Falling values means that the assumptions on which commercial loans may have been taken out cease to be valid and there could be contractual consequences for borrowing companies which should be kept under review. It could mean that a complete financial restructuring is required. Here are some potential risks and action points:
1. Review Loan Agreements
Many commercial loan documents will include covenants that the property has a certain value in relation to the loan (loan to value). Whether these are breached depends on whether there is a current valuation which evidences a fall in value and consequently the borrower’s obligation to obtain an up-to-date valuation in certain circumstances, or the Bank’s ability to require one, is extremely important.
There are also “material adverse change” covenants that could be triggered whether or not there is a demonstrable loan to value breach, where the value of the company’s portfolio is clearly falling. Material adverse change clauses are harder to enforce especially when the company is continuing to pay interest as normal but nevertheless there is a potential breach if it can be demonstrated that there has been an adverse effect on the Bank’s security.
Practical Notes:
(a) Review all your loan agreements especially in relation to financial covenants and events of default that could be triggered by a fall in property values.
(b) Obligations to seek up-to-date valuations are often only triggered in the event of some other event of default and therefore directors should ensure that all other covenants in the loan agreement are complied with.
(c) Directors have no implied obligation to seek a valuation especially when this would bring about the company’s insolvency through withdrawal of its banking facilities.
(d) If a valuation is approaching then discuss potential remedial action with the Bank at an early stage. The Bank has no interest in forcing a sale of the property in a falling market but may require additional security.
2. Review Security Documents
Where property values fall the value of the borrower’s equity will be eroded and the incentive for continuing to manage the property may evaporate. The directors need to look at the Bank’s security and to consider what leverage they have. There may be an opportunity to negotiate with the Bank an incentive for a favourable realisation.
Practical Steps:
(a) Consider what other properties are within the security net.
(b) Consider the effect on solvency of guarantor companies.
(c) Consider the corporate implications to each individual company of enforcement of security rather than the group as a whole.
(d) Make a note of the position of each company involved and discuss it at a Board Meeting in case decisions need to be made.
(e) Bear in mind directors’ duties under the Companies Act 2006.
3. Consider Whether the Company is Wrongfully Trading
In the event that the company is insolvent then the directors could incur personal liability if the company continues to trade while insolvent and should take advice (see below). This arises in particular if there is any shortfall in interest payments but it could also arise in the event of valuation issues resulting in an irremediable negative balance sheet.
Practical Note:
(a) In the event that holding companies have provided suitably worded letters of support then these could be withdrawn and the directors would then have no alternative but to cease trading.
(b) Ensure that the conversations with the company’s lenders, tenants and advisers are recorded so that documentation exists to establish the financial state of the company at any point.
(c) Consult with advisers should there be any doubt about the position of any company.
4. Consider the Implications of Administration
If it becomes clear that the company cannot survive then either the Bank or the directors could put the company into administration. This will have the effect of bringing in an insolvency practitioner to deal with the realisation of the company’s assets ensuring that the property is sold at the best price obtainable.
Practical Note:
(a) The Bank is likely to choose receivership/administration (or administrative receivership in the case of old security) only as a last resort in this climate.
(b) The directors’ recourse to administration is effectively “giving back the keys” but may be done if there is no reason to devote management time to saving the company.
(c) There is nothing to stop the directors or any other group company making an offer for the property from the administrators.
(d) Consider the reputational risk of insolvency on the group and the relationship with the Bank.
5. How Can We Help?
Hamlins can undertake a review of all loan or security documents and can advise on corporate and loan restructuring.
If you would like a quote for a review or would like to discuss any other aspects of the above in more detail or have any queries relating to the above, please contact Mark Copping on 02073556115 (mcopping@hamlins.co.uk) or Stacey Dutton on 02073556117 (sdutton@hamlins.co.uk).