As the COVID-19 pandemic continues to impact the global economy, many in the energy and resources sector are considering the potential implications on their financing arrangements. With travel restrictions and border controls, potential disruptions to on-shore and off-shore supply chains including possible delays in equipment manufacturing and delivery, many borrowers are seeking legal advice.
In this guide, we discuss three potential scenarios that borrowers in the mining sector may face as a result of COVID-19 together with practical advice as to their financing arrangements.
Scenario One: Mining operations suspended or shutdown
Any outbreak of COVID-19 on mine sites or travel restrictions imposed by government may result in the suspension or shutdown of a project making it difficult for a company to continue operations, including to meet production and sales targets, repay loans, or comply with financial covenants and undertakings. Financing issues that may arise in these circumstances include:
Events of defaults
The consequences of an event of default can be dire for a borrower. If the default continues and is unremedied, a lender usually has a right to declare the loan, accrued interest and other amounts immediately payable. If the loan is secured, the lender would typically also have the right to enforce its security.
Common events of default that may be enlivened should COVID-19 cause the suspension or a shutdown of mining operations are:
- Non-payment: A failure by a borrower to repay any amount payable under the loan agreement by its due date or within a grace period is usually an event of default. Particularly for single-project borrowers, any suspension or shut down of mining operations can have a significant impact on the borrower's ability to generate revenue and meet its repayment obligations. At this stage, a borrower should engage with its lender to seek an extension to any upcoming repayment date.
- Material Adverse Effect: Where an event or circumstance occurs which has a material adverse effect on a borrower's ability to perform its obligations under the finance documents, or on the financial condition of the borrower (MAE), it is likely to be an event of default.
Whether a MAE occurs as a result of any suspension or cessation of mining operations will depend on two things. First, the specific drafting of the definition of 'MAE' and the default provision in the loan agreement. Second, the project portfolio of the borrower (particularly if the borrower operates projects in different jurisdictions which have been impacted differently by COVID-19). For example, a MAE may be unlikely to occur if a borrower operates several mines but only one of the borrower's mines is shut down, and that mine contributes only a small proportion of the borrower's overall production. On the other hand, a single-project company is more at risk of a MAE occurring if its project is suspended or shutdown.
Australian lenders, including the big four banks, traditionally have rarely sought to rely on a MAE as a sole event of default. While the unique circumstances posed by COVID-19 may lead some lenders to adopt a more aggressive interpretation of a MAE default, it is still too early for lenders to assess the impact of the pandemic on a borrower's financial condition.
- Suspension or cessation of business: An unscheduled suspension or cessation of a material part of a borrower's business would usually be an event of default. In some cases, it will be an event of default if an unscheduled suspension or cessation of a borrower's business has or is reasonably likely to have a MAE.
Review events
Some events or circumstances may result in a 'review event' of a borrower's financing arrangements. If a review event occurs, the parties will often be required to negotiate in good faith as to how the borrower can continue to fulfil its obligations. This will often require amendments to the loan agreement. If negotiations are unsuccessful, the lender will have the right to declare the loan repayable.
Common review events that may occur if COVID-19 causes the suspension or shutdown of mining operations include:
- Suspension or cessation of production: Even if COVID-19 does not directly force the shutdown of mining operations, it may be that production is suspended or ceases indirectly due to the pandemic. For example, a borrower's supply chain may be so heavily impacted that it can no longer deliver its product to its refiner. In such circumstances, the commercial decision may be to suspend operations until the supply chain resumes functioning.
- Failure to meet production targets: In some cases, a failure by a company to meet production targets will constitute a review event. This is often the case where the purpose of the loan is for the development of a project. If it is a gold project, then typically a review event would be a deadline for the first gold pour. While this review event would not be tested until the date of the scheduled first gold pour, any suspension or shutdown of operations may make it difficult to achieve the first pour by the specified date.
- Failure to meet construction targets: In the case of project finance for a mine, the loan agreement will often specify an agreed date by which construction of the project must be completed. A failure to meet that target will sometimes be a review event or more often an event of default.
Financial covenants
Loan agreements often contain a series of financial covenants, which are usually tested each quarter. Common financial covenants for corporate loans include a debt service cover ratio, an interest cover ratio, a gearing ratio, and minimum liquidity requirements. Common financial covenants for project loans include a loan life cover ratio, a project life cover ratio, and an ore reserves tail ratio. Depending on the project portfolio of a company, a material impact on production at even one project may strain the company's ability to comply with these financial covenants as revenue, and production may fall substantially.
Lenders are already waiving compliance with financial covenants for the June and September 2020 quarters. Although waivers will need to be negotiated on a case by case basis.
Draw stops
A borrower will almost always be prevented from drawing down its loan if an event of default occurs. In some cases, the continuation of a review event will also prevent a draw down. So it is important a borrower seeks any necessary waivers for events of default or review events to ensure they have the flexibility to access any undrawn amounts should cash flow begin to slow.
Changes to life of mine plan
Naturally, any suspension or shutdown of mining operations may result in a borrower needing to make changes to its life of mine plan for the project. This will almost always require the consent of the lender. The borrower should engage with its lender as early as possible to discuss the particular issues it is facing and the changes it needs to make to the life of plan.
Impact on hedging arrangements
Most hedging arrangements are documented by a 2002 ISDA master agreement (ISDA) and schedule. Subject to any amendments made to the ISDA by the schedule or any confirmations, the suspension or shutdown of mining operations would likely trigger a 'Force Majeure Event' under an ISDA. A 'Force Majeure Event' is a 'Termination Event' under an ISDA. If the Termination Event continues, each payment or delivery under an affected hedge transaction would be deferred until the earlier of the end of the waiting period (which is eight business days) or the date on which the Termination Event ceases.
If the Termination Event continues beyond the end of the waiting period, each party to the ISDA would have a right to terminate the affected hedge transactions (which may include all hedge transactions made under the ISDA), and payments would then need to be made either to or by the borrower, depending on whether the hedge transaction was 'out of the money' or 'in the money' from the borrower's perspective.
A borrower should also be aware that ISDAs contain cross-default provisions which may provide that if an event of default occurs under the loan agreement, a default will also occur under the ISDA.
Scenario Two: Travel to project sites (including FIFO and DIDO) is restricted, which inhibits a company's ability to mine or develop a project
States and territories are imposing stricter travel restrictions. Some Australian states, such as Queensland and Western Australia, have restricted the ability of interstate FIFO workers to enter the state (see our earlier alert, Understanding new restrictions on FIFO mine workers). In addition, the Western Australian Government has imposed increased travel restrictions which inhibit movements between nine designated regions of the state. Many of the energy and resources projects in Western Australia fall within designated regions, such as the Goldfields-Esperance, Pilbara and Gascoyne regions.
At this stage, exceptions to most of the travel restrictions include those travelling to work (although in some cases these workers are required to self-isolate for 14 days after arrival or meet certain requirements), or for the transport of freight. While this means project companies will be able to continue operations in the short term, it is unknown whether these travel restrictions will be tightened going forward. This has led many resources companies, including majors such as BHP, Rio Tinto, and Fortescue, to either relocate workers from the eastern states to Western Australia, or make amendments to FIFO workers' rosters to reduce the amount of travel required.
Increased travel restrictions to project sites may have a material impact on production for many projects. As mentioned above, this may also lead to reduced revenue and an inhibited ability for a borrower to repay a loan by its scheduled repayment date. Again, this would likely present a draw stop in most cases, so a borrower should seek waivers of any relevant events of default or review events, and an extension of time for any upcoming repayment date.
In the case of project finance, it is common to see as specific conditions precedent, the completion of certain development milestones by specified dates. These can be conditions precedent to either the first draw down or to the availability of a portion of the lender's commitment. If travel restrictions prevent a company from achieving these milestones, draw down will not be possible and it may even be the case that the parties need to either waive the conditions precedent, or amend the terms of the loan agreement to accommodate the impact of COVID-19.
Scenario Three: The supply chain is disrupted or manufacturers of critical mining equipment are shutdown
It is now foreseeable that the spread and impact of COVID-19 may result in material restrictions on the logistics chain, including trucking, marine and rail freight (foreign and domestic), or even in the suspension of manufacturing processes. This could delay mining operations or project development. This would have a significant impact on mining operations and production, even if the ability to mine itself is largely unaffected. It would be of particular concern to those resources companies that rely on overseas markets for the delivery of their product.
In such circumstances, a borrower may find it is prevented from performing its obligations under certain material contracts, as well as its loan and hedging agreements. In addition to the events of default and review events mentioned above, it is usual that a borrower provides undertakings in a loan agreement that it will perform its obligations under material contracts. Examples of such contracts include goods and services contracts, construction contracts and shipping contracts. If, for example, shipping or rail freight is restricted or suspended, a company may not be able to comply with a material obligation to provide its product for delivery. This may also result in the borrower breaching an undertaking in its loan agreement.
While a borrower may seek to enliven any force majeure provision in the material contract or argue that contract has been frustrated, loan agreements do not usually contain force majeure provisions. For more information on force majeure and frustration of contracts, see our earlier alert, COVID-19: Force majeure and frustration of your contracts.
What you should do now to manage the risks
- Lenders do not like surprises. So it is imperative for a borrower to keep its lender informed on a regular basis especially in relation to potential defaults or review events. A borrower should clearly articulate to its lender how it is proposing to remedy and manage any issues that may arise. A key risk for lenders is management. If a lender believes management is being proactive and has a strategy to deal with issues, then a lender will gain confidence that the borrower will be able to manage the situation.
- A borrower should closely consider its current financing arrangements and determine whether it needs to seek any waivers for events of default or review events, or an extension of time to meet production or development targets or repayment dates.
- Even in circumstances where a borrower is not experiencing any material impact on production or revenue, it is advisable that a borrower draw down on any loan in advance of any potential events of default or review events arising, to ensure sufficient capital to continue operations.
- A company should consider obtaining greater credit lines, such as overdrafts, to tide it over in any potential liquidity pinch.
- If a borrower is worried about its solvency, consider safe harbour strategies. See our earlier alert, Putting Safe Harbour in the Spotlight.
- Seek tailored legal advice if you have any concerns regarding your financing arrangements. MinterEllison is well equipped to help you in that regard.
