If your business defaults under its loan arrangements, you may be able to avoid a severe reaction from your lender if you seek a waiver letter or a consent letter.
A default that’s not your fault
Whether your business utilises term debt, invoice discounting or ancillary credit facilities, as a responsible borrower, you want to make sure that payments are made on time. You keep a close eye on financial covenant compliance to check that next month’s accounts will not give your bank manager any cause for concern. You keep in mind the other provisions in the loan agreement, like the restrictions on change of control.
Of course, the covenants are there so that the lender can be comfortable that the business is running as expected. You are all too aware of the consequences of a breach of covenant, which could entitle to lender to impose more onerous terms, demand repayment, withhold further funding or enforce its security.
However, unforeseen circumstances can easily trigger a breach of covenant, for example, a major customer does not pay on time, significantly reducing revenues for that quarter and tripping a covenant. Unexpected events may result in a breach, for example, a shareholder decides to emigrate and wants the company to buyback his shares. Such occurrences should not spell disaster for your relationship with your lender so long as you respond promptly and properly.
It is generally advisable to contact your bank manager to notify them of an actual or potential breach of a covenant as soon as you become aware of it. The loan agreement probably imposes a duty to disclose such actual or potential breaches anyway and being forthright allows you to present your case openly before issues are compounded or the lender finds out another way.
If you wait until an actual default occurs you may also trigger cross-default provisions in other loan agreements. These say that a default under one loan agreement automatically causes a default under the other and often take effect even if the first lender waives the original default.
If possible, explain to the lender your plans for rectifying the issue, for example, providing revised financial projections backed up by an accountant’s report. Your bank may be willing to revise the terms of the loan to accommodate the new business plan. After all, it is in the interests of the bank that your business thrives!
In some circumstances you may have a right to “cure” a default, by reducing the loan or getting additional equity from shareholders. If so, you need to start putting this into action.
Get it in writing
Following discussions with your lender, it is useful to document the bank’s acceptance of the breach in a waiver letter. This is because, under the terms of the loan agreement, the default could be deemed continuing even if it is actually remedied unless the waiver is obtained. Usually, a waiver letter contains an acknowledgement by the bank that the breach of covenant has taken place but that the bank agrees not to enforce its strict legal rights to, among other things, demand repayment, as a result.
If the covenant has not actually been breached yet, you can seek a consent letter from the bank to the action that would otherwise result in a default under the loan agreement. This is appropriate, for example, where you want to restructure the shareholdings in such a way that would result in a change of control or you want to dispose of a particular property or part of the business. A consent letter will describe the action that the borrower wishes to take and the lender will consent to that specific action and confirm that it will not trigger a breach of the loan arrangements.
Not carte blanche
Such waiver or consent letter might contain provisions amending the loan arrangements to accommodate the new business plan. In addition, the waiver or consent may be subject to conditions, like a different rate of interest or the provision of more regular management information in order for the bank to monitor the progress of the new arrangements. Typically, the waiver or consent letter will oblige the borrower to cover the lender’s costs for dealing with the waiver or consent.
Finally, the waiver or consent letter will most likely contain a reservation of rights clause. This means that, other than as specifically set out in the letter, the lender reserves any rights or remedies it has to demand repayment of the loan, etc should a different breach occur (or have occurred) or if the same breach happens again in the future. Therefore, once you have a waiver or consent letter in place, it is important to keep covenant compliance in mind and flag any other potential future breaches to your lender in good time.
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