With the continuing rise in the number of COVID-19 cases worldwide declared to be a pandemic by WHO, the movement of anyone in Malaysia, like many other countries, has been restricted following the announcement by the Prime Minister of the implementation of a Movement Control Order (“MCO“).
The Government of Malaysia had gazetted the Prevention and Control of Infectious Diseases (Measures Within the Infected Local Areas) Regulations 2020 which took effect from 18 March 2020 to 31 March 2020. The MCO was subsequently extended for a further fourteen days, ending on 14 April 2020, barring any further extensions.
As the COVID-19 pandemic and the MCO have severely affected the nation’s economy and the incomes of all people across the nation, there are obvious implications for individuals and businesses alike when it comes to financial arrangements.
Bank Negara Malaysia has already on its own initiative, implemented a number of regulatory and supervisory measures in support of efforts by financial institutions to assist individuals, SMEs and corporations to manage the impact of the COVID-19 outbreak. This includes a deferment of all loan/financing payments for a period of six (6) months with effect from 1 April 2020 to ease the burdens of individuals and SMEs. As for corporations with existing financings, financial institutions will also facilitate requests to defer or restructure the existing financing arrangements in a way that will enable corporations to stay viable and swiftly resume economic activities once the MCO comes to an end (for more details on this, see our Client Alert: COVID-19: DEFERMENT AND RESTRUCTURING OF FINANCING dated 30 March 2020).
In this article, we further address some of the specific issues in financing documents that both financial institutions and their customers may have to consider and take note of due to the COVID-19 pandemic.
Events of Default
Cessation of Business
An event of default may be triggered if there is a suspension of a substantial part of the present business operations of SMEs and corporations. However, the applicability of this triggering event would highly depend on how the clause pertaining to events of default is actually worded. For example, (i) whether the event of default applies solely to the business of the customer or it applies wholly to include the business of the customer’s group or (ii) whether it applies to the customer’s business in whole or in part.
Material Agreements and Cross-Default
As financing documents typically contain a cross-default in respect of failure to make payments to financial institutions when any indebtedness becomes due, the customers and financial institutions alike should be aware of such terms across their financing documents.
That said, most project financing documents will also involve undertakings by customers to ensure that there are no defaults in, or changes made to, the material agreements in relation to the project, such as a concession agreement with the Government, a construction agreement with the main contractor, etc. In this regard, the failure to meet payment obligations to third parties in these material agreements can trigger an event of default under the project financing documents.
Customers may also wish to assess the likelihood of a breach and contact their financial institutions in order to have the requisite waiver in place prior to a breach occurring, to avoid the risk of triggering cross-defaults elsewhere.
Financial covenants act as a barometer in signalling whether a particular customer is heading into financial distress. Particularly relevant may be financial covenants such as debt-to-equity and finance service cover ratios which focus on a customer’s ability to service interest/profit or to make scheduled payments on outstanding debt. As there may not be any grace period afforded for breaches of financial covenants, customers should contact their financial institutions as soon as there is a possibility of a breach to obtain the requisite waivers.
Material adverse conditions
Where there is an event (or series of events) which has happened or come into effect and the same is likely to have a material adverse effect on the condition (financial or otherwise), prospects, results of operations, properties or assets of the customers, this may trigger an event of default – this is the material adverse effect (“MAE“) clause. The applicability of a MAE clause will largely depend on the actual wording of the clause. Common distinctions include the degree of certainty that the circumstances “may” or “will” have a MAE or whether the circumstance is determined by an objective test or in the sole discretion of the financial institutions.
However, financial institutions generally do not invoke MAE clauses without proper justification as the financial institutions may be in breach of contract if they get it wrong. Therefore, it is not common for MAE clauses to be the sole basis for a financial institution to accelerate the repayment of a loan or the payment due under an Islamic financing facility. Rather, it is likely that financial institutions will look to alternative justifications such as a separate event of default before recalling a loan or demanding payment due under an Islamic financing facility.
Representations and Warranties
It is common for customers to represent that they are not in default under any agreement to which they are a party, and that no bankruptcy or winding-up proceedings have been initiated against the customers. This representation may be relevant in cases where a customer’s performance under third party contracts is substantially curtailed due to the COVID-19 pandemic and the MCO.
Material change in financial condition
This representation may also be relevant as it is typically made by the customer that there is no material adverse change in the financial condition or operations of the customer since the date of granting of facilities by a financial institution.
Conduct of Business
If customers do not conduct their business and operations in compliance with the Government of Malaysia’s advice on business conduct during the COVID-19 pandemic and the MCO, a representation as to compliance with applicable laws and regulations would be breached.
Change in law/circumstances
The impact of the COVID-19 pandemic and the MCO may make it improbable that the business of the customers can be carried on. In such cases, the customers affected may not be able to observe and perform the covenants and obligations on their part under the financial agreements. Likewise, a change in the application of any law may make it unlawful for financial institutions to continue their obligations or may increase the cost to maintain or fund their participation under the financing agreements. Under such circumstances, the financial institutions may require customers to make an early settlement of the outstanding debt or to furnish further security in exchange for indulgence or to restructure the debt.
Covenants on information undertakings
Financing documents will require customers to furnish information in respect of their business, operations, properties and assets as may from time to time be required by financial institutions. It is likely that financial institutions will require full visibility on how the businesses of customers are affected and how such businesses are recovering (or whether they are able to recover) under the present circumstances. As such, customers would need to keep a close eye on potential breaches in material agreements due to the effects of the COVID-19 pandemic and the MCO on businesses.
The effects of the COVID-19 outbreak have been widespread and continuing, and affect many financial institutions and customers alike.
For the financial institutions, unwanted reputational consequences may ensue if they ignore the mitigation initiatives implemented by the Government of Malaysia. In this respect, it is encouraging to note that financial institutions have supported the payment moratorium and other initiatives by Bank Negara Malaysia. However, financial institutions will be forced to consider ways to recover their capital if the pandemic does not slow down and the adverse consequences thereof continue.
Customers, on the other hand, will need to be able to demonstrate how the effects of the pandemic are managed effectively and thoroughly. Financial institutions are likely to be more inquisitive and may see themselves being more involved in the business of the customers than before as business recovery is central to any loan or Islamic financing rehabilitation.
With the COVID-19 pandemic and Bank Negara Malaysia’s moratorium in mind, it may also be worthwhile in the future to consider incorporating a modified Force Majeure clause in financing agreements which expressly includes epidemics, pandemics and similar outbreaks of disease as events of force majeure, and which allows customers and financial institutions to consider a temporary deferment or suspension of payment obligations for a limited period of time or an option to reschedule or restructure existing financial arrangements.
If you have any questions or require any further assistance, please do not hesitate to contact any of us.
|Hoh Kiat Ching
|Alden Yeoh Shuen Chun
|Benjamin Chia Lin Fung