The COVID-19 pandemic and the consequent lock-down has impacted the business of all non-essential services and supplies and has disrupted collection and flow of revenues for such businesses. This impact has primarily been on account of the effect on global supply chains, foreign travel and inland transportation of goods and movement of people, especially for businesses which rely heavily on supplies from China or on end sale in domestic, Europe and American markets.

While the regulatory regime is being relaxed to provide temporary reprieve to businesses and soften the blow of the anticipated economic crisis, it is prudent for the businesses to revisit their financing contracts and review the payment terms therein, keeping in mind the ability of current circumstances to trigger material adverse effect or material adverse change (MAE) clauses and consequent ability of the lenders to enforce mandatory prepayment or other remedies under these contracts. Some key provisions to look out for in the course of the review are:

Notification requirements

Typically, financing contracts contain provisions which require the borrower to provide information to the lender(s) at regular intervals. While the scope of this obligation varies across different facilities, projects and sectors, it is likely to be most extensive during the construction phase of a project. In such a scenario, borrowers should consider whether such obligations have been triggered by the pandemic COVID-19 outbreak or the consequent visa and travel restrictions and lockdowns in the country. Further, financing contracts may also set out requirements to notify lender(s) within appropriate timelines on any information sought by them in case of occurrence of such events and with respect to effects of such events on the project.

Increase in expenditure

A notice for invoking force majeure relief may be required to be accompanied with a notice detailing the remedial action being taken by the borrower to minimise the effect of force majeure. Such remedial action may include an increase in the project cost. However, lenders may have a right to approve any changes to the project budget and expenditure, for sums exceeding a certain threshold. They may also have rights to request the borrower revise budgets in the event there is a change in circumstance which may affect the accuracy of the existing budget. If the provisions of the financing contracts do not provide flexibility to the borrower to revise the project budgetary estimates, the borrower may need to request for a waiver of these provisions, from the lenders, to allow for an emergency budget to be approved.

MAE under the financing documents

MAE clauses are designed to protect lenders against unknown risks as on the signing date, which is also the reason for their very broad drafting. Typically, the term MAE is defined under standard loan documents as:

“Material Adverse Effect shall mean the effect or consequence of an event, circumstance, occurrence or condition which has caused, as of any date of determination, or could reasonably be expected to cause a material and adverse effect on:

(i) The financial condition, business or operations of the borrower;

(ii) The ability of the borrower and/or the sponsors to perform their obligations and/or enforce any right, benefit, privilege or remedy under the financing documents and/or material project documents, to which they are a party;

(iii) The ability of the borrower and the sponsor to comply in all material respects with the terms and conditions of the project clearances; or

(iv) The validity, enforceability or effectiveness of any financing documents (including the ability of any secured party to enforce any of its remedies thereunder and ranking of security created by the security documents), which adverse effect, as on such date is continuing.”

If the requirements of a MAE clause are met, such MAE could constitute an event of default, allowing the lender to accelerate a facility by declaring all loans under that facility to be immediately due and payable, regardless of whether any other default has occurred under the facility agreement. In such a scenario, in all likelihood, a borrower would not be able to repay its outstanding loans, which would then cause a payment default. This payment default could then lead to enforcement of security by the lender. Thus, invoking a MAE clause can have far reaching consequences for a borrower and may even result in insolvency proceedings.

Will COVID-19 or consequential lock-downs qualify as MAE

Whether a MAE provision may be triggered by the COVID-19 pandemic and the consequential lock-down of non-essential services depends on the specific provisions of the financing documents.

While Indian courts have not set any precedence in this regard, the courts in UK have held that the effect of the adverse change must be long lasting. Drawing a corollary from English Law, the lender may be required to demonstrate that the changes/effect on the borrower caused due to the outbreak of COVID-19 and the consequent lock-down are long-term or terminal changes which adversely affect the business of the borrower as opposed to temporary or recoverable changes, in order to invoke the MAE provision. Accordingly, in the event of invocation of a MAE clause, it may be reasonably argued that while the duration of the COVID-19 outbreak remains uncertain, the effect of the outbreak is generally expected to not be long term.

Recent moratorium granted by RBI and its effect

On 27 March, 2020, the Reserve Bank of India (RBI), with a view to provide relief to borrowers, issued a notification permitting lending institutions to allow a moratorium of 3 months on the payment of instalments in respect of all term loans (the payment of which was due from 1 March, 2020 to 31 March, 2020) without changing the terms and conditions of the loan agreements. Accordingly, under the notification, the repayment schedule, subsequent due dates as well as the tenor for the loans may be shifted across the board by three months by lending institutions. However, interest will continue to accrue on the outstanding portion of the term loans during the moratorium period (RBI Notification).

Will the RBI Notification imply that MAE cannot be enforced?

Lenders who permit a moratorium in line with the RBI Notification will not be able to claim the MAE under the financing documents, irrespective of whether such MAE has a long-lasting effect or not. This is because a MAE cannot be enforced if a moratorium for repayment has been provided by the lenders.

Effect of RBI Notification on non-performing assets

Under the asset classification regulations of the RBI, any default in repayment of loans for a period of 90 days leads to the classification of an asset as a non-performing asset (NPA). Thus, it is important to understand whether a moratorium pursuant to the RBI Notification may lead to the downgrading of a facility or loan to an NPA.

The RBI Notification clearly states in paras 5 and 6, that the moratorium by itself will not result in an asset classification downgrade i.e. creation of an NPA. The notification further states that the asset classification of the term loans which avail the moratorium will be determined on the basis of the revised repayment schedule. Thus, since the entire repayment schedule will be revised for the benefit of the borrower, the timelines leading to the declaration of an asset as an NPA will also stand revised to account for the moratorium period.

Proposed Actions

· Revisit your financing documents for notification requirements

·Review the provisions for any approval requirement for change in budgetary expenditure

· Evaluate what constitutes MAE and check if any notice has been received from the lenders

· Consider approaching the lender for deferring the payment of installment

Authored by :- Ms. Anuja Tiwari, Partner; Ms. Mallika Anand, Senior Associate; Ms. Amoolya Khurana, Associate and Mr. Aman Raj, Associate.