{"id":56284,"date":"2018-10-22t07:09:24","date_gmt":"2018-10-22t11:09:24","guid":{"rendered":"https:\/\/48e130086c.nxcli.net\/?p=56284"},"modified":"2018-10-31t14:19:35","modified_gmt":"2018-10-31t18:19:35","slug":"blown-covenants-and-how-to-recover-from-them","status":"publish","type":"post","link":"\/\/www.g005e.com\/2018\/10\/22\/blown-covenants-and-how-to-recover-from-them\/","title":{"rendered":"blown loan covenants and how to recover from them"},"content":{"rendered":"

\"business<\/a>sometimes a detailed memo can buy you time.
\n<\/strong><\/p>\n

by ed mendlowitz<\/i>
\ncall me before you do anything: the art of accounting<\/i><\/a><\/p>\n

one time, one of my clients had a very large equipment term loan from a bank and was in danger of being put out of business because the company had blown an essential loan covenant.<\/p>\n

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a covenant is a condition the lender must meet or the bank has the right to call the loan. most businesses that borrow cannot pay loans back on demand. instead, they are paid out of future profits that have hopefully been generated from the added business the loan helped to achieve.
\n
\nin this case, the covenants to maintain net worth and working capital were violated. the company had losses because of noncash charges dictated by accounting rules.<\/p>\n

the covenants were based on the net worth as appearing on audited financial statements, but the accounting changes caused the losses while the client had a generous cash flow. when a covenant is not met, the loan becomes due in full. this then requires the loan to be moved from the long-term liability section to the current liability section.<\/p>\n

long-term liabilities do not affect working capital and solvency requirements, but current liabilities do. the second covenant that would be blown was the working capital or solvency ratio, which would change from a strong positive amount to a terribly negative amount.<\/p>\n

well, the bank needed full compliance with the terms of the loan. the loan officer\u2019s behind also was on the line if the full consequences of the blown covenant were realized.<\/p>\n

our report on the financial statements would have had a clause stating that there was doubt the company could consider as a going concern, which would further accelerate very disagreeable banking procedures. the bank would have to call the loan demanding payment and there was no way this could have been done. the company\u2019s debt would then be transferred to the workout section, which would start a super-unpleasant process. (for an interesting picture of how loan workouts are handled, i refer you to the beginning of chapter 2 in “a man in full” by tom wolfe).<\/p>\n

discussions with the loan officer showed that he understood the situation and wanted to help us avoid the wrath of the bank. because of the size of the loan and the importance to the client, our efforts were not constrained by costs. i put someone on this project for a solid week and together we came up with a memo detailing<\/p>\n