Borrowers examine Ebitda definitions in credit agreements as coronavirus spreads

NEW YORK, March 17 (LPC) - As the fast-spreading coronavirus shuts down operations across the globe, companies are examining their loan agreements seeking any potential relief to stave off a default as they prepare for what could be a steep drop in earnings.

Companies including golf equipment manufacturer Callaway Golf and toy maker Hasbro have warned investors that the virus, which the World Health Organization (WHO) in late January declared a ‘public health emergency of international concern,’ could hurt their earnings.

Some borrowers are now looking to see if they would be permitted under their credit agreement to make adjustments to their earnings before interest, taxes, depreciation and amortization (Ebitda) based on virus-related losses.

More than 190,000 people globally have been infected with over 7,800 deaths as of March 17, according to data compiled by the Johns Hopkins Center for Systems Science and Engineering. To prevent a wider contagion, businesses around the world, including Apple, Under Armour and Nike, have announced plans to shut retail stores.

As a result of supply chain disruptions, which have impacted manufacturing operations and reduced consumer demand, a significant number of businesses will probably experience lower earnings, at least in the near term, Shearman & Sterling lawyers wrote in a March 11 report. Amid declining revenues, borrowers could face difficulties complying with financial covenants in their debt documents and in possibly servicing their debt.

With little clarity for when businesses might reopen and facing downgrades due to interruptions in operations, companies are looking to see if there is a way within their loan documents to offset losses to boost Ebitda, which could help avoid a potential default.

There has been a focus on credit agreement language on Ebitda addbacks – with borrowers asking for a coronavirus cost addback in new deal documents, according to Jake Mincemoyer, head of law firm White & Case’s Americas banking unit.

There have also been discussions about whether cost implications arising from the coronavirus would fit within the definition of an existing addback such as the “extraordinary, unusual, or non-recurring charges” clause, he said.

The majority of US leveraged loans lack a full set of lender protections, known as covenants. If companies are forced to draw on their revolving lines of credit for liquidity, they could trigger springing maintenance tests that rely on a measure of Ebitda, which could be negatively impacted by the coronavirus.

Research firm Covenant Review said in a March 6 report that borrowers might be able to make an argument that charges related to a pandemic could be characterized as “extraordinary, unusual or non-recurring.” Thus, virus-related charges could be added back to Ebitda.

But decreased earnings and access to liquidity are not just issues that will affect business’ first three months of 2020; companies need to be prepared to address the problems over an extended period.

Depending on how long this virus lasts, there are leverage ratio tests for maintenance covenants or incurrence covenants based on Ebitda, according to Michael Chernick, a partner in the finance group at law firm Shearman & Sterling.

“This is something that borrowers are going to have to think about for the next year in terms of navigating through their credit agreements,” he said. (Reporting by Kristen Haunss; Editing by Michelle Sierra)