by Angela Drumm
In the midst of the COVID-19 pandemic, we saw small businesses across the country race to their lender – or really any lender – to apply for PPP loans. Time was of the essence in applying for the PPP loans; therefore, many borrowers did not assess the ramifications of taking advantage of a PPP loan on their primary lending facilities. However, borrowers should quickly analyze the impact of their PPP loan on their primary lending facilities and reach out to their primary lender to address the following risks:
Is the PPP Loan Authorized Under a Borrower’s Primary Lending Facility?
Most loan documentation generally prohibits a borrower from incurring additional indebtedness such as a PPP loan. If so, a borrower’s primary lender will need to consent to such additional indebtedness in the amount of the PPP loan and waive any covenant violation due to borrower’s receipt of the PPP loan.
How does the PPP Loan Impact a Borrower’s Financial Covenants?
Many financial covenants could be adversely impacted by a borrower incurring additional indebtedness such as a PPP loan. For example, (i) the numerator of a leverage ratio, which compares debt to EBITDA, would increase by the amount of the PPP loan, (ii) the denominator of a fixed charge ratio, which compares EBITDA to fixed charges, might increase by the amount of the interest incurred on the PPP loan, and (iii) the denominator of a liquidity ratio, which compares current assets to current liabilities, might increase by the amount of the PPP loan. These changes could cause a borrower to breach its financial covenants and trigger an event of default under its primary loan facility.
A borrower should discuss the effects of the PPP loan on its financial covenants with its primary lender and, if needed, revise the calculations of the applicable financial covenants to disregard the PPP loan. Most lenders have been willing to do so at least initially. However, lenders will most likely require any amounts of the PPP loan that are not forgiven to be included in the calculation of a borrower’s financial covenants. Accordingly, a borrower should continually monitor and analyze the effects of any potential unforgiven amounts of the PPP loan on its financial covenants.
Does the PPP Loan Trigger a Mandatory Paydown?
Some lending facilities require a mandatory paydown be paid by a borrower from the cash proceeds of any additional indebtedness. This has drastic consequences for a borrower, as any such payment would not be an authorized use of the PPP loan and would not be forgiven. Accordingly, a borrower should request that any such mandatory paydown be waived in connection with the proceeds of the PPP loan.
Is the PPP Loan Inadvertently Secured?
One requirement of a PPP loan is that it be unsecured. If a borrower’s PPP lender is also its primary lender, a borrower should examine whether its loan documents include a clause requiring all indebtedness to such lender be secured by the existing collateral and/or include a right to setoff against any existing accounts of a borrower held with the lender. If so, the PPP loan should be excluded from such requirement so that the PPP loan is not inadvertently secured.
If a borrower has not already done so, it should immediately notify its primary lender of its PPP loan, carefully review its primary lending facility’s loan documentation, and work with its primary lender to obtain any needed amendments or consents in order to stay in compliance with its obligations and covenants thereunder.
Angela L. Drumm is a shareholder at Carmody MacDonald P.C. She focuses her practice on banking & finance, real estate, and financial restructuring & bankruptcy. Contact Angela at firstname.lastname@example.org or 314-854-8623.
This column is for informational purposes only. Nothing herein should be considered legal advice or as creating an attorney-client relationship. The choice of a lawyer is an important decision and should not be based solely on advertisements.