With a potential recession on the horizon, many business owners and individuals will be wondering what steps, if any, they can take to manage costs going forward. Bhavini Kalaria Partner, Litigation and John O Donovan, Partner, Banking & Finance at Harold Benjamin Solicitors report.
One of the most significant obligations may come in the form of mortgage, facility and secured loan agreements – in other words, agreements which tie a borrower to a lender, often with serious consequences on default because of security (which could be in the form of property, assets or some other type of valuable thing).
What can borrowers do in the face of a recession to re-negotiate terms which might otherwise be unfavourable now; is it possible and what are the possible consequences of taking such steps?
First and foremost, it should be noted that contractual agreements under English law can be terminated in only a handful of ways – normally arising out of a breach of the contract, or because of some unforeseen circumstances, leading to an argument that the agreement itself has been frustrated by events. Think back to the covid-19 crisis, which resulted in many parties seeking re-negotiated terms of various agreements ranging from loan agreements to leases. In those circumstances it was suggested that parties should treat each other fairly. However, these suggestions did not change the law as such; instead, best practice and guidance to help manage a completely foreign situation helped facilitate commercial resolution, to everyone’s benefit.
Where recession is concerned, it would be highly unlikely that this would be seen as meriting the same arguments as those which arose out of a pandemic. Instead, it would be advisable for parties, where there are concerns about the costliness of a contract to explore alternatives to termination. Practical, commercial solutions which don’t result in on-going litigation or a breakdown of relations, would be a sensible approach. Alternative approaches could include negotiating a variation of the agreement to reflect changed circumstances, perhaps pre-empted by a threat of termination to help facilitate a re-negotiation or use of a dispute resolution procedures. Questions which might arise will include whether new security can be offered, what the nature of the amendments are and whether the amendment will affect other borrowers/security.
This can also be in the lender and/or landlord’s best interest to re-negotiate and agree a commercial solution. For example, a lender would much rather have a performing loan on revised commercially acceptable terms rather than having to work through a default scenario and the knock-on effects that will have. Both from an enforcement and capital holding perspective. Similarly, landlords will always try to avoid having vacant properties, particularly when it is extrapolated across extensive portfolios which are funded by debt that needs to be serviced.
Aside from re-negotiation, a final alternative would be to simply walk away and take the commercial consequences. This is a high-risk scenario but would force settlement or giving up of security. There are financial and reputational risks associated with such an approach, but where the costs seem to outweigh the benefits, there could be a commercial argument for such a course of action.
However before embarking on such a final course of action the full range of consequences should be considered. For individuals this could lead to county court judgements, bankruptcy proceedings and a negative impact on their future credit scores. Whilst for corporate borrowers, particularly those in group structures this could inadvertently cause other banking covenants to be breached and have a far broader impact than originally intended.
The reality of a negotiated loan agreement under English law is that the four corners of the contract will be considered in the first instance, any termination will arise out of a breach of terms, or under any provisions of the agreement. Where there is room for negotiation, this will be determined by the terms of the agreement or forced because of circumstances.
In any event the room for negotiation will be predicated by the relationship, and previous conduct between the parties. Therefore, those with a longstanding successful relationship may find it easier to reach a deal. If the school of thought is that recessions are cyclical, then they will also want to do business going forward. Thus, even if there isn’t an established relationship there should hopefully be enough motivation for all parties to reach agreement.
In all cases, it is very important to take legal advice first to understand properly the commercial consequences of the steps you intend to take.