Tips and Insights for Companies Operating in the Current Environment

MoFo Perspectives Podcast

15 April 2020

London Lawyers Alistair Maughan and Edward Downer share, explore and discuss the current issues faced by our clients during the COVID-19 Pandemic.

This soundbite covers trends and reoccurring questions from our clients, from fundamental business considerations, such as cash flow, to duties as directors and governmental relief.

This pragmatic and informative discussion is designed to help our clients navigate the months ahead. It’s an easy listen of substantial and practical value.

A concise one page summary, 10 Tips for Companies Operating in the Current Environment, accompanies this podcast.


Speaker: Welcome to MoFo Perspectives, a podcast by Morrison & Foerster where we share the perspectives of our clients, colleagues, subject matter experts, and lawyers.

Jo Mhari Witham: Hello and welcome to our MoFo podcast. I’m your host, Jo Mhari Witham, director of marketing and client development for Europe. I’m joined today by my fellow colleagues and speakers, Alistair Maughan and Ed Downer. Alistair leads MoFo’s European Commercial and Technology group, and he’s also managing partner of MoFo’s London office. He’ has a long track record of working on a wide range of complex commercial projects, primarily, but not exclusively, in the technology sector. Ed is a finance lawyer at MoFo’s office based in London. Ed assists clients with stressed and distressed financing matters, financial restructurings, and cross-border insolvency. Ed and Alistair are going to spend the next 30 minutes or so exploring a number of considerations for companies operating in the current environment, sharing their tips and insights to successfully navigate the months ahead. This conversation has been specifically designed to supplement and support their recent publication, “10 Tips for Companies Operating in the Current Environment.” And that’s available now on the Morrison Foerster website, mofo.com. That’s M-O-F-O.com. So, Alistair, without further ado, can I hand over to you?

Alistair Maughan: Yeah. Thanks Jo, for that introduction and as you say, we’re going to talk over the next 30 minutes or so about tips that we’ve seen within MoFo of our collective experience of companies operating in the current economically stressful environment. And Ed, I know that as part of that, we’re really doing our best to channel the collective thoughts of lots of our MoFo colleagues across various disciplines—commercial disputes, financing, restructuring, and corporate. So maybe let’s try and do them justice and maybe kick off perhaps with, if you can just fill us in where we culled these 10 tips from?

Ed Downer: Well, as you said, Alistair, a group of us did come together to consider the issues being faced by our clients as we enter Q2 2020. And as we counsel them to navigate a path through what is, worldwide, going to be an extremely challenging period, some particular trends and recurring questions arose. And while some were more pertinent to particular sectors than others, there seemed to be so much commonality. We wanted to distill the issues and share them with our clients and contacts.

Alistair Maughan: Okay. So it sort of feels like, given our shared interest in sport Ed, we probably should have come up with some sporting or cricketing theme for this, but maybe that would just make us a bit too nostalgic in this lockdown situation, but maybe let’s start off with what any good team needs in a batting order, a good strong opener. And I think in our experience, we really start from the perspective of needing—companies need to undertake an examination of their business fundamentals and probably primarily initially at cash flow issues.

Ed Downer: And hopefully I can crack this one to the boundary quite easily. Cash is obviously a critical feature for businesses and cash flow fundamentals being brought into stark focus. Our first tip is to list out some of the fundamentals that finance departments across the globe will be extremely focused on. And they, of course, have a lot of KPIs tied to the recurring points that we mentioned here. The first is monitoring cash in doing so against forecasts. As business forecasts undergo where, you know, an urgent and then somewhat speculative rewrite, those who can keep extremely accurate controls on their use of cash and forecasting it with a degree of rational business interruption assumptions will stand themselves in pretty good stead to identify future challenges and headwinds, as well as to prepare for negotiations with suppliers and finances. So one of the smart things we are seeing is the stress testing of those forecasts, considering especially the speculative nature of them. Preparing contingency plans to address the changes. And those things will be especially helpful for finance departments so that they can better help—better inform business decisions.

Alistair Maughan: So when you’re looking at this, I mean, obviously you are a primarily restructuring lawyer, but you guys in the restructuring team and the, and the finance team, when you look at this sort of situation and when cash flow’s tight, what are the sort of general cash flow best practices that you see businesses looking to follow?

Ed Downer: Cash flow is a matter of cause and effect. There is, in the business community today, widespread recognition and understanding about how the coronavirus pandemic and the associated worldwide lockdowns are having massive and—pardon the pun—contagious impacts on revenue streams across supply chains. So a sensible management of a business’s fixed costs and implementation of other cost-cutting measures will be key to keeping businesses on an even keel. The better these things can be presented to potential sources of cash, be they existing or new credit providers or others, then the better the prospects of obtaining additional cash are. And the last point, which almost goes without saying, is trying to keep debt days as low as possible. This is an impossible dream, some might say, as society struggles through this. And so it’s something that will need to be handled sensitively to the current environment. But the key points remain; good and regular information flows between customers and suppliers. And introducing payment plans—sound like they’re going to be commonplace for the next period. Alistair, in terms specifically of being sensitive to the market that each business operates in, what are the key things we’ve been talking to prudent businesses about?

Alistair Maughan: Yeah, I think as we’ve been sort of, as you indicated, as we’ve been talking to clients over the past few weeks, the most common themes we see are about understanding of the threats and opportunities in the different sectors and industries in which business’s clients operate, trying to understand and mirror market practice, and then attune market practice to business’s, own particular circumstances. Obviously there’s been a very short term focus on prioritization of key areas, and doing so defensively, but also working out what forms of external financial support’s available. And, and I guess we’ll come on to talk about that later on, but we also see, I think companies trying to get insight on how competitors in the industry generally is responding to the COVID-19 situation. Maybe surprisingly as a commercial lawyer, I’ve probably seen better communication up and down the supply chain in better, more stable times. Companies, there’s a sense of we’re all in this together.

Alistair Maughan: And companies are trying to be familiar with the pressures on their customers and suppliers and react accordingly. Basically trying to, I guess, work out if there are ways to support customers and suppliers, which also benefit their own business. So obviously, a lot of the work I do is in the tech sector. That’s the one I know best. And many companies rely for example, on outsourced or offshoring relationships to deliver support or technology needs. And it’s been gratifying, I think, to see how strong levels of collaboration between an outsourced customer and supplier in terms of how they get through this together. While an offshore provider, for example, might be in lockdown, what are they going to do jointly with SLAs, service level agreements? How do they get resources prioritized away from more aspirational type of development projects onto keep the lights on type of work? So, I know there are finance issues and lessons to be learned from experiences of restructuring, but from, from a commercial perspective, I think one of the keys is how to set up a business to strengthen the company’s performance during a challenging market and what approach to take to contracts and supply chain relationship to make all of that happen.

Ed Downer: So there’s certainly going to be a recognition that a business won’t be stronger coming out of this environment than they were coming into it. But what sort of work streams are being undertaken to come out of it in a position of relative strength?

Alistair Maughan: Yeah, probably a lot of the focus has to be on corporate management and the role of the board. And a lot of this is similar to what we see during general times of crisis or specific scenarios, for example, in respect to the data breach situation. And I know there’s lots of stuff on the MoFo website about general crisis management and data breach or leak situations. And there’s probably no point in you or I, Ed, going over what people like our colleagues, David Newman, or Miriam Wugmeister, can say far more eloquently than we can, but obviously boards need to meet frequently during tough times. I think decisions and discussions need to be carefully documented and recorded, and then companies need to work out who’s going to be responsible for making decisions and coordinating the response, and then kind of collapse the hierarchy so that the decision makers are hearing from the experts directly, rather than filtered through layers of management.

Alistair Maughan: Best practice, certainly I think we see being—identifying a clear leader and their supporting team and then makes it, and they communicate internally and externally and to do so very visibly, but probably, as you know, maybe better than me, Ed, directors also have their own personal duties and their legal duties to comply with. So I don’t know if you want to elaborate a bit on whether ’you think we’re seeing evidence of boards knowing how best to react to this situation while still being mindful of their legal duties, or is that still something that companies are having to work their way through?

Ed Downer: No, I think we’ve seen widespread and very close engagement of boards with the coronavirus outbreak and its impact on business interruption, and that’s appropriate. Directors’ duties are always assessed against the standard of prudent business people. And in these unprecedented times, ’it’s become essential for boards to meet much more often than usual And at those meetings, to consider commercial strategy, align it with best practice cash management and such market understanding as you can develop. It all changes so quickly and so differently across geographies. So enhanced communication is fundamental to satisfying that duty to manage businesses properly.

Alistair Maughan: So I guess, what do we see happening? There are scenarios where even prudent stewardship, as you mentioned before, even that isn’t necessarily solving the problem. What, are boards having to do when even that course—sensible prudent course of action, isn’t having the desired effects straight away?

Ed Downer: There are a lot of businesses out there that recognize there’s only so much they can do, and boards recognize that. Liquidity becomes tight. Directors, at that point, need to be mindful that their duties can shift. They shift so that they then need to act with particular concern to the interests of their creditors, in precedence, to the interests of shareholders. There’s also a concern around, and we field lots of questions in the UK, about wrongful trading, which is the personal liability that arises when a company incurs more credit once it is clear that the company’s headed for insolvency., This liability was given particular attention in many countries. In the UK, Australia, and elsewhere, the liability has been suspended. However, the general director’s duties, against which a director’s conduct is assessed, continue to operate. If we switch our focus back, Alistair, to some commercial arrangements, I know we’ve fielded a lot of questions about the impact of coronavirus on contracts in particular, and obviously with freedom of contract in the UK, the U.S., and elsewhere, there are a few limits on what commercial contracts do, but what are some of the specific things businesses can and should be doing around their contracts?

Alistair Maughan: Well, clearly, as far as key commercial contracts are concerned, I think almost every business is expecting and trying to plan as much as they can for disruption in their supply chains. And as that happens, it’s probably inevitable there’s going to be greater potential for contract cancellations and contract disputes. And, we’ll come and talk about that in a few minutes’ time. I think the first task that I’m seeing from a commercial and contractual perspective probably is companies identifying the main service and supply lines that might be affected or that they might need to rely on even more in a time of crisis. So we think about who in any given organization knows what the key service and supply arrangements might be, and then work out who’s assessing whether and how those might be affected. And then also, are the key commercial drivers under those contracts affected or not, or how are they affected?

Alistair Maughan: So if performance starts to become affected, which contracts do you need to prioritize? And then, of course, those questions apply equally across both customer and supply relationships. So you need to think both upstream and downstream to understand how you’re going to be affected, depending on where you fit in the overall supply chain. Generally, I would always begin by reviewing contracts to understand the key risks and options. And obviously, the starting point needs to be the actual text of the key business agreements. You mentioned, when you handed it over to me last time around, it comes down to freedom of contract. Certainly, that’s the common law experience of making certain that you understand what the agreement actually requires. Sometimes you even got a prior questions of that of can you find the contracts? Do you know where they are? And that even that challenge may leave some businesses wanting, but assuming that you can find the contract and you can assess it.I typically think about things, whether the contract requires that a business continuity plan or resilience plan exists, figure out if it does actually exist, and how current is it? Has it ever been tested? And then what does it require you to do? And what does it require your contract counterparty to do? And then probably, before I hand back to you, maybe’, I’d say it’s always worthwhile checking the text of each key agreement to determine what the contractual rights and obligations are, especially focus at clauses that are either covenants or repeating representations that might go into default, or obligations or clauses, which might oppose obligations or relief from events of default, obviously, force majeure possibly being one of the key one of those from a commercial perspective.

Ed Downer: What are you seeing about that great lawyer’s catchall, material adverse change?

Alistair Maughan: It can mean anything to anyone, material adverse changes, I suppose. But obviously some contracts do contain the clause that you mentioned, providing for termination or suspension in the event of a material adverse change or MAC, as we tend to call it. And these MAC clauses are designed as a kind of sweep up to cover termination events or events of default that are not expressly included in the agreement. I know it sometimes surprises you and your other colleagues in the finance and restructuring sectors how few commercial contracts contain a MAC clause. Force majeure is really the fail safe that we tend to see. MAC clauses are kind of the same concept, but are more often creatures of financing agreements. Regardless of the reasons why it may be in an agreement, typically the interpretation depends on the scope or the looseness of the drafting of the MAC clause.

Alistair Maughan: There’s often a degree of uncertainty, I guess, as to whether the clause has been properly triggered, and that can sometimes leave the enforcing party in the unfavorable situation of having breached the contract itself if it’s later found that the conditions for a MAC haven’t been met, but what we do know about the interpretation of a MAC clause, the interpretation is really specific to the facts of each situation and the wording of each clause. There are certainly court decisions that make it clear that, well, three things really. First, a change is only going to be material in the context of a material adverse change clause if it affects a company’s ability to perform its obligations on the relevant agreement. Second, a party can’t trigger a MAC clause in respective circumstances of which it was aware at the outset. And thirdly, to be material a change mustn’t be merely temporary. It must be of a more permanent nature. So holding up any given set of circumstances at any given clause against those three tests will give you an idea of where you sit in terms of your contractual obligations or potentially relief from contractual obligations.

Ed Downer: Sounds like there’s certainly some scope there for argument by the way. When we do see potential breaches of contract, what are businesses able to do to navigate around those?

Alistair Maughan: I might turn that back to you in a minute to think about the finance documents, but my main suggestion, I think from a commercial perspective, is that if a breach could arise, you need to evaluate the options open to you to avoid or limit the impact. Obviously, commercially, you want to try to comply with the contract requirements as best you possibly can, while at the same time, protecting the company’s position. If that’s not possible—so if there’s a slight two-headed nature to the way a company needs to operate in that particular situation, is that split approach consistent to what you see from a finance or restructuring perspective?

Ed Downer: Well, in finance documents, the main focus is around the future breach of financial maintenance covenants. And the covenants are built into finance documents to provide lenders with the early warning signs, usually in advance of a payment default, that all’s not well with the financial health of the business. So in particular, we field inquiries about what can, and cannot, be included within the calculation of EBITDA and consolidated net income, and the potential impact of a breach of financial maintenance covenants tripping calculations based on EBITDA and CNI, can have significant cross-default consequences. What we’ve not yet seen, but we could see come quite soon is a wave of preemptive waivers that can be sought by an organized and well prepared borrower. That’s certainly on the table for a number of borrowers who can see the potential of all event of default down the line. I wonder, is there something similar that arises under commercial contracts?

Alistair Maughan: Yeah, that’s probably the same. I’d say we haven’t seen a wave of actual claims yet or resorting to law, but there’s usually a time lag in these sorts of situations. As I kind of mentioned before, a lot of companies don’t have a lot of alternative options in many cases, so they kind of just have to plow on regardless, although, hopefully, keeping clear records and preserving their contractual rights. I think that’s kind of the situation that most people feel as if they’re in at the moment.

Ed Downer: So when, when the proverbial iceberg appears dead ahead in the form of a breach of contract?

Alistair Maughan: Yeah. Kind of as I mentioned a few moments ago, take a closer look at the contract, especially the MAC clause or force majeure provision, certainly under any common law jurisdiction, the analysis is typically heavily driven by the specific language of the clause. And is the drafting wide enough to cover a coronavirus type situation or an economic situation triggered by coronavirus? So generally, I think if an unforeseeable event occurs like this public health crisis, parties to a contract may be partially or completely exempt from performance, but you need to remember that the situation usually requires objective assessment and clearly following official government guidance is much more likely to protect you contractually, than simply acting out of extreme prudence. Which is why companies are looking around to make certain they understand what the government guidance is and what market practice is.

Alistair Maughan: And I think it’s also possible that some duties could conflict with each other. So for example, a company may want to protect its employees by shutting down production early, just out of prudence and care for the health and safety of their employees. But if that’s a more aggressive approach than what might be deemed reasonable, you might not be excused under key commercial contracts with customers or raw material suppliers. So I think, things to think about in looking at MAC or force majeure clause, include, how broad or narrow is it, does it use generalized broad language like event beyond the control of the parties, or does it spell out specific kinds of force majeure event? And then usually a MAC or force majeure provision will turn on issues around foreseeability or the degree to which the pandemic makes performance impossible. And it’s a bit hard to talk about that in abstract, but generally, I think the key point is really that just because performance is more expensive or burdensome, it doesn’t necessarily mean it will be excused, even under a force majeure clause.

Alistair Maughan: On the other hand, absolute impossibility may not be required. So you need to think in each situation where the party’s inability to perform, because of this pandemic situation, falls in that spectrum. And I think there’s two or three other key things that I always ask around a MAC or force majeure clause. Number one, usually it means that performance is excused, but not always. So some contracts say that force majeure only after a business continuity plan has run its course, for example. Second, some contracts might say that if the other party has to make other arrangements because of your inability to perform, then they’re entitled to be reimbursed the cost difference. So that’s clearly something to be aware of, or even thirdly, and, and worst case, I guess, could a protracted force majeure situation turn into a right to terminate. So I think, watching out for that risk and considering carefully, whether you want to invoke the force majeure provision or take steps to prevent someone else terminating a contract that you want to continue. Those are three key things to look out for ’when you’re examining what your contract says.

Ed Downer: So there’s certainly a few areas here, not just the specific issues in finance documents around EBITDA, CNI, and MAC clauses, but certainly some broader issues, particularly foreseeable in relation to force majeure contracts that are going to give rise to potential disputes.

Alistair Maughan: Yeah. And I think I, I’d be looking out for grace periods, thinking about counter measures, thinking about an open dialogue with key contractual counterparties that still protects your rights and remedies, and then understanding what the notice periods are, or the contractual requirements for dealing with potential defaults. But maybe we can switch back from, kind of commercial contracts, to more finance side, and think about, how we referred earlier on to financial support that’s available for businesses in the current situation. Maybe I can turn it back to you to talk about what are people—businesses doing to access existing credit that might be available to them?

Ed Downer: Well, in general terms, existing credit facilities and drawing on those is the first port of call and that’s been well publicized. Many medium and larger businesses will have availability under working capital facilities if they’re revolving credit or some other asset-based lending facility. A lot of businesses have had these things in place, but not been using them. So drawing down on those is certainly the easiest and ’it’s helpful, but a few things to bear in mind, especially if these facilities haven’t been drawn in a while. Firstly, repeating representation when you draw a facility and at the end of interest periods, there are series of representations that are repeated. So businesses need to be mindful of those. The main reps that we’re sort of fielding questions about are continuity of business operations and financial maintenance covenants. It’s also important for some facilities to bear in mind that they spring in covenants, which kick in when a facility is drawn above a certain level.

Alistair Maughan: And if that’s not enough, how easy is it in the current environment to get new third party debt into structures?

Ed Downer: Well, perhaps fortuitously, the last six or seven years have seen, certainly private equity backed businesses import great flexibility into finance documents. So what were historically tight restrictions on incurrence of further debt have been replaced with a much more permissive regime. So permitted debt baskets today are looser than they have been. And that flexibility may allow borrowers to borrow on super senior basis above existing debt in the structure, or otherwise to get debt in equal or pari passu with existing debt. There may also be permissions to incur debt against otherwise unencumbered assets.

Alistair Maughan: Okay. So, but I guess that depends on flexibility being in the finance documents. What if it just isn’t there? What are we seeing around how borrowers can incur the necessary additional credit at the moment?

Ed Downer: Whether you can, or cannot obviously, the additional debt needs to be marketable. So debt ranking and collateral will have the most significant bearing on not just pricing, but whether there’s any appetite at all for banks or alternative capital providers to lend. It may be the case that existing lenders aren’t prepared to fund further amounts or third parties can’t come into a structure unless, as you allude to, changes are made. And so borrowers need to explore, and their owners will want them to explore, a raft of ways to make changes. And we spend a lot of time, especially in restructuring capital structures, looking at the softer ways we can do these things, including through simple waivers, extensions of maturity of debt, as well as, to wholesale changes of debt ranking, reduction of principle, and capitalizing cash interest payments.

Alistair Maughan: I feel a bit like the harbinger of doom, but I’ve got the same question as before. That’s great, but what if that fails, what’s kind of the next step down after that?

Ed Downer: Well, that’s certainly where we open the restructuring and insolvency toolbox. In the UK, we can move assets into new structures using prepackaged administrations. Lenders are able, in certain circumstances, to force the issue by enforcing security. Administrators have rights to obtain funding to trade during administration. And that’s without regard to those unsecured debt incurrence restrictions. And there are always other jurisdictions to consider. In particular, one area we give a lot of advice on is the potential use of the U.S. Chapter 11 proceeding where a very healthy market exists for providing debtor-in-possession financing. They’re the main market mechanisms, I suppose we’ve seen, but Alistair, we’ve seen governments in the UK and elsewhere stepping in to provide a lot of relief.

Alistair Maughan: Yeah. In the UK, almost feels recently as if new measures have been announced here in the UK, almost on a weekly basis now. But I’m certainly aware because my, you know, our colleagues are doing some work to pull together the stimulus measures that lots of main, lots of large jurisdictions are offering, but follow a similar path, but with differences between them. So certainly, a lot of these businesses that have multi-country operations need to be looking at the stimulus support by relevant governments. In the UK, the main operational support, I guess, has been the form of the job retention scheme for government funding of workers who are put on furlough during the impact of coronavirus on business. In the UK, that’s capped 80% of the employee’s pay, capped at two and a half thousand pounds per month. If you ally that to business rates holidays, and local authority grants, as well as, revenue relief in the form of statutory sick pay and general time to pay relief, that’s kind of one raft of measures. And then there’s probably, other things on top of that, from a more, slightly more macro perspective.

Ed Downer: Well, we’ve got the cash that businesses can access. So depending on the size of a business, there’s a smaller business loan scheme where loans up to 5 million pounds are available, which are 80% guaranteed by the government. They’re available to businesses with a revenue less than 45 million pounds where annual revenue is between 45 and 5 hundred million pounds, that loan limit increases from 5 million to 25 million pounds. And so this scheme is being made in fact, direct to businesses through commercial banks, each of whom must be satisfied of certain credit criteria. There’s a further funding source in the market for investment grade borrowers, and that status is assessed against their pre-coronavirus financial position. And those investment grade borrowers need to make a material contribution to the UK economy. For those businesses, the government is providing funding for them through the underwriting of commercial paper at attractive pricing.

Alistair Maughan: I know we’re coming up on time, so we better probably wrap this up, but it’s sort of nice to finish on a somewhat positive point of the opportunities that are out there for stimuli—economic stimulus and business support. And in many ways what’s been out there means there’s maybe a little something for everyone, I suppose.

Ed Downer: It is a tremendously expansive package in the UK. It’s got equivalents across the globe. There are huge packages available for certain borrowers in the U.S., Germany, and most other major jurisdictions where we and our clients operate. But in the UK in particular, there is a bit of a hole, and some significant businesses which were sub-investment grade pre‑coronavirus. they might not be able to access government support for future funding. That has already been a subject of a significant amount of lobbying. And I think, we’d all expect that to continue in earnest as  we work our way through this crisis.

Alistair Maughan: Yeah. Okay. Well look, we probably should wrap it up there because I think we’re at the promised time. So, thanks to you for doing this. It’s for it been an interesting experience, both of us speaking into the ether from our individual lockdown situations, but thanks to anyone who’s listened to it and the MoFo team for pulling it together. And maybe, Jo, will hand back to you to close this off.

Jo Mhari Witham: Yeah. Thank you, Alistair. Thank you, Ed. This is the end of our episode on “Tips for Companies Operating in the Current Environment.” Once again, I’m your host, Jo Mhari Witham, speaking with Alistair Maughan and Ed Downer. Thank you so very much for joining us.

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