Book traversal links for Appendix 4: Details of Relevant Agreements
Appendix 4: Details of Relevant Agreements
No: 41033343 | Date(g): 6/1/2020 | Date(h): 11/5/1441 | Status: In-Force |
Versions (5 versions) |
Standstill Agreement
In cases, where several creditors are involved, formalizing a standstill agreement is typically the first step involved in the workout process. The standstill is an agreement between the borrower and relevant creditors, typically lending banks, confirming that they will not enforce their rights against the borrower for any default during a limited period. The main purpose of the standstill is to give the borrower sufficient ‘breathing space' to collect information and prepare a survival strategy, while in parallel creditors work on formulating a joint approach. Standstill agreements may also include other obligations to be observed during the standstill period, for example, that creditors grant additional financing to the borrower to cover working capital or postpone any capital or interest payments due. | |
In the context of an MSME workout, it may be necessary to sign a Standstill agreement, even if the number of creditors is limited. The main advantage of formalizing such document is that it will provide sufficient certainty to both parties that a workout is being negotiated, ensuring that the borrower can focus his efforts in the operational changes needed to succeed. For those cases where it is required to formalize a Standstill agreement, a simplified template adopted to the MSME context. However, in certain cases, it may not be necessary to formalize a Standstill agreement and creditor(s) and borrower will proceed on the mutual understanding that a standstill exists. This will typically occur when there is just a single creditor that holds a close and long-standing commercial relationship with the borrower, who is being cooperative in the workout negotiations. | |
The contents of the standstill agreement will largely depend on the transaction at hand, but typically will imply that creditors will assume some (or all) of the following obligations, among others: | |
i. | Not to start enforcement actions against the borrower or his assets; |
ii. | Not to declare the loan agreement breached, or accelerate the loan; |
iii. | Not to take additional collateral or improve his position with respect to other creditors; |
iv. | Not to charge additional fees or penalty interests; |
v. | Not to set-off any amounts against the borrower for pending obligations. |
In return, the borrower will agree not to take any action that would harm the creditors, such as the sale or transfer of assets to a third party or make payments to any creditors except in the ordinary course of business, and will allow the creditors full access to all necessary books and records. |
Restructuring Agreement
The restructuring agreement is the main document that regulates all the details of the workout. In the case of MSMEs, where the workout documentation will often be simplified, the restructuring agreement will many times be the only document formalized, and it is very important that all details be captured accurately, not just in connection with the payment obligations of the borrower but also with his behaviour during the lifetime of the restructuring agreement. When drafting a restructuring agreement, it should be born in mind that the main purposes of this document are (i) to explain how the borrower is going to restructure both his debt and his operations, if applicable, and (ii) to specify how and when creditors are to be repaid. | |
There is no standard format for how a restructuring agreement should look like. The details of the agreement will largely depend on the needs of the business and the willingness of creditors to make concessions to avoid a bankruptcy of the borrower. For example, in the case of a workout consisting of a simple rescheduling of maturities, a signed letter may be enough to document the workout. However, in case of modification in the maturity dates as well as the principal and applicable interests of the loan agreement, drafting a new agreement will probably be necessary. In this case, it is highly advisable that the legal department of the lending banks is brought on-board from the outset, since they should determine whether | |
i. | the workout will be documented into a new agreement that will replace the existing contractual documentation existing between the borrower and creditors, or |
ii. | the original loan agreement will remain in place but as amended by the terms and conditions included in an additional agreement. |
This second approach has the advantage that it will not be necessary to amend the already existing security package, which will keep its priority without the need of seeking new registrations. | |
In terms of the substantive content of the restructuring agreement, the document may include any of the loan restructuring techniques. These options can be combined or arranged in such a way that alternative options can be offered to several types of creditors, depending on the class to which they are allocated. Restructuring plans are consensual in nature and assume all parties to the agreement consent to the terms agreed in the document. However, a key concept for restructuring agreements to succeed is to treat all parties fairly and avoid discrimination of similarly situated creditors in terms of their collateral, priority and outstanding obligations. All creditors holding the same position vis-à-vis the borrower should obtain a similar treatment. |
The Restructuring Proposal - Term Sheet
The term sheet is the most important piece of the workout documentation, as all further documentation will find their origin therein. A draft term sheet drawn up right at the beginning of the workout process provides banks with a useful checklist of parties involved in the workout process and of the terms that will have to be agreed upon with the borrower, other banks, and stakeholders. The draft term sheet is revised at every stage of the workout process, particularly during negotiations. In addition, before drafting the final and formal workout documents, including the new or amendatory loan agreement, lawyers will want to make sure that they can see the full picture of the proposed workout and can iron out any discrepancies and controversial points.
Term-sheets are a common feature in project lending or in the structuring of term loans. They facilitate the negotiations in that the various terms that have been discussed and agreed upon during the progress of the negotiations can be laid down until the final deal or transaction is agreed.
Term-sheets are particularly useful in workouts, as they allow the borrower and bank to spell out what has been agreed upon and move on to the next item to be negotiated. In a workout, it may be necessary to include more than one creditor or stakeholder in the transaction, and the term-sheet allows the parties to agree on the main terms of the proposed restructuring transaction before the lawyers are asked to prepare the legal documents.
After determining, that a workout will be feasible, banks will want to put a proposal on the table. For smaller borrowers, this may take the form of a conversation between the bank and the borrower, to be confirmed in writing. For medium to large companies, where the terms are likely to be more complex and there is a need for the borrower to carefully study and absorb them, the proposal will more typically be in the form of a draft term sheet spelling out the conditions on which the bank is willing to restructure or reschedule the loan(s).
The Restructuring Documents:
- Loan Agreements
The complexity of the restructuring dictates which documents will be necessary. For a simple rescheduling of maturities, a letter may suffice and will have legal validity. However, if the face value of the loan and basic terms such as maturities and interest are changed, there may be a need for a new agreement. Legal practitioners are better placed to determine whether this will take the form of an amendatory agreement, where the body of the original loan agreement is left intact and the terms and conditions to be changed are covered in an additional agreement, amending the original.
- Security Agreements
In the event that there is additional security under negotiated strategy, additional agreements will be required to have such security registered. Particular care will be necessary to ensure that the existing rights of the senior, secured banks are honored and are not diluted or set aside in favor of those of the junior and unsecured banks.
- Ancillary Agreements
These will include additional overdraft agreements, guarantee agreements, share pledge agreements, security-sharing agreements, and the like, all in line with what has been agreed among the borrower and banks.
Key covenants
Covenants are undertakings (or promises) given by a borrower as part of a loan agreement. Their purpose is to provide the bank with an early warning sign of potential problems. They also provide another avenue of communication between the borrower and the bank.
Covenants can be affirmative, negative or positive in nature. They usually cover such areas as financial performance (e.g., will maintain total debt to EBITDA not greater than 2:1, or pay all taxes as they become due); information sharing (e.g., will provide audited annual financial statements); or ownership/ management arrangements (e.g., will employ financial management with demonstrated experience, or will not pay dividends without the consent of the bank).
Violation of any covenant gives the banks right to call the loan, charge fees, or collect interest at a higher rate. In practice, it has proven difficult to call a loan that is paying as agreed based on a covenant default. In this case, after developing a thorough understanding of the cause of the problem and its severity, the borrower is likely to issue either a temporary or permanent waiver in return for the borrower undertaking an agreed upon corrective action program.
All restructuring agreements should contain covenants. At a minimum, they should include provisions to submit financial statements; pay taxes as they become due; prohibit sale of company, completely or in part, without prior approval of bank. Covenants for larger, more complex borrowers need to be specifically tailored to meet their individual situations. Bank should include covenants pertaining to but restricted to profitability, efficiency, liquidity, and solvency ratios; requirements to dispose of assets or raise equity within specific timeframes; or prohibit investments or restrict business activities to those currently engaged in. Bank should also develop an internal process to be able to monitor adherence to these covenants.