By Bill Gambrill - 6 May 2020
On Friday, 1 May 2020, the Government announced changes to the
operation of the Business Finance Guarantee Scheme (BFGS). As
readers might recall, the BFGS was introduced as part of its
initial economic approach to the COVID-19 response. The specific
change announced was that it would no longer be a Government
requirement that a bank which was making a loan of more than
$50,000 under the scheme would have to take security against the
debtor's default by way of a General Security Agreement (security
over all of the assets of a debtor in the event of a loan default)
- although a bank is still entitled to ask for security if it
wishes to do so.
At the same time, the Government announced the Small Business
Cashflow Loan Scheme, to provide reduced-rate loans of up to
$100,000 to firms employing 50 or fewer full time equivalent
employees, to be administered through the Inland Revenue
Department. The Government's announcement expressed the view that
the support available currently through banks was not
meeting the needs of small and medium business or the
expectations of the Government.
The BFGS was announced by the Government in the early days
of Level Four. The BFGS's premise was that the Government would
support new loans of up to $500,000 to eligible businesses which
had a turnover of less than $80 million per annum. Government funds
of $6.25 billion were to be available under the BFGS. The loans
would be made by through the banks to business customers (including
new customers) on the basis of normal lending processes and
assessments. The Government was to assume 80% of the risk of the
loans under the BFGS, with the lending bank assuming the remaining
20%.
Making Government money available to business through the banks
under the BFGS no doubt reflected the (not unrealistic) expectation
that the banks would be better placed than the Government to do
what needed to be done, practically, in order to assess a
borrower's eligibility and to make loans. However, one suspects
that the reason why the BFGS does not appear to have functioned as
the Government had hoped is that, essentially, there would be
challenges for both lenders and borrowers in making assessments and
decisions regarding financing in a "normal" way (as was required
under the BFGS) in the face of the current, abnormal,
circumstances.
Provision of Security by Borrowers
It is inherent in any responsible lending process that the
lender obtain adequate security over some asset as collateral, to
ensure repayment in the event of the debtor's default. In most
business lending, that collateral will be the assets of the
business. The value of the assets of the business will be closely
tied to the value of the business itself.
However, a business seeking emergency finance will almost always
find it difficult to demonstrate to a lender that it has adequate
collateral for any loan, if strictly "normal" criteria were to be
applied to valuation of the collateral available - the business
needs the loan because of what is, fundamentally, a depreciation in
the value of the business. Furthermore, even if other collateral
were available - typically, a mortgage over residential property
owned by the business-owner - any uncertainty in the housing market
or wider economy would affect whether the value of that collateral
is sufficient to allow the bank to make loans applying "normal"
criteria.
Whether there has been a reluctance by some businesses to seek
to borrow on "normal" terms, or businesses have not been able to
demonstrate to the banks that any such loans would satisfy "normal"
criteria, it is perhaps no surprise that the BFGS has not proved to
be as effective as the Government might have wished; it will have
to be seen if the change in policy results in more loans being
made.
Potential Consequences of General Security Agreements
under BFGS
However, there might also yet be an unintended consequence of
providing emergency business finance through the banks.
Notwithstanding the proposed change in policy, banks may still
require security for BFGS loans. Generally, secured creditors'
rights to enforce against an asset subject to a security are not
affected by the debtor's insolvency. If the business ultimately
fails and goes into a formal insolvency process, the assets
available to unsecured creditors will not include those subject to
any security - including, potentially, those assets which are
security for any loans made under the BFGS. Any increase in a
business's exposure to its bank (as a secured creditor) might well
cause that business's suppliers to hesitate in providing any
unsecured trade credit.
Any change in approach by trade creditors could be compounded by
the proposed changes to the insolvency regime. In
response to the COVID-19 situation, the Government wishes to create
a mechanism for a moratorium on enforcement of business debts,
which is described as "Business Debt Hibernation". The bill to give
effect to these changes was introduced to Parliament on 5 May 2020.
Under the proposed legislation, those holding a General Security
Agreement would not be bound by a moratorium in the way that other
creditors would be. (For more on this see clause 20, Schedule 4 of
the COVID-19 Response (Further Management Measures)
Legislation Bill.) A scenario could arise in which those
holding General Security Agreements (including for loans under the
BFGS) could still retain significant rights to enforce security
when a debtor is in "hibernation", while all of the debtor's
pre-existing obligations to its unsecured creditors were subject to
a moratorium.
All of this illustrates the practical challenges faced in making
public money available quickly through the conventional mechanisms
of finance. It is perhaps no surprise that the Government has not
ruled out unconventional approaches to getting money into the
economy, including "helicopter money".
Corporal O'Reilly, a character in the 1970s television series
M*A*S*H, was given the nickname "Radar" because he could
sense that helicopters were coming before they were audible; one
wonders what Radar is thinking now.
Contacts
Bill
Gambrill
Jacque
Lethbridge