In this note we seek to clarify what the likely impact of the EU referendum result will have on loan agreements and provide guidance on what borrowers and lenders should be doing now.
No immediate effect
It is important to note that the referendum was a non-binding advisory referendum which does not have any legal effect. While politically it would be difficult for the current British government to disregard it, as a legal matter nothing has changed as a result of the referendum and until the UK formally leaves, it will remain a full member of the EU with its people and businesses continuing to have full access to the single market.
It is unlikely that the result of the referendum of itself will have any immediate impact on LMA-based loan agreements. While we were aware in the run-up to the referendum of “Brexit clauses” being discussed in the context of loan agreements (ie, clauses requiring early repayment of loans or margin increases if the UK voted to leave), we are not aware of any such clauses actually being included in loan agreements. As such, in the absence of explicit provisions specifying what will happen in the event of a vote to leave, parties should consider the general terms of their financing arrangements carefully to establish what impact (if any) the vote will have.
Has there been a MAC?
Many loan agreements contain some form of “material adverse change” event of default. In general they give the lender the right to require early repayment of the loan if an event or circumstance occurs which constitutes a material adverse change to the borrower’s ability to repay the loan or its broader financial position. There are many varieties of these clauses: some are subjective in favour of the lender, some are forward looking and some look beyond the borrower’s ability to repay to the borrower’s “prospects”. As always, parties will need to consider the precise wording of the material adverse change provisions but our view is that in general, lenders will be unable to rely on material adverse change provisions simply as a result of the referendum result.
MAC clauses are notoriously difficult for lenders to rely on and getting it wrong could lead to substantial damages being claimed by borrowers and/or reputational damage for lenders. As such, a well advised lender would need to be extremely confident of its position before calling a MAC. While the UK has voted to leave the EU, the manner in which it will leave (and indeed when) remains to be seen. Clearly, for businesses a settlement giving full and unencumbered access to the single market will be better than a settlement where access is limited, thus until a final model has been established it will be too soon for a lender to take a position on a borrower’s ability to pay or its financial prospects. Further, for loan agreements signed after 7 May 2015 (i.e. the date the Conservative party won a Parliamentary majority on the basis of their manifesto promising the referendum) it will be even more difficult for lenders to rely on a MAC event of default. MAC events of default are intended to protect lenders against the unforeseeable and while the result is surprising for many, the possibility of a vote to leave cannot be said to have been completely unforeseeable.
I’m a borrower – what should I be doing?
The economic and political uncertainty is likely to have an impact on borrowers in the short to medium term. The impact might be positive for some and negative for others. Borrower’s should take early action to review the terms of their loan agreements to anticipate any identifiable breaches of loan covenants. Particular focus should be paid to any financial covenants as these are likely to be provisions which are triggered first if the current political and economic uncertainty has a negative impact on business. While many borrowers will have already done the analysis and sought advice, now is the time to do this or to re-confirm your views and consider whether your contingency plans are adequate. As always, having early discussions with lenders about possible bumps in the road will most likely lead to better outcomes but borrowers need to be careful not to prejudice their legal position by having those early discussions. If in doubt we recommend seeking legal advice.
I’m a lender – what should I be doing?
For existing transactions, our advice is as above. In the absence of explicit “Brexit clauses” it is unlikely that the referendum result will have had an immediate impact on your documentation. If you have information/monitoring covenants, you may now want to evaluate them to understand what (if any) information you can seek from your borrowers over the coming months and years.
For new transactions, we do not anticipate any material mechanical changes needing to be made to LMA-based loan agreements as a result of the referendum. It may be that changes are required if/when the UK leaves the EU but in our view it is far too soon to try and anticipate these changes now. In terms of commercial terms, it may be that lenders now seek to tighten covenant controls or reduce tenors to take account of the likely timetable for any withdrawal from the EU but these matters will need to be considered by lenders and borrowers on a case by case basis.
The Mills & Reeve banking team are here to help our clients navigate the impact of Brexit on their financing arrangements. If you would like to get in touch please contact Will Roles or David Varnham.
For more information please visit www.mills-reeve.com/foresight/brexit.