IMPLICATIONS FOR CREDIT AGREEMENTS AFTER THE RUSSIAN INVASION OF UKRAINE
Following the recent Russian invasion of Ukraine, many countries, including the United States, the United Kingdom and member states of the European Union, have imposed a coordinated series of sanctions unprecedented in scope and scale against various Russian and Belarusian businesses, banks and individuals.1 In addition, many global businesses have ceased or suspended their operations in Russia and Belarus entirely. These actions have already had, and will continue to have, far reaching impacts on global financial systems as well as on companies that have operations, or that have significant business relationships with other businesses, in the affected jurisdictions.
In light of these ever-changing developments, a borrower and its lenders should understand the impact of recent events on such borrower’s business and applicable provisions (e.g., representations and warranties, covenants and events of default) in its loan documentation. In addition, for borrowers and lenders seeking to enter into new credit facilities, there could be significant transactional impacts for such financing depending on the ownership, management and operations of the business of the potential borrower. At a minimum, lenders will likely require enhanced due diligence reviews on corporate ownership and organizational structure, key business relationships, the status of executives and directors as well as assessing the impact of the conflict and related sanctions regimes on the operations and financial condition of the borrowing entity and its subsidiaries.
Given the constantly evolving conflict, commercial teams should work closely with counsel to assess sanctions issues under existing credit facilities and in structuring and documenting new facilities.
Considerations for Existing Credit Agreements
Borrowers and lenders need to consider multiple issues under their loan documents, given the ongoing uncertainty surrounding the economic impact of the conflict in Ukraine and the related sanctions programs imposed on various businesses and individuals. A priority will be identifying facilities for which the borrower or its subsidiaries have connections to Russia, Belarus or Ukraine, or with substantial ties to any sanctioned individual or business. Relevant provisions of existing loan documents should be reviewed to ensure that a borrower can continue to make any necessary representations and warranties to obtain future extensions of credit and that such borrower will be in compliance with its ongoing obligations. For lenders, a review may reveal deficiencies with key terms themselves. In some cases, definitions may not be sufficiently “future proof” to encompass countries or territories that later become subject to sanctions. In addition, depending on the duration of the conflict and the scope and breadth of sanctions enacted by various governments, borrowers and lenders may need to evaluate the longer-term effects on the financial condition and results of operations on the borrower and its business, including its ability to comply with its financial covenants (if any) and meet its liquidity needs. Relevant language in credit agreements will vary on these matters, but a review should focus on:
- Representations and Warranties: Review representations relating to compliance with laws, compliance with sanctions and related regulatory representations and use of proceeds. Certain of these representations may be qualified by “materiality” and “material adverse effect” qualifications which may provide a borrower comfort on its ability to continue to make such representations and warranties on an ongoing basis. In addition, for borrowers that have material operations, or critical business relationships with counterparties located, in Russia, Belarus or Ukraine for which there could be a significant decline in the operational results of such business a borrower may also need to consider whether it could make its material adverse effect representation. What constitutes a “material adverse effect” is highly contextual, but magnitude (such as a very large reduction in EBITDA and revenue) and duration will be significant considerations.
- Affirmative and Negative Covenants: Review covenants relating to compliance with laws, compliance with sanctions compliance provisions, and use of proceeds not in violation of any applicable sanctions laws. As described above, certain of these covenants may be subject to materiality and material adverse effect qualifications, so parties should carefully review their loan documentation to confirm the scope of such provisions. In particular, borrowers when reviewing sanctions provisions in their existing credit agreements for compliance with the above may need to take various mitigation actions—for example to relocate operations or dispose of assets in affected jurisdictions (which would then require careful analysis of the relevant dispositions covenants and prepayment requirements in a typical credit agreement), to revise their policies to match new regulatory rules on their business or to cease all business dealings in a jurisdiction—all of which are likely to be governed in some manner by a borrower’s existing credit agreement.
- Financial Definitions and Financial Covenants: The financial performance of companies with material operations in Russia, Belarus or Ukraine (or that have significant commercial relationships with suppliers and customers located in such jurisdictions) may, depending on the duration and escalation of the ongoing conflict, be affected significantly. Borrowers and lenders should review the levels of any financial covenants and the related financial definitions (such as “consolidated net income” and “EBITDA”) in their existing credit agreements.
- Financial Covenants: Although “covenant-lite” credit facilities have become more common in the U.S. and Europe in recent years, a material drop in a borrower’s earnings will have an adverse impact on its cash flows and may lead companies to become more reliant on their revolving facilities for future liquidity needs. This increased usage by borrowers of their revolving facilities could trigger related springing maintenance test thresholds in loan financing documents. A borrower and its lenders will need to assess the impact of the conflict and the related sanctions programs on such borrower’s ability to comply with its financial covenants.
- Consolidated Net Income and EBITDA Definitions: Many credit agreements will contain a significant number of add-backs to the definitions of “Consolidated Net Income” and “EBITDA” that will need to be evaluated in light of current events. Expenses and losses due to mitigation measures in reaction to the conflict, such as discontinued operations, increased professional compliance expenses, one-time contract termination fees or relocation expenses, may fall into one of the add-back provisions to Consolidated Net Income and/or EBITDA based on the extraordinary nature of such expenses. Adjustments made pursuant to these definitions may have implications beyond financial covenant compliance such as step-downs for the asset sale and excess cash flow mandatory prepayment provisions, certain covenant baskets (such as additional debt and lien incurrences) and possibly pricing step-downs.
Considerations for New Credit Agreements
In addition to the considerations described above for existing credit agreements, there are a number of additional considerations that should be taken into account when drafting new credit agreements:
- “Sanctioned Country” Definitions: Ensure any definition of a “Sanctioned Country” (or related definition) is sufficiently broad to include “all regions which are subject to the target of sanctions” and, to the extent there is a list of specified regions, ensure that it is described as a non-exhaustive list of currently sanctioned regions (such as the Russian occupied regions of Donetsk and Luhansk or the Crimea Region of Ukraine). Depending on context, it may also be appropriate to broaden the scope of any sanctions-related covenants to address the future operations of a borrower.
- Use of Proceeds: Credit agreements typically will restrict the use of loan proceeds in violation of sanctions provisions. Since lenders face strict liability for violations of sanctions, there is generally limited flexibility to excuse breaches, even those that might be considered “immaterial breaches.” Accordingly, lenders should have a clear understanding of the business operations of the borrower and conduct adequate due diligence to ensure that loan proceeds will be not be used unlawfully.
- Collateral Packages and Guarantees: Consider excluding collateral and guarantor entities located in affected jurisdictions (even those only potentially affected jurisdictions to the extent the conflict further develops) given both the scope of sanctions to currently sanctioned regions and countries and the potential recovery risk in neighboring unsanctioned regions and countries.
- Operational Covenants Generally: Depending on the materiality of the affected operations, adjustments to customary operational covenants may be needed to provide flexibility for changes required to be made to the operations of a business to ensure it complies with all sanctions requirements (such as the cash management systems of such business) and covenants, including compliance with laws and use of proceeds and limitations on debt, liens, investments and asset sales.
The unprecedented level of sanctions against Russia by the U.S. and Western allies presents unique legal and compliance complexities for borrowers and lenders. Given the rapidly evolving geopolitical landscape and the broader ramifications of a possible long-term conflict, borrowers and lenders should be in frequent communication with counsel to ensure there is adequate understanding of a borrower’s key operations and its obligations under existing credit agreements. Future credit agreements must also be developed carefully to navigate the developing complexities surrounding the conflict. Proactive review and consideration of the potential impacts of the conflict will help ensure borrowers and lenders meet their respective regulatory and contractual obligations in a manner best suited to their commercial needs.
Special thanks to associate Aylmer Wang who contributed to this publication.