Reconstruction of lender and shareholder interests is key in COVID economy, writes Robert G.S. Hull
As the economic challenges brought on by the COVID-19 pandemic continue, a rebalancing of lender and shareholder interests has taken on increased importance. While the duration of these challenges will persist longer in certain industries, the temporary reconstruction of lender and shareholder entitlements is paramount. There’s a real need to ensure businesses not only survive the pandemic but emerge with a strong capital structure.
General counsel and chief financial officers seeking forbearances, waivers and extensions from their credit facility providers will quickly find themselves grappling with this dichotomy. Facilitative lenders in the pandemic are taking a longer-term view and co-operating with requests from their corporate borrowers. At the same time, they require corresponding relief and reductions from shareholders on their ongoing entitlement to dividend streams. How then should general counsel best navigate these challenges and advise their boards?
As a precursor to these discussions, it is imperative that reliable business and revenue forecasts be made available. Ideally, these will underscore the temporary nature of the revenue interruptions, as well as demonstrate a realistic timetable for return to profit stability. They will then drive the timeline for temporary waivers and forbearances from debt holders and lenders and, in turn, inform requests to shareholders for a suspension or reduction in their dividend streams.
In the absence of a unanimous shareholders agreement, directors must act as a fiduciary in the best interests of the corporation and its stakeholders in order to balance lender-generated requests for dividend reductions. Prior to navigating the lender/shareholder minefield, however, general counsel will need to advise their boards on compliance with the statutory solvency tests before declaring and paying any dividends.
The CBCA and most provincial corporate legislation provides that directors of the corporation shall not declare a dividend if there are reasonable grounds to believe that:
a) the corporation is or, after the payment, would be unable to pay its liabilities as they become due; or
(b) after the payment, the realizable value of the corporation’s assets would be less than the aggregate of its liabilities and its stated capital of all classes.
In addition, interest and principal payments due on operating or term debt of the corporation will be relevant and must be taken into account. Projected accounts payable into the future will be less reliable. General counsel and their CFO colleagues need to emphasize to their boards that the dividend solvency tests are operational on each date that any dividend is declared. Then, once compliance with the applicable solvency tests has been ascertained, the impact of any applicable dividend policy of the corporation needs to be considered.
Informed general counsel will ensure that any mandated reduction in dividend streams will be commensurate with the duration of temporary waivers or forbearances from lenders, such that full dividend restoration can be reinstituted once revenue streams return to pre-COVID levels. This will, of course, be more easily ascertainable in certain business sectors.
When shareholders have taken the decision-making for dividends out of the hands of their directors through a unanimous shareholder agreement, general counsel will be advising those shareholders directly on the prudence of facilitating lender requests. Where those shareholders continue to be reliant on an ongoing dividend stream for their own financial resources and solvency, shareholder financial hardship may come into play and lead to shareholder resistance to facilitating lender requests.
Where there is no unanimous shareholder agreement granting dividend-making jurisdiction directly to the shareholders but shareholders have board nominees acting in a non-independent capacity, general counsel may need to apprise those directors of their duty to declare a conflict of interest and abstain from voting in any consideration of dividend reductions.
While lenders and debt holders have the right (in the event of a borrower default) to insist upon a complete dividend prohibition as a condition to not crystallizing their loans and related security, prudent lenders will see it in their own best interests to have motivated shareholders and directors of their borrowers throughout the crisis. Such an approach by lenders will assist in fostering a mutually beneficial long-term relationship with their borrower clientele.
Temporary concessions among debt holders and equity holders will position all parties for future success after the initial shocks of the pandemic-driven economy have passed. General counsel can demonstrate their value by encouraging and facilitating such an outcome.