The numbers alone are enough to cause a fever. For the hospitality industry, COVID-19’s symptoms include single-digit to zero occupancy rates, plummeting revpar and forced closures, and many businesses in the industry will struggle to survive.
Early sentiment that successful containment of the virus and a swift bounce in business performance is giving way to fear of a protracted period of disruption and a slow hard recovery.
Brown Rudnick has re-mobilised its resources to be on top of the challenges facing the industry and track the government responses. Our corporate, finance and restructuring teams are closely co-ordinating to advise clients in real time on how best to react to the current environment. These are our suggestions so far.
Borrowers should be re-familiarising themselves with their financing documents, particularly the financial covenants provisions. Financial covenants are generally used as an early warning indicator that the financial health of a borrower is slowing or failing. Although the trend in recent years in the US & Europe are ‘covenant-lite’ facilities, the impact of COVID-19 has led to such significant trading challenges with an almost overnight reduction in revenue meaning that financial covenants may well already have been breached.
In the context of reviewing financial covenants, a borrower should consider: whether the covenants are calculated and tested on historic performance or if there is also a forward looking element; how much head room has been built in to the covenants and whether any add-backs are available which could be used to limit the impact of decreased net income; and whether there are any cure rights available which obligors may be in a position to exercise.
Borrowers should also be wary of material adverse change (“MAC”) clauses in finance documents, giving lenders further leverage to negotiate in a distressed situation - further discussed in our alert on force majeure, frustration and MAC clauses.
Early engagement with lenders is key and if lenders have not yet been in contact, it is never too early to be picking up the phone to the relationship manager and updating them on where things stand and what options are available. These options may include a financial covenant holiday, waiver of a financial covenant breach or amending the financial covenant provisions. In any amendments to the financing documents, it will be necessary to strike the right balance between agreeing amendments which will provide lenders with the comfort that they may require in these turbulent times as against tightening terms to such extent that borrowers find themselves unable to effectively manage their business.
There is good news. Most lenders will be willing to entertain discussions to deal with the emergency and unforeseen disruption. Enforcing is a pain for lenders at the best of times, and more so in a disrupted market (if we learnt anything in the last financial crisis), and where there are large numbers of potential defaults lenders will be grateful for borrowers showing initiative and realistic survival plans. The drops in interests rates will also help with debt pegged to official rates.
In the UK, certain SME borrowers may also consider asking their lender about availability of the Government’s new guaranteed loan schemes, with the Coronavirus Business Interruption Loans Scheme providing up to £5m of government guaranteed loans for enterprises with a turnover of £45m or less - refer to Brown Rudnick’s alert on this topic for more details - and the newly announced Coronavirus Large Business Interruption Loan Scheme, providing loans of up to £25m to companies with a turnover of £45m to £500m. Be wary that despite the UK Government guarantee, borrowers are still liable for the full amount borrowed and will still need to present a credible borrowing proposal.
Plans and proposals need to be realistic, or at least have reasonable assumptions about how the situation will play out. The shock is a minefield for company directors, who need to consider their duties carefully and avoid potential personal liability in the event that trading continues in an irreparably insolvent position.
The UK Government may be softening the position on wrongful trading and introducing a moratorium for companies while they seek a rescue or restructuring on insolvency procedures, but there is very little detail on these proposed changes and until more is known it is business as usual for directors who should be making decisions , on a reasonable basis, to ensure so far as possible that the company’s stakeholders, most notably the creditors, get the best return possible as we begin to emerge out of this crisis. We recommend boards seek advice sooner rather than later and don’t allow the breathing space provided by Government action or commercial lenders to give a false sense of security.
Otherwise to weather the storm, cash is king. Wages cover from the Coronavirus Job Retention Scheme and support for the self-employed from the Government will help support a decimated workforce. Business rates relief is available for the hospitality industry in England. Capital expenditure plans will be put on hold (albeit one idea touted in the market, at least until the lockdown made it impractical, is to use the drop in occupancy rates to push forward with major refurbishment plans). As in other countries, some hotels are in the short-term be re-purposed to support key workers or otherwise help in the effort to control the virus. Following the example in China, F&B parts of hotels may be able to link up with delivery services to keep that part of the business operational.
If a hotel owner can’t (or doesn’t want to) agree a restructuring to something more manageable, perhaps they can find someone who can. There has for some time now been an active, competitive market in hotels as an asset class. Despite some positive long-term trends flattening out recently, there’s still plenty of money and new ideas, with enough of a long term view, to provide some liquidity (this is, for now, one contrast between the current situation and the global financial crisis of 2008-2010, where practically all capital dried up). At this stage, the fog of war still needs to clear sufficiently for the outlook and the opportunities to become clearer, but when that happens, there’s money waiting in the wings.
So among all the distress, there are still deals to be done. China is currently the bell weather for the spread of the virus and industry hit, and can also provide clues as to how the recovery will play out – so far there are some indications of a bounce there led by growing demand in the domestic market. Perhaps the more bullish will find good buying opportunities in distressed assets in advance of a bounce, or the bears will be exiting at the right moment at the start of a long dark night for the industry. Time will tell.
We at Brown Rudnick wish everyone the best of health and the strength to face the many challenges at home and at work that these difficult times bring. In the meantime, we are open for business and here to help.
The views expressed herein are solely the views of the authors and do not represent the views of Brown Rudnick LLP, those parties represented by the authors, or those parties represented by Brown Rudnick LLP. Specific legal advice depends on the facts of each situation and may vary from situation to situation. Information contained in this article is not intended to constitute legal advice by the authors or the lawyers at Brown Rudnick LLP, and it does not establish a lawyer-client relationship.
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