipulated in the credit agreement.

In Lithuanian law further restrictions are applied with respect to mortgage loans. Under the Lithuanian Law on Real Estate Related Credit a lender is not only required to cooperate with a borrower in the case of delayed payments but is also required to meet stringent requirements for accelerating the payments under mortgage loans (including delay of payments by the borrower for longer than 90 days, written notification to a borrower at least twice, and etc.).

In Latvia the Consumer Rights Protection Law stipulates that before terminating the consumer credit agreement secured by a mortgage and commencing the sale of the property, the creditor shall, where possible, offer the consumer solutions to enable the consumer to continue to meet his obligations under the consumer credit agreement, as well as inform the guarantor of the consumer's debt and the possibility for the guarantor to settle it or to take over the consumer's obligations.

As such, it may be expected that the current outbreak may potentially lead to a recession in the long run, which in turn may affect the value of the real estate securing the mortgage loans. It should be noted that the lenders may not demand additional security or partial repayment of the debt due to a decrease in the value of the mortgaged property.

Remedies by borrowers

There are no statutory requirements for lenders to provide grace period in respect of consumer loans, for which borrowers default payments due to COVID-19. This does not mean, of course, that the lenders would not offer such grace periods, when approached by the borrowers, or at their own initiative. Thus, we would recommend that that borrowers having financial difficulties to meet payment obligations under consumer loans due to being laid off or other reason caused by COVID-19 outbreak should immediately inform the lender and request for grace period.

In Lithuania, in the case of mortgage loans the lenders are required to offer grace period for mortgage instalments (except interest) of not more than 3 months for borrowers having financial difficulties due to certain events, such as dismissal from work.

It must also be noted that as part of the emergency measures taken in connection with COVID-19 outbreak, the governments may take certain steps to ensure availability of grace periods to consumers. For instance, the Lithuanian Government already announced of extending the grace period for payment of mortgage instalments (except interest) by laid off employees from 3 to 6 months by granting state guarantees.

Capital markets

1. For the intended new issues of equity and debt instruments, what should the issuers take into account?

The issuers of the intended new issues of equity and debt instruments should take into account the current market volatility and the general risk of insufficient market demand. At the same time, saving measures may be fuelling additional funds to retain the stability of the markets. For example, European Central Bank has already announced its decision to start buying more assets with a focus on private sector bonds and inject even more liquidity at even more favourable terms into the banking system (https://www.cnbc.com/2020/03/12/european-central-bank-stimulus-package-amid-coronavirus.html), which would support the further issues of the corporate bonds in the near future.

Occurrence of the new circumstances will also warrant their proper discloser in the issue documentation. Prospectuses or information documents will need to specifically bring out the risk factors relating to COVID-19 and its impact. The wording of documents will need to be adjusted to shield the issuer to the extent possible against the unknown.

Issuers that have already distributed their bonds or equities may need to review their issue documentation to assess whether the lack of risk factor (general or otherwise) relating to the situation currently caused by the outbreak in their prospectus may lead to any claims of the investors and whether amendments to these documents would need to be prepared.

2. For covered bond issues, how can the current situation affect the covered bonds?

If the current situation leads to payment defaults under many mortgage loans forming part of the cover pool and/or if the issuer decides or is obliged by a governmental decision to permit substantial grace periods for the loans, the value of the cover pool may be affected, which may lead to the obligation to top up the cover pool. The failure to do so may lead to issues with the compliance by the issuer with the statutory requirements and potential issues with the regulator / risk of separation of cover pool.

Reporting by listed companies

1. Does the announcement of emergency situation and measures adopted by the Government allow listed companies to delay the public disclosure of mandatory required information or waive such disclosure?

Listed companies must further continue reporting of periodic information and disclosure of material events to markets. COVID-19 outbreak and preventive measures adopted by the governments do not foresee any reporting-related exemptions. On the contrary, each listed company must assess how adopted preventive measures will affect its business and financial standing and, in the case of immediate adverse effect, disclose the information as material event.

The ESMA also instructed that issuers should disclose as soon as possible any relevant significant information concerning the impacts of COVID-19 on their fundamentals, prospects or financial situation in accordance with their transparency obligations under the Market Abuse Regulation. Issuers should also provide transparency on the actual and potential impacts of COVID-19, to the extent possible based on both a qualitative and quantitative assessment on their business activities, financial situation and economic performance in their 2019 year-end financial report if these have not yet been finalised or otherwise in their interim financial reporting disclosures.

Reporting to supervision authorities

2. Does the announcement of emergency situation and measures adopted by the Government allow companies operating in finance sector delay submission of mandatory reports or dispense of reporting at all?

All the reports are filled electronically (either through dedicated system or email format), therefore, companies operating in finance sector must submit mandatory reports in usual manner despite the emergency situation and measures adopted by the governments.

However, as was announced publicly on the website of the Bank of Lithuania, the Bank of Lithuania will provide some leeway in terms of reporting deadlines and take other measures to alleviate the immediate regulatory burden for financial institutions at this challenging juncture.

3. Does the announcement of emergency situation and measures adopted by the Government allow supervision authorities to prolong periods for reviewing licence and other applications submitted by market participants?

Announcement of emergency situation and measures adopted by the government do not allow supervision authority to prolong periods for reviewing license and other applications submitted by market participants. in Lithuania, for instance, the Bank of Lithuania announced that irrespective of remote mode of work, main supervision functions will be carried on as usual.

4. What additional actions companies operating in finance sector must take?

The companies operating in finance sector must ensure they update their business continuity plans and procedures in order to ensure uninterrupted business activities.

The Bank of Lithuania announced that it will start implementing measures targeted to increase bank lending in the face of economic downturn caused by COVID-19. The Financial and Capital Market Commission of Latvia has announced that itwill ensure an individual and flexible supervisory approach for financial and capital market participants to mitigate the adverse effects of COVID-19 on the financial sector. The European Central Bank (ECB) has also announced of discussions with banks on individual measures directed to flexibly assess risks brought by COVID-19.

Lithuania team: Partner and Head of Banking and Finance practice group Akvilė Bosaitė, Partner Eva Suduiko. Estonian team: Partner Marina Kotkas, Partner Kristel Raidla-Talur. Latvian team: Specialist Counsels Andrejs Lielkalns and Edgars Lodzinš.