Reviewing default triggers: pragmatic solutions from the Antipodes

August 2020 | SPOTLIGHT | BANKING & FINANCE

Financier Worldwide Magazine

August 2020 Issue

Australia’s status as a mature, independent, resource-rich nation with a strong core banking sector, seemingly immune to the business cycles to which many of its peer nations are tied, gives rise to some interesting market divergences in documenting loan transactions when compared to European loan markets.

One of those in particular is the fact that, historically, loan facility agreements across the spectrum often incorporate ‘review events’. These are an additional category of lifetime events alongside the usual suspects of events of default or potential events of default. Review events provide flexibility by setting out a more specific framework for renegotiation or reorganisation of debts – and the borrower’s business – than the comparatively blunt tools of grace periods or defined cure mechanisms or by patching holes with conditional waivers and consents.

As credit conditions and the wider lending landscape adjust and adapt to life in the wake of the COVID-19 pandemic, there will be increased focus on default trigger events and their destructive consequences. Including review events as an additional category in loans originating or being repapered during the current crisis, may provide a more constructive roadmap for lenders and borrowers in other jurisdictions to navigate their way through potential credit events.

Not every ‘default’ or ‘potential event of default’ can, or should, be recast as a review event. There are good reasons why certain events of default lead to acceleration, cancellation and ultimately enforcement. But defaults need not be an excuse to pounce.

While much will depend on the credit and the deal, review events in the current climate might include: (i) insolvency-related events in relation to certain members of the obligor group; (ii) breach of certain representations or warranties; (iii) temporary cessation of business; (iv) cancellation, suspension or breaches of operational contracts, which is likely with a materiality threshold; (v) failure to satisfy a condition subsequent; (vi) a change of management personnel, which may include where key staff are furloughed; and (vii) a change of control in relation to the borrower or the obligor group.

In a real estate finance context, for instance, and particularly having regard to the trajectory of the current business cycle, there may be a role for review events to play in allowing for transactions to adapt to the new normal. Rent reductions, company voluntary arrangements (CVAs) and property revaluations might all be circumstances that lend themselves to these kinds of arrangements. On the development and construction financing side of things, project cost overruns and completion delays might fall in the category suitable for review events.

Each sector and market will have its own suitable candidates and the category of events is bounded only by the commercial positions of the parties and the credit risk environment. Many of the usual discussions on materiality and threshold conditions will come into play to inform what might be appropriate.

That is not to say that review events are simply another side of the same coin. The distinction between English law and the Australian approach comes from the way in which the consequences of a review event are documented in a loan facility agreement. While some of these may be built into more bespoke event of default provisions, they may sit more usefully in their own category.

Review events give rise to hardwired negotiating or consulting periods. In much the same way as the Loan Market Association’s screen rate replacement language – in the context of the London Inter-bank Offered Rate (LIBOR) transition – is designed to do, parties agree to come together to seek a solution, in good faith, and that during such period no enforcement action will be taken.

This operates as a form of standstill period, with a view to: (i) repapering the finance documents on new terms, such as repricing margin ratchets, adding new funding lines, extending maturity, modifying conditions and financial covenant ratios; (ii) providing or requiring extra security or credit support; (iii) restructuring the debt entirely, perhaps with junior, mezzanine or equity injections; (iv) taking any other steps to overcome or reduce the effect of, or risk associated with, the particular review event with any cure or remedy actions depending on the extent to which the issue is within the obligors’ control; and (v) the possible cancellation and repayment of the facilities.

The standstill period should be calibrated to give parties time to agree a course of action. Should they get to the end of the period without agreeing how to remedy or overcome the effects of the review event – it is also helpful to include language around recalcitrant parties – the lender and borrower alike should understand this will trigger the usual acceleration mechanisms and a deemed event of default.

Mechanisms of this nature do have some areas to be aware of. Most significantly is English law’s nervousness around ‘agreements to agree’. That is, provisions that seek to establish an agreement at a future point in time. English law requires agreements to be formed only once all the essential elements of the contractual paradigm are in place and courts may void such arrangements for uncertainty.

English case law teaches us that it may be prudent to include terms in the contract which will apply in the event that the parties are unable to reach their future agreement and that allow the terms of any subsequent agreement to be determined objectively, for example by a third party, perhaps through arbitration. Clear provisions can assist the parties in demonstrating, evidentially, their intention to be legally bound by the resulting contract or arrangement.

As a general rule, if a clause gives the parties an opportunity to agree or disagree on contractual terms at a future point in time, whether reasonably or not, all parties should assume that the courts will be slow to enforce such a term. As such, review events are instead more typically framed as an understanding that such events have defined contractual consequences and their occurrence triggers a standstill and period of good faith negotiation, with any resulting agreement documented separately.

In addition to being a pause button on acceleration and enforcement rights, review events will usually be a drawstop to new lending and loan rollovers will be restricted. Borrowers should also expect to see: (i) repeating representations as to there being no review event; (ii) undertakings to notify or report review events; (iii) monies on account to be applied in a certain way if a review event is subsisting; (iv) cross-defaults triggered and potentially tripping review events or other consequences in other documents; and (v) any failure to remedy or cure a review event triggering an immediate default.

Some may argue that English law finance documents already have the mechanisms to deal with these events through the combination of potential default regimes and cure and grace periods. However, the idea is that review events are expressed either to displace or work alongside potential defaults, which are more broadly events or circumstances that would become a default with the giving of notice, the making of a determination under a finance document or the passage of time.

Instead review events provide clarity of direction in hardwiring the consultation and negotiation regimes that are often agreed after the event, and on a case-by-case basis, in English law deals. Default or potential event of default triggers typically lead to frantically drafted consent and waiver letters, which often include the same cures and consequences as are pre-emptively contemplated by review event provisions. Review events can also head off arguments in the initial documentation stage about materiality or hair triggers. They set a clear and defined regime for flexing the finance terms that may be more palatable to borrowers and lenders alike.

For syndicated transactions, as has been seen in the context of the ‘tough legacy’ transition of LIBOR contracts to new rates, there can be significant practical difficulties in obtaining consents or agreeing amendments across large lender groups. Issues can be magnified dramatically when you take into account distressed positions and cross-border transactions. A baked-in review event mechanism may be welcomed by agents and security trustees, providing a more useful framework than a doomsday creditors’ meeting hair triggered by a typical event of default.

Clearly their place and deployment in the Australian market was a product of the very different lending landscape and had evolved through a particular set of market conditions. However, there is something trite in that familiar reductive riposte of lawyers and customers alike that a proposed position is ‘off market’. Moreover, as those markets shift once more to accommodate a global pandemic and the inexorable economic downturn, successful stories (and the rewards they reap) will come from those who are able to adapt and innovate. Pragmatic and constructive solutions are far more helpful in this regard than obstinacy.

Richard Gibbard is of counsel at Fieldfisher. He can be contacted on +44 (0)20 7861 4381 or by email: richard.gibbard@fieldfisher.com.

Richard Gibbard

Fieldfisher