Skip to Content

FAQ: How Will COVID-19 and its Economic Impact Affect Businesses, Lenders, and Other Creditors?

Publications - Client Alert | March 16, 2020
Coronavirus, COVID-19, and its fallout are threatening the United States economy and markets around the world.

Supply chains risk significant disruption, and travel and other service-based industries are experiencing reduced demand and losing revenue. Recent market losses also threaten confidence and demand in the economy. These issues will likely threaten companies across multiple industries, including retail, travel and hospitality, healthcare, insurance, automotive, energy, real estate, construction, and shipping and logistics.

As everyone’s health remains our top concern, below are FAQs for businesses and their lenders as we begin to work through what could become challenging economic conditions. What steps should businesses immediately take to protect themselves from disruption?

  • Preserve cash. Now is not the time to pursue large capital expenditures.
  • Put together short- and long-term budgets. Having both short-term and long-term budgets is always a good idea to help prioritize sources of revenue and expenses. This is especially critical heading into an economic downturn. Look at what equipment and other assets you really need to run the business and make appropriate adjustments.
  • Look at your loan documents and covenants and work preemptively to deal with any concerns that may be raised by your lender.
  • Look at current staffing. While reducing staff is often a difficult and emotional decision, especially in this health crisis, companies should review their staffing needs and determine whether any adjustments can be made.
  • Review customer credit terms and accounts receivable. To service customers effectively, you need to know which customers you can count on, which ones you may be able to assist, and which ones will be unable to pay. Work to reduce the risk for both you and those customers.
What should lenders and borrowers do if they are concerned about borrower cash flow and ability to continue making loan payments in the coming weeks and months?

While no one size fits all, lenders and borrowers should be proactive, communicate early, and get ahead of potential covenant and payment defaults. Every lender is different, so a general characterization of how to respond is not possible. But under current conditions parties should work through issues early rather than allow conditions to deteriorate with no communication. Lenders often have other banking relationships with their borrowers, and having a wholistic understanding of where their borrowers stand may allow lenders to react quickly to address cash flow and other financial issues that their borrowers may be experiencing. Working together will help lenders and borrowers weather the storm.

What should lenders do in preparation for impacts from the global pandemic?

Triage and communication are key. Just like people, the most vulnerable borrowers will be those most severely impacted by the COVID-19 outbreak, including those already in workout, under forbearance or in default. This most-distressed subcategory should be addressed first. Then, lenders can focus on particularly impacted industries like tourism, hospitality, etc. Lastly, it will be time to evaluate the “healthy.” Because of the quick shift from bull to bear markets, lenders will need to be internally nimble, moving resources into special assets and workout departments to handle the triage and ultimate “treatment” of those customers impacted by the outbreak. In all instances, open and honest communication, both internally and with the customer, is the number one priority. Lenders need to understand the impact COVID-19 on their customer, work with the customer to estimate the financial implications of the impact and, if possible, work in tandem to formulate a plan moving forward. One of the bright spots of this downturn is the relative health of our major financial institutions and the abundance of liquidity in the debt market. With triage and proper communication, lenders can make sober assessments of their portfolios and work with their internal team members and customers to blunt the inevitable impact in the short and long terms.

What impact will economic changes have on commercial tenants?

Like the lender-borrower relationship, the landlord-tenant relationship will likely be impacted by economic distress in the wake of the virus. The extent of this impact is not yet known. Nevertheless, landlords and tenants should communicate early and frequently. Landlords and tenants will need to consider whether to close facilities and, if so, for how long. These closures will doubtlessly trigger lease obligations, and landlords and tenants should work together to avoid litigation over their decisions. For example, while leases generally provide for the tenant’s quiet enjoyment of the premises, some leases may give landlords the ability to close a facility temporarily in the event of an emergency. Meanwhile leases may also require a tenant to remain in continuous operation of the premises. As closures ensue, both landlords and tenants risk cash flow disturbances and, potentially, economic viability. Collaboration will mitigate the risk of litigation and economic failure.

What impact will supply chain disruptions and a reduced labor force have on businesses?

The total impact of supply chain disruptions and a reduced labor force are difficult to predict at this point. They will, however, likely lead to delays, lost opportunities and revenue, and significant disruption to business operations. A cascading effect may result. To mitigate the impact of this disruption, communicate frequently with customers and manage expectations. As conditions change rapidly, solutions may be made available by governmental authorities and others to mitigate the negative impact of these disruptions. But until that happens, businesses should do what they can in their own power to protect themselves, as outlined above.

Does the inability to comply with the terms of a contract due to COVID-19 virus excuse performance under a force majeure clause?

Every contract has different terms, and each contract must be analyzed separately to determine if performance may be excused on the basis of the COVID-19 virus. The specific types of events under a force majeure clause that may trigger non-performance may very well be covered in these situations, but analysis of the specific provisions is needed. As events quickly develop, including declarations of emergency, travel bans, and forced shutdowns and closures, force majeure provisions will more likely be triggered. If triggering force majeure provisions is widespread, companies may experience significant revenue disruption, and litigation will likely ensue.

Will the outbreak of COVID-19 cause bankruptcies?
Unfortunately, yes. Because bankruptcy is usually a lagging indicator (it comes after, not before or during the precipitating event), when the bankruptcies will come and what they will look like are unknown. As a preliminary matter, healthcare costs are one of the most significant causes of personal bankruptcies. Any increase in per capita healthcare costs is going to drive up individual chapter 7 and chapter 13 bankruptcy numbers. Unfortunately, a significant number of Americans do not have the excess income or savings available to address a medical crisis. With regard to businesses, undercapitalized companies in industries directly impacted by “social-distancing” mitigation protocols—tourism, airlines, hospitality, retail, gaming, etc.—will be the most likely candidates for financial restructuring in the short term. Other industries could follow. However, at this point, with the spread of the virus in the U.S. in its early stages, containment and mitigation strategies underway and limited guidance on potential relief from (or back-stopped by) the government, it is simply too soon to make predictions.
Are bankruptcy courts still open and what will happen to pending chapter 11 bankruptcy cases?

As of now, the bankruptcy courts are still open; however, the courts are on alert. Many bankruptcy courts have issued notices to attorneys asking them to notify the court if they or their clients have experienced any symptoms of COVID-19 or have been exposed to anyone who may have COVID-19 so the court can reschedule hearings. Bankruptcy courts are allowing for more telephonic appearances and expanding video hearings to avoid larger gatherings of people. Because of the widespread adoption of telephonic and video appearances, we expect the bankruptcy courts to be able to continue operations, at some level, even if courthouses are closed. That said, parties-in-interest in bankruptcy cases should consider expected or potential relief that will be sought from the court over the next few weeks and start making contingency plans by filing motions early, seeking expedited relief or making contact with the clerk’s office and the Office of the U.S. Trustee to discuss alternatives for emergency relief in the event of court closures.

Download FAQ: How Will COVID-19 and its Economic Impact Affect Businesses, Lenders, and Other Creditors?