Thin capitalisation: practical guidance: creating agreements between HMRC and the group: covenant breaches and unforeseen circumstances
The ATCA should, wherever possible, contain an explicit statement about unexpected circumstances which would have a significant effect on the business and which may result in a breach of covenant. This is sometimes referred to as a “force majeure” clause.
It is impossible to give an exhaustive list of the circumstances that may qualify, but in general they only include one-off, unexpected events that fall outside of normal business experience and therefore may invoke some forbearance by a third party lender, such as:
- a terrorist attack temporarily affecting business.
- contamination resulting in a food producing factory being taken out of production for a significant period.
- an event that does not affect cash flow, for example, a one off accountancy provision that, while it has significant impact on the profit and loss account, does not affect the borrower’s ability to service its debts.
These examples are illustrative only and every case must be considered according to its own facts and circumstances.
Generally, a force majeure clause will only cover unexpected events, and it should be made as clear as possible what type of event the clause covers. Otherwise the clause will become an exclusion clause for almost every breach. A company which is “maxed out” on its debt and has a history of breaching covenants should not elicit much sympathy if it leaves itself vulnerable, though it is nevertheless necessary to consider each breach on its merits.
There is scope for dispute here, but it should be possible to establish an understanding of what kind of breach should merit leniency. These are events from which a business will recover, by resumption of trade, insurance claim and the rebuilding of damaged premises, gradually getting back to business as usual, etc. The lender’s forbearance would most likely be a consequence of its belief that overdue payments will be made within a reasonable period. Any latitude given will include an agreed time within which a borrower will be expected to be back on track. If this time is highly uncertain or distant, or full recovery is doubtful, a new agreement may be needed.