This alert highlights certain key matters impacting technology and high growth businesses, and investors who invest in those businesses, at this unprecedented time in world history. While we cannot provide all the answers, we hope that the recommendations provide some food for thought. At Brown Rudnick, we pride ourselves on the long relationships we develop with our clients and, with that in mind, we have created an Interactive Discussion Forum (the "IDF") where entrepreneurs, SMEs as well as larger enterprises and investors such as venture capitalists, private equity houses, funds, family offices and others can share their concerns with their peers and ask questions of our team. The aim is to get through this together. Further details on time and date of the IDF will follow in the next few days, but if you would like to be added to the invite list please contact Camilla Davis.
UK Government Schemes
The scheme relating to interruption loans in the wake of COVID-19, the Coronavirus Business Interruption Loans Scheme (“CBILS”) went live on Monday 23 March and will initially run for 6 months.
The aim of the scheme is to alleviate any issues SMEs have accessing credit during the COVID-19 outbreak via the partial government guarantee of any loans issued under CBILS up to a value of £5m per borrower.
CBILS is intended to cover a wide range of funding, including term facilities, overdrafts, invoice finance facilities, and asset finance facilities.
The scheme is provided by the British Business Bank via participating lenders, a list of whom can be found here. It is worth noting however, that participating lenders may not individually cover all the forms of lending noted below.
The key features of the CBILS are:
- Maximum facility provided of up to £5m on repayment terms of up to 6 years.
- 80% Government-backed guarantee against the outstanding facility balance subject to an overall cap per lender.
- No guarantee fee for SMEs: only lenders will pay a fee for accessing the scheme.
First 12 months of interest payments and fees (such as lender-levied fees) paid by the Government: Certain lenders have showed some willingness in suspending charging arrangement fees or applying early repayment charges so benefitting the smaller businesses though a lack of upfront costs or lower initial repayments. Please note however, that businesses in the fishery, aquaculture and agriculture sectors may struggle to qualify for the full interest and fee payment cover.
- Increased finance terms: Up to 6 years for term loans and asset finance facilities and up to 3 years for overdrafts and invoice finance facilities.
- Availability of unsecured lending: Facilities of £250,000 and under may qualify for unsecured lending but it remains at the discretion of the lender. The lender will have to establish a lack or absence of security in the first instance, prior to the businesses attempting to use the CBILS, where they are seeking facilities above £250,000.
It is worth noting the following:
- The CBILS guarantee is to the lender and not the business.
- As with any other commercial transaction, the borrower is always 100% liable for repayment of the facility supported by CBILS.
To be eligible for the CBILS, subject to additional elements that may be announced:
- it must be UK based, with turnover of no more than £45m per annum;
- it must generate more than 50% of its turnover from trading activity;
- the CBILS-backed facility will be used to support primarily trading in the UK;
- it must operate within an eligible industrial sector. A small number of industrial sectors are not eligible for support including banks, building societies, insurers and reinsurers (though not insurance brokers), the public sector and membership organisations or trade unions; and have a sound borrowing proposal which, were it not for the current pandemic, would be considered viable by the lender, and for which the lender believes the provision of finance will enable the business to trade out of any short-to-medium term difficulty.
Final decisions on eligibility have been entirely delegated to the accredited lenders and will be decided on a case by case basis. Borrowers should check which accredited lenders provide the type of finance they are looking for and reach out to that particular accredited lender to discuss their eligibility. The British Business Bank has published a quick guide to help borrowers understand if they could potentially be eligible prior to contacting the accredited lender. The quick guide can be found here.
Funding is accessed by application to participating lending institutions. The British Business Bank does not offer any specific guidance and instead notes that businesses should approach any participating lender and discuss their borrowing needs. An application should take no longer than a standard application.
If the accredited lender can offer finance on normal commercial terms without the need to make use of the scheme, they will do so. The CBILS will only be used by lenders in circumstances where the credit decision would otherwise be negative to ensure those small businesses with a sound borrowing proposal but insufficient security are still able to access financing.
Recommendation: It should be borne in mind that these loans do allow the participating lenders to request personal guarantees and these guarantees may be enforced against the personal assets of directors (excluding their main residence). Press reports to date have shown that the interest rates available can be high in comparison to typical loans.
Our recommendation is to discuss the loan, but also think of other options to support companies through these unprecedented times such as further equity investment.
As a result of the social distancing restrictions placed on UK businesses, the Government has established the Coronavirus Job Retention Scheme ("CJRS") which is aimed at supporting public services, people and businesses in the period of disruption caused by COVID-19.
Under the CJRS, all UK employers - regardless of size - are eligible to seek support from HMRC in continuing to pay part of their employees' wages for employees that would have otherwise been dismissed due to the crisis. As a result of new legislation in force, these employees are referred to as 'furloughed workers' or workers that remain on the payroll but are not working at all. Notably, zero-hour contract employees or casual workers are not yet considered to be covered by the CJRS unless they work on the PAYE system and those working normal or reduced hours (agreed short time working) will not be covered by the CJRS.
HMRC will reimburse up to 80% of wages for all employment costs, not being more than £2,500 a month; there is yet to be guidance on the exact definition of wages i.e. whether or not pension and National Insurance contributions are included. Importantly, employers are required to, in the first instance, pay 80% of the employees' wages, receiving their reimbursement from HMRC thereafter, the system for which is still urgently in progress. The employer is, however, not required to make up the additional 20% pay; our suggestion in such circumstances is that the employer reaches and records an agreement with the furloughed employees to waive all or part of the additional amount.
The scheme can only be accessed where the employer:
- designates affected employees as 'furloughed workers' and notifies the employees of the change; and
- submits information to HMRC about the employees that have been furloughed and their earnings through a new online portal (further detail to be provided in due course by HMRC).
Importantly, the reclassification of employees to furlough workers is subject to existing employment law and as such, is subject to negotiation and the specific terms of the employee's employment contract. Typically, employment contracts do not contain an employer's right to change an employee's status or to temporarily lay off employees for whom there is no work. In such circumstances, employees will need to agree the change or the change must be introduced on contractual notice.
The issue, then, is that by unilaterally imposing the change, the employer risks employees resigning to claim for wrongful dismissal and (if they have two years' qualifying service for the employer) unfair dismissal or claim damages or unlawful deduction from wages for the balance of contractual salary. Our belief, though, is that in all likelihood, employees will accept the change to furloughed workers no doubt because the alternative is likely to be redundancy.
It is unclear at this stage whether or not furloughed employees cease to qualify for the grant if the employer serves notice of dismissal. This is likely to be regulated or, in theory, the employer can designate a furloughed employee, claim the grant, serve notice and use the grant to pay for the dismissal.
There remains information and guidance outstanding, however, the CJRS is likely to be regulated in order to prevent exploitation by employers claiming workers are furloughed when in reality they remain at work or continue to work from home.
While we adjust to a new normal, there remain questions as to how the CJRS will work. As the situation develops, the Government will provide further information which we will as soon as practicable relay back to you.
On 28 March 2020, the Government announced it will make changes to UK insolvency legislation to enable companies undergoing a rescue or restructuring process to continue trading, giving them a breathing space that could help them avoid a damaging formal insolvency process, like liquidation, as a result of the COVID-19 pandemic. This will also include provisions to enable companies to buy supplies (such as energy, raw materials or broadband) whilst attempting a rescue and "temporarily" suspending the wrongful trading provisions in UK insolvency legislation retrospectively as from 1 March 2020 for three months so directors, acting reasonably and in accordance with their fiduciary and other duties, can keep their businesses afloat without the threat of personal liability.
The thinking behind this announcement is clear: the Government wants viable businesses to emerge from the current crisis intact by giving them time and space to "weather the storm" whilst ensuring creditors "get the best return possible". The Government made clear, however, that "all other checks and balances to ensure directors fulfil their duties properly will remain in force".
It is crucial therefore that directors appreciate that this latest Government announcement is not a license to behave unreasonably or irresponsibly over the next few months; decisions still must be made, on a reasonable basis, to ensure so far as possible, that the company's stakeholders, most notably the creditors, get the best return possible once the COVID-19 pandemic is over and we begin to emerge out of the crisis.
These changes proposed to UK insolvency laws have not yet passed onto the statute books and may not for some time: details therefore are awaited.
The two principal policy measures being proposed are in relation to (1) a "suspension" of wrongful trading (but not in respect of such matters as antecedent transactions, fraudulent trading, transactions defrauding creditors and/or misfeasance where directors must remain extremely careful at the current time and seek appropriate professional advice and guidance); and (2) a temporary "moratorium" on insolvency procedures for companies undergoing a restructuring process, during which time they cannot be put into a formal insolvency process by creditors and to make it harder to wind up companies because they are experiencing severe financial challenges caused by the pandemic. In effect, this latter proposal is a revival of previously proposed insolvency law reforms aimed at giving companies a breathing space to reorganise their business and affairs whilst being monitored by a licensed insolvency practitioner - in effect, a completely new rescue regime.
The important point here for directors to note is that these measures do not modify the existing regime for directors' duties. So, when taking on new indebtedness, for example, under the terms of the various funding packages being made available by the Government, directors ought still to consider very carefully if such additional borrowing will benefit the company's stakeholders; if it is later shown that decisions in this respect were made in bad faith, irresponsibly or recklessly, the directors will be in breach of their duties and likely held to account by a subsequently appointed insolvency office-holder should the business fail. Directors must therefore remain as cognisant of the existing regime on directors' duties and responsibilities as before the announcements made by the Government on 28 March 2020. In our view, it would be a mistake for directors to relax too much thinking they have carte blanche to rack up additional indebtedness, stretch creditors and defer other obligations absent a coherent and plausible strategy for normalising the business once the pandemic ends. This especially applies to those companies experiencing financial challenges before the start of the pandemic.
So, practically, what does this mean for directors in the position of having to make decisions about carrying on trading during the crisis? Here are some tips:
- Directors must continue to take appropriate professional advice.
- Decisions about trading on must be debated robustly in the boardroom, on a regular basis, and minuted for future reference.
- Because there is a heightened risk of failure leaving stakeholders worse off at the end of the pandemic, even greater care and attention needs to be given to business planning - what is the plan for emerging from the crisis - stress test it - is it viable? Or is it "pie in the sky". If the latter, this cannot be any justification for trading on to the detriment of stakeholders. Directors need to take an honest and frank look at the situation and options available.
- Critically, the rationale for taking on additional indebtedness needs due and proper consideration - is this likely to merely postpone the inevitable (at the expense of creditors) or support the business so it can return to normalised trading in the best interests of stakeholders over the next few months? What is the supporting rationale?
- Ensure there is a sensible strategy in place for communicating with stakeholders and minimising capital expenditure and discretionary costs; engaging with stakeholders is critical.
- Ensure that decisions to carry on trading are regularly assessed by the board of directors, adjusted if necessary, based on up to date financial information.
- Contingency planning is essential - directors need to envisage, on a sensible and rational basis, how best to exit from the pandemic when the time comes in a way which is demonstrably better than simply going into formal insolvency now or, worse still, incurring significant indebtedness and other liabilities with no obvious exit strategy or means of showing why stakeholders will benefit.
Review of existing company documentation
Check Debt Documentation
In light of the ongoing COVID-19 crisis, we recognise the increased uncertainty in relation to financial instruments and ongoing financial arrangements that corporates may have with their financial services providers. Given these arrangements are purely contractual, an analysis can only be undertaken on a case by case basis.
However, generally, corporates – to the extent that they have finance facilities in place – should be cognisant of their covenants and any material adverse change clauses contained in their documents to avoid ending up in an event of default position.
Share schemes are a useful tool in incentivising employees and provide employees with a tangible way to feel as if they are receiving returns on the efforts they put in the course of their employment. However, with the ongoing COVID-19 crisis, questions arise as to how such share schemes will work in practice following the crisis.
Many employers may find that outstanding share options will now be underwater (meaning that the exercise price is higher than the current fair market value of the underlying equity). In certain circumstances, employers may wish to consider whether the exercise price of these share options can be decreased so that the awards can continue to serve as an appropriate tool to retain and motivate employees.
In those circumstances where a share scheme will need to be adjusted for the current market, the starting point will be to check the plan rules - or the option agreement if there is a stand-alone option to determine:
- whether there are any restrictions on the ability to amend the plan rules in general (including investor consents), or the terms of exercising options; and
- whether the proposed amendment is already provided for in the plan rules.
Some plans may have provisions that are broad enough to cover the circumstances brought about by COVID-19, however, in situations where the virus does not fall under events in contemplation at the time the plan was established or the option agreement entered into then the plan will need to be amended or a specific agreement to amend the terms of a particular option will be necessary. This course of action should be considered if the:
- need for the proposed amendment might arise again in the future; and
- the company wants the amendment to apply to all option holders.
However, in order to make the necessary amendments to the plan or an option agreement, the consent of the option holder will be required and some amendments will always require shareholder approval.
For UK employees participating in company share option plans ("CSOPs") and save-as-your-earn option schemes ("SAYE"), as these are tax-advantaged share option schemes, any amendments will need to comply with certain legislative requirements to benefit from statutory tax advantages; the certification that such amendments comply with legislative requirements will be the burden of the company.
If it is proposed that a CSOP or SAYE scheme should be amended, the company needs to consider whether:
- the proposed amendment would involve amending a key feature of the scheme (any provision necessary to meet the requirements of Schedule 3 or Schedule 4 of the Income Tax (Earnings and Pensions) Act 2003) and whether the amendment still complies with such legislation;
- there are restrictions on making the proposed amendment;
- the amendment needs to be reported to HMRC; and
- amending the option amounts to the creation of a new right.
For employees who are subject to U.S. taxes, any adjustment would need to comply with U.S. tax law, which can be extremely complex. For example, one requirement for any adjustment is that the exercise price of the adjusted share option cannot be lower than the fair market value of the underlying equity on the date of the modification. Before taking any action, employers will also need to consider whether any adjustments will require shareholder approval, as well as any securities law or accounting implications.
Though little has been reported in terms of the effect of COVID-19 on share schemes, it appears likely that eligible employees will increasingly be less interested in share schemes due to the fact that the value of the company will be more uncertain than prior to the crisis. Accordingly, companies are likely to have to re-calibrate their share schemes and the terms therein, making them more attractive to employees. For example, growth schemes are used to provide employees the opportunity to receive returns when the company’s value surpasses a certain ‘hurdle’; it may be the case in the current circumstances that lowering the hurdle will make participation in a growth share scheme more appealing to an employee.
We anticipate that as the crisis develops, more literature and guidance will be published in this respect.
Anti-dilution clauses are clauses aimed at protecting investors from unfairly losing ownership in a company upon the issuance of new shares in new financing rounds or in the exercise of convertible debt and can occur in two circumstances:
- share dilution: a reduction of the shareholder’s holding due to fund raising from new investors; and
- economic dilution: a decrease in the economic value of a shareholder’s holding as a result of new shareholders acquiring shares at a lower price than the one paid by the previous shareholders or by converting debt to equity at a price lower than what the existing shareholders paid.
With the uncertainty brought by COVID-19, it may become increasingly necessary to issue new shares or restructure debt to ensure a company has a workable cash-flow to sustain itself. In these circumstances, it is imperative that due consideration is given to anti-dilution clauses. Companies must determine whether they have anti-dilution clauses in place and, if they do, understand the terms of those clauses.
Importantly, if the price of the shares for new shareholders and/or creditors converting their debt is lowered, despite attracting more interest, companies will be facing repercussions of breaching anti-dilution clauses which may entitle the shareholder to breach of contract remedies.
Often companies will include a pay-to-play provision in their agreements with shareholders, which provides that a shareholder must continue to pay (keep contributing to the financing) to continue to play (avoid diluting their shares), which not only provides a secure source of income for the company but incentivises the shareholder to continue contributions to avoid dilution of their shares. In such circumstances, there are differing benefits for participating and nonparticipating
shareholders, whereby only those who participate are entitled to preferred shares and rights.
We have issued a detailed analysis of force majeure clauses in general and their applicability under both English and US law in separate client alerts – please see here in respect of the English position and here in respect of the US position.
Given the crisis and likely reduced staffing at HMRC, the turnaround time for EIS advance assurance may be longer than usual. HMRC are reviewing these applications in strict date order and endeavour to respond within 30 working days. Whilst the receipt of advance assurance is not essential for investments to qualify for EIS, it can often be a condition to the investment for some EIS investors. Companies seeking to attract investment may be better, for the time being, to ensure that the "books" are not EIS heavy.
Companies that have received or are due to receive investments that are anticipated to attract SEIS tax relief should consider whether any emergency support received by them will reduce the amount of SEIS investment available. In many cases emergency support may fall within permitted 'de minimis' grant limits but the position should be monitored.
Alternative Liquidity Solutions
In addition to exploring options to raising equity and obtaining further Government or senior lender debt, businesses are left with multiple additional options to solve their short/medium term liquidity issues that come as a result of COVID-19. These options include:
- addressing fixed costs within the business, including:
- negotiating rent relief between landlord and tenant;
- seeking professional advice on employee redundancies; and
- salary negotiations (including deferral of bonuses and cessation of annual pay increases);
- pausing non-essential capital expenditure and planned projects; and
- making use of government grants and VAT relief.
The views expressed herein are solely the views of the authors and do not represent the views of Brown Rudnick LLP, those parties represented by the authors, or those parties represented by Brown Rudnick LLP. Specific legal advice depends on the facts of each situation and may vary from situation to situation. Information contained in this article is not intended to constitute legal advice by the authors or the lawyers at Brown Rudnick LLP, and it does not establish a lawyer-client relationship.