Line of Credit Affirmative Covenant Audit Question

[porcupine]

Was wondering if anybody with an accounting/audit background could help with this.

 

Given the statement below found in this particular company's credit agreement, could the line of credit potentially be cancelled if this company were to receive a qualified audit opinion (or worse)? The potential qualified opinion would likely be related to their internal control procedures.

 

Below is included in the Affirmative Covenants Section:

 

"...audited and accompanied by a report and opinion of an independent certified public accountant of nationally recognized standing, which report and opinion shall be prepared in accordance with generally accepted auditing standards and shall not be subject to any “going concern” or like qualification or exception or any qualification or exception as to the scope of such audit;"

 

Thanks in advance.

[John Hjorth]

porcupine,

 

My answer to your question would be a "Yes". If you look at the description "as is" of this specific term for the covenants overall & from a birds perspective, I think that you will agree with me, that this particular term is about the intent that the company will not have the opportunity to circumvent the covenants by deliberately tinkering with the audited financials to keep up with the covenants at the expense of qualification from the auditors in report & opinion.

 

The catch here is also that the mere existence of covenants can trigger qualified auditors opinions, expressed as various degrees of doubt/conviction about going concern alone because of the existence of the covenants, thereby creating a [bit weird] circularity among causes and effects.

[SharperDingaan]

The day a 'going concern' qualification appears, the outstanding loan immediately becomes due.

 

SD

[John Hjorth]

The day a 'going concern' qualification appears, the outstanding loan immediately becomes due.

 

SD

 

Yes, SharperDingaan,

 

But that part of the whole process is actually pretty boring & uninteresting, if it has [already] come so far.

[Cigarbutt]

^I don't have the 'right' background and continue to wonder if that's a disadvantage when dealing with those types of questions.

 

The opening post contains limited info and possibilities are vast but it is implied that the potential breach may be more technical in nature and relatively easy to remediate, simply indicating that, even if a default could be contractually called, this is an opportunity for the lender to revisit the agreement and 'negotiate' better, (in the sense of more constraining) and more expensive terms.

 

Whatever the context, to assess refinancing-type risk, it would be perhaps relevant to look at the other Cs: credit history, collateral, capacity and especially character. Even if we live in an increasingly intermediated world, this could boil down to a face to face outcome. FWIW, reading many bond agreements and much leveraged loan documentation, I continue to be impressed by the degree of easing in covenants with, for example, many companies being able, in the last 2 years or so, to issue debt with an agreement throwing even the going concern requirement out the window. Maintenance covenants used to have a leading indicator type of quality and it seems that, often, value can no longer be appropriately appraised from documents delivered at period ends. This too shall pass.

[John Hjorth]

Yes, Cigarbutt,

 

In practice, things work in another way - at least if this is financing provided a bank or a consortium of banks. There will be an ongoing dialogue, during thick and thin, and if the relationship between the lender and the financing party/ies turns sour & distressed because of perceived increased risk related to the financing provided by the financing party/ies, a call is way to set an example of "Who is this going to be a pitty for?"

[SharperDingaan]

Credit agreements just spell out the contractual terms of the lending

While the stated terms were 'negotiated' (at time of agreement), the 'tone' of the agreement is equally important.

'Tone' being specific language, the frequency and nature of the ongoing loan review process, etc.

 

Citing the term: 'going concern'  in a trigger point, indicates termination of discussion.

The lender either gets repaid the loan in full within the 'cure' period (typically 5 business days), or forecloses and begins a liquidation.

The external auditor has pronounced the business is no longer viable, and the banker is just acting accordingly.

 

The struggling business makes its case to an independent 3rd party (external auditor), familiar with the business.

There's no 'negotiation'; management spends its energies delivering results, and evidences the business is a viable going concern.

Harsh, but a very practical solution.

 

SD