Adrian Houstoun: Do not break your loan covenant
Not surprisingly in this economic climate, there have been some high-profile problems in the leisure and hospitality industry. Loan covenants took centre stage when accounts filed by Gordon Ramsay Holdings showed that the group had breached covenants on its overdraft and loans. New banking covenants were eventually agreed, but not before the potential implications of such a breach were revealed.
All borrowers should be aware that breaching loan covenants could have drastic consequences, such as your lender calling in the loan or at least charging a penal rate of interest.
Obviously, you should start by making sure that you fully understand and monitor all the loan covenants that apply to your club’s borrowing. As you know, in these difficult times, lenders are tightening up their procedures and monitoring covenants more carefully, so you cannot afford to ignore the small print.
It sounds simple but the first point is that someone must read and understand the loan agreement to see what the covenants are and how they are calculated, making certain that the relevant people are aware of them. Many covenants are customised to the business, so you need to know how many times a year they are measured, which could be quarterly or annually. From there it should be a matter of understanding the components of each covenant.
One covenant that has caught out a number of businesses in this recession is filing audited accounts on time. If you think a potential breach of covenant is likely, you will need to consider your options in order to prevent it from occurring. Speaking to your lender and advisers well before the breach, and well before the balance sheet date if it’s a balance sheet covenant, should allow you to form a strategy to disclose or correct it. In extreme situations, some clubs have considered extending their year-end so that any breach can be rectified before the new balance sheet date.
A breach may have direct consequences for your statutory accounts, as the loan will need to be re-categorised as a current liability on your balance sheet rather than a long-term liability given that it can be recalled immediately. This will affect the liquidity position of your club and may even mean that you are showing a net current liabilities position, which could easily alarm suppliers and others interested in your accounts. Your credit rating will also be impacted.
The auditing and accounting rules do not allow for any discretion. So, where a loan covenant has been breached and then rectified after the balance sheet date or where the lender has taken no action, the classification of the loan as a current liability cannot be changed retrospectively, despite the lender deciding not to call in the loan. The reclassification of a long-term loan could result in your balance sheet looking very different and raise questions about whether your business is viable as a going concern. However, an additional disclosure in the accounts stating that the breach has been corrected may help to alleviate concerns.
Some golf clubs have shares that are traded publicly and if they breach their covenants they need to take advice about whether they need to advise shareholders of the breach. Alternatively, your club might be a members’ club, in which case, you should make sure that you and the rest of your team are aware of your responsibility and liability for any issues.
To summarise, the economic downturn means that tighter lending criteria and closer monitoring of loan covenants are now the order of the day. It is therefore essential that as a borrower you are aware of the terms and conditions of your loans and discuss any breach or potential breach with your lenders and advisers at the earliest opportunity. Burying your head in the sand could mean grave consequences for your club and should not be an option.
The information contained in this article was correct at the time it was sent to Golf Club Management magazine, which was before the date it was published on this website