Disposal Of Assets To Discharge Debt Ahead Of Enforcement By Receivership

• Published date: 29 July 2020
• Subject Matter: Finance and Banking, Corporate/Commercial Law, Coronavirus (COVID-19), Debt Capital Markets, Financial Services, Corporate and Company Law, Directors and Officers, Contracts and Commercial Law, Financing, Operational Impacts and Strategy
• Law Firm: Cadwalader, Wickersham & Taft LLP
• Author: Mr Duncan Hubbard and Livia Li

As COVID-19 lockdowns are sustained and business activity deteriorates, loans secured against properties which are reliant on certain business activities will be affected, both from loan covenants and ultimately value perspective. In particular, COVID-19 could exacerbate valuations for sectors that were already seeing signs of distress, such as the retail sector.

Where the income streams are under pressure (due to non-payment of rent or rent reductions otherwise) this may ultimately affect debt service. Where debt service gets close to a critical 1:1 ratio, then risk parameters and strategies are likely to change - negotiations will focus around the viability of deferred amortisation or, in the case where only interest is payable, requesting lenders to consider capitalising interest in the loan and restructuring the facility. At this point in time, it would be prudent for both lender and borrower to consider exit strategies such as disposing the asset.

Understanding and reviewing your security structure

It is important to understand the security around the asset and also the corporate structure, as this would determine how the disposal should be structured. A typical security package for vanilla real estate loans should cover:

(i) mortgage over the property;

(ii) debenture over all assets of the borrower and each guarantor/operating company;

(iii) fixed charge over all receivables and key contracts; and

(iv) most of the time, security over the shares of the borrower/obligor group and any intragroup debts along with full subordination of any such intragroup debt and restrictions around any equity payment (dividends or repayment of subordinated debt).

A security package such as the one set out above is structured in such a way to ensure that on enforcement, sale of the underlying assets as a whole package (i.e., the asset is sold along with the structure which would ensure that any disruptions to the income streams and third-party arrangements are kept to a minimum) can be achieved and therefore maximise value. In addition, any intragroup liabilities or any sponsor debt which are subordinated should be severed so that the package can be sold free of such liabilities to the new purchaser.

Lenders will need to think carefully about their position and have strategies in place if the event of default might warrant enforcement action; it will be prudent for the lender to conduct security reviews of the existing security package to ensure the security taken...