In this article, we discuss the impact on the COVID-19 outbreak on credit facilities and the economic measures announced by the Dutch government to provide credit support for credit facilities made available to SMEs.
The COVID-19 outbreak is having a profound economic impact on numerous industries. Lenders that are exposed to borrowers that are hit particularly hard may review their loan documentation to assess whether they are entitled to limit their exposure by refusing or restricting further drawdowns. In some cases they may even consider to accelerate the credit facilities. Below we briefly discuss possible grounds lenders may invoke, possible defences available to borrowers and the possibility for borrowers to require that the terms of the credit facilities are amended.
Material Adverse Effect / Change provisions
Material adverse change
Facility agreements usually contain provisions that provide that the occurrence of a "Material Adverse Effect" or a "Material Adverse Change" (MAC) constitutes an event of default and/or a ground to stop further utilisations under the credit facilities. This raises the question whether the COVID-19 outbreak qualifies as a MAC. This will depend on (i) the wording of the MAC definition and (ii) the extent the which the relevant obligors are affected by the outbreak.
Burden of proof
In the absence of a specific provision, the lender has the burden of proof that a circumstance qualifies as a MAC. In practice, this is quite difficult. To ease the burden of proof it is fairly common for the MAC to provide that the determination of whether a MAC has occurred is subject to the (reasonable) opinion of the relevant lenders. Whilst inclusion of such provision may help the lender, the overriding Dutch law principles of reasonableness and fairness are such that the lender should act reasonably in forming its opinion that a MAC has occurred.
Precedents in case law
Dutch case law provides very little (if any at all) guidance on the interpretation of MAC provisions. The case law from the UK and the US on the subject is also very limited. In a rare judgment on the interpretation of MAC provisions in Grupo Hotelero Urvasco SA v Carey Value Added SL  EWHC 1039 (Comm) the English High Court gave some guidance. In that matter the lender invoked a MAC in relation to a repeating representation that there had been no material adverse chance to its financial condition. The court provides the following guidance:
a) MAC provisions should be interpreted in accordance with the normal rules of contractual interpretation;
b) to be material, the adverse change must substantially affect the borrower's ability to perform its obligations, which in the case at hand – as a consequence of the reference to financial condition – means the ability to repay the loans;
c) the adverse change in question cannot be temporary of transitory; and
d) a lender cannot invoke a MAC on the basis of circumstances of which it was aware when the lender signed the agreement.
Application to Dutch law agreements
The above referenced case law was rendered under English law. Whilst the Dutch courts may derive some inspiration from it, the considerations under Dutch law may well be different for several reasons, including:
a) as matter of Dutch law, contractual provisions are also interpreted on the basis of what the relevant parties could reasonably have believed to be the parties' intention at the time the contract was entered into; and
b) under Dutch law principles of reasonableness and fairness can – in short – set aside contractual provisions or restrict the exercise of a contractual right or remedy (see below).
Setting the MAC aside, the impact of Covid-19 may also trigger other events of default, for example a breach of financial covenants or a lack of funds to pay scheduled repayment instalments. The question is whether the relevant borrower may have a defence by stating that its non-performance is beyond its control and qualifies as force majeure.
Force majeure under Dutch law
The Dutch Civil Code includes a definition of force majeure (Section 6:75 of the Dutch Civil Code). Under this definition force majeure is a situation where a failure to perform cannot be attributed to the debtor, because it is neither due to its fault nor for its account pursuant to the law, contract or generally accepted principles. Under Dutch law the statutory force majeure provisions apply automatically to all contracts, provided that parties can include an express provision on force majeure if they wish to override or deviate from the statutory provisions. While the 2002 ISDA master agreement, for example, includes a force majeure provision, most financial contracts do not.
Does COVID-19 qualify as force majeure?
There is no clear answer to the question whether COVID-19 qualifies as a force majeure event. It seems clear that COVID-19 is not the fault of the borrower. However, there can be debate whether or not – in the relationship between a lender and a borrower – the occurrence of such circumstance is for the account of the borrower pursuant to generally accepted principles. Such assessment should be made on a case-by-case basis. One of the relevant factors will be whether the borrower has taken all measures within its power to mitigate the impact of COVID-19 and to comply with its contractual obligations under the loan agreement.
Legal effect of force majeure
The legal effect of force majeure is that the lender cannot demand performance or damages from the borrower and that the borrower can suspend its performance under the loan agreement, but in each case only to the extent that performance is impossible due to force majeure. This means that – if force majeure is established and continuing - the lender cannot accelerate. It is, however, uncertain whether force majeure will take away an event of default altogether. The question is what the status is of the event of default when the force majeure event has ended. Moreover, if the facility agreement provides that no further drawdowns can be made whilst an event of default is continuing, it is questionable whether a lender can be forced to allow further drawdowns on the basis that the event of default was caused by force majeure.
As for interest payments and scheduled repayments, we consider it highly unlikely that these can be suspended based on force majeure as it remains possible to make the payments and any payment difficulties result from the lack of income and liquidity rather than e.g. system failures. That is not to say, however, that lenders under all circumstances may insist that borrowers fulfil all their payment obligations.
COVID-19 as unforeseen circumstance
The COVID-19 outbreak in our view qualifies as an unforeseen circumstance in the meaning of Dutch law. The Dutch Civil Code (Section 6:258) defines unforeseen circumstances as circumstances that are of such a nature that the counterparty (in most cases the lender) on the basis of the principles of reasonableness and fairness may not expect that the relevant agreement remains in full force and effect. On the basis of unforeseen circumstances, the affected party (in most cases the borrower) may request the courts to amend the terms of an agreement.
Requirement to enter into negotiations
Based on this argument, we feel it is prudent for lenders and borrowers to enter into negotiations with a view to amend the terms of the credit facilities if the payment difficulties of a borrower are the direct consequence of the outbreak of COVID-19. As a first step, amendments are likely to see to the postponement or reduction of scheduled repayments and in exceptional circumstances possibly interest payments. Amendments may however equally see to e.g. the reset of financial ratio's.
Different from bank waiver
The difference to a typical bank waiver is that a bank waiver normally is given at the discretion of the lender with a view protecting its long term interest. The amendment of the terms of the credit facilities based on unforeseen circumstances however is a legal requirement which may ultimately be enforced before the courts. Having said that, we believe that a lender cannot be forced to amend the terms if the payment difficulties are not the direct result of the Covid-19 outbreak and clearly misuse should be avoided.
Termination and principles of reasonableness and fairness
Lenders that wish to terminate a facility or accelerate a loan under a Dutch law facility agreement on the account of an event of default, should apart from the possible requirement to renegotiate based on unforeseen circumstances be aware that under Dutch law, overriding principles of reasonableness and fairness may impose restrictions. Moreover, as regards lenders that are Dutch banks, further restrictions may apply pursuant to Clause 2 of the general banking conditions (Algemene Bankvoorwaarden, ABV).
Dutch case law – applicable to all lenders
The following principles can be derived from case law of the Dutch Supreme Court as regards lenders that wish to terminate a facility or accelerate:
a) starting point is that a lender can invoke a contractual termination / acceleration clause in accordance with its terms;
b) however, exercise of these contractual remedies can be limited or subject to restrictions if and to the extent that exercise would be unacceptable otherwise according to standards of reasonableness and fairness; and
c) for the assessment under b) a broad spectrum of circumstances can be relevant; most importantly (i) it may mean that the lender should observe a reasonable notice period, (ii) whether the lender has consulted with the borrower and (iii) the value of the security in relation to the amounts outstanding.
The extra-ordinary nature of the COVID-19 outbreak may mean that the principles of reasonableness and fairness dictate that the lender observes a longer notice period or period for recovery, unless it is clear that recovery is not possible.
Clause 2 ABV – applicable to lenders that are Dutch banks
The ABV are applicable to all Dutch banks in relation to their clients. Clause 2 of the general banking conditions stipulate that banks will observe a duty of care vis-à-vis their clients. This is a contractual duty of care that may further restrict the exercise contractual acceleration and termination rights.
Economic government measures to provide credit support
From 16 March 2020 to 1 April 2021, the small and medium-sized enterprises (SME) Credit Guarantee Scheme (Borgstelling midden- en kleinbedrijf: BMKB) will be extended to support SMEs that are affected by COVID-19. Under the SME Credit Guarantee Scheme the government provides guarantees to lenders to enable SMEs to borrow more than would otherwise be possible based on their collateral.
The regular regulation provides that the SME Credit Guarantee Scheme covers 50% of the credit amount provided by the lender. The guarantee provided by the government amounts to 90% of such amount. Under the extended SME Credit Guarantee Scheme the guaranteed credit has increased from 50% to 75%. The extended SME Credit Guarantee Scheme is intended to be used by SMEs for a bridge loan or to increase the overdraft limit on their current account with a maturity up to two years. In addition, some other conditions under the SME Credit Guarantee Scheme shall be more flexible in order to enable SMEs to meet their payment obligations
The government has not (yet) published any specific eligibility criteria in relation to the extended SME Credit Guarantee Scheme. SMEs that want benefit from the scheme should apply for a loan from one of the participating banks or other funders, which in turn submits an application for the (extended) SME Credit Guarantee Scheme from the Netherlands Enterprise Agency (Rijksdienst voor Ondernemend Nederland: RVO).