June.23.2020
As has been extensively publicised in the past few months, a number of credit support initiatives have been introduced by the UK government with the aim of helping businesses (both small and large) navigate the turbulence caused by COVID-19. This note explains which initiatives may be available in a commercial real estate finance context and offers some practical points to consider when analysing the applicability of such initiatives.
For the purpose of this note, we have assumed a structure involving a traditional real estate finance model with a property owning company (a "PropCo") borrowing from a third party lender to finance an existing commercial real estate asset situated in the UK, or to finance the purchase and building of a commercial real estate asset in the UK. In relation to this model, the relevant government initiatives to be considered are:
a) the Coronavirus Business Interruption Loan Scheme (“CBILS”), which is intended to support small and medium-sized businesses to access loans and other kinds of finance up to £5 million with a term of up to 6 years; and
b) the Coronavirus Large Business Interruption Loan Scheme (“CLBILS”), which is intended to support mid-sized businesses to access loans and other kinds of finance up to £200 million with a term between 3 months and 3 years,
in each case, to be provided through accredited lenders listed on the government’s British Business Bank (the "BBB") website and supported by government-backed, partial (80%), guarantees of the finance (together, the "Schemes").
In relation to the Schemes, whilst there are some differences, the eligibility criteria generally provide that in order to benefit from a Scheme, an entity must:
Which Scheme will potentially be available will then hinge on whether annual turnover is more or less than £45 million. Evidence of compliance with the above criteria will need to be presented to an accredited lender and such lender will need to be satisfied with the eligibility, with decision making as to lending being fully devolved to the accredited lender.
Whilst many businesses with a PropCo structure may satisfy the above criteria, there are additional considerations which have been outlined in the further guidance provided by the BBB in the form of its Frequently Asked Questions (the "FAQs").
The BBB has confirmed that the Schemes can be accessed by private equity owned companies, without aggregating turnover at the fund level when determining eligibility under the turnover threshold requirements; this is helpful where the PropCo is ultimately owned by private equity real estate funds. Furthermore, the FAQs make it clear that the company itself can be a foreign-owned UK company or an overseas company with UK ownership, provided that the company is trading in the UK, which again would likely apply to a number of commercial real estate ownership structures and businesses. Our view is that this would require the relevant commercial real estate asset and the rental cashflows derived therefrom to be in the UK (and this should be simple question of fact).
However, the FAQs also state that to be eligible, more than 50% of income (in the case of CBILS) or 50% of turnover (in the case of CLBILS) of the company must be generated from "trading", which the FAQs appear to suggest means the sale of goods or services. It should be noted that the FAQs use the terms "turnover" and "income" seemingly interchangeably however neither such term is defined. The FAQs further note that the Schemes are not designed to support shell companies. Although a PropCo may be a special purpose vehicle, with the purpose of ring-fencing the commercial real estate asset and the rental cashflows as much as possible from the actions of creditors, that has no employees and which might also have outsourced most of the “trading” related aspects of the real estate by appointing third parties such as property managers and asset managers, it will still hold significant assets (i.e. the commercial real estate itself and the cashflows, bank accounts and rights under contractual arrangements). Each structure will have to be analysed on its own merits, but in our view this would not per se cause the relevant PropCo not to be eligible. This point is especially interesting in the context of operational real estate such as data centres, logistics centres, service offices and the private rented sector, including student accommodation, as the "outsourcing" element of these businesses tends to be even more significant. With that being said, given that from a tax perspective letting activity will often only constitute trading where the property owner offers services over and above those typically offered by a landlord, it should certainly help a PropCo argue that it satisfies the eligibility criteria if it were to offer some other services, although this will ultimately be assessed on a case by case basis and the FAQs also suggest that a lender may look at the overall history of the "group" when assessing eligibility.
To be eligible for the Schemes it will therefore be necessary to argue on the basis of the individual circumstances of a PropCo (and potentially the group it belongs to) as to the satisfaction of the above eligibility condition. Generally, however, our view is that even if a PropCo outsources the running of its business and/or the commercial real estate asset (including the collection of rental income), an operational PropCo could still be argued to be trading so long as it is entitled to receive rental income (which can include proceeds derived from factoring or securitising such income) and such income is evidenced in its accounts.
Additionally, in the FAQs, a particular question has been noted as to whether a company that derives income from commercial real estate is eligible for CBILS. On this point, the BBB responded in the affirmative, noting:
"If it derives more than 50% of its income from commercial activity that generates turnover, whether or not this is with the intention of making a profit. This includes real-estate SMEs that derive income from property (including real-estate investment companies and housebuilders)"
Given that the second sentence in this response provides examples that are not expressed to be exclusive, it therefore appears that the relevant test is whether the relevant entity derives more than 50% of its income from commercial activity. This will again need to be considered on a case by case basis, however it is our expectation that this should be applicable to the majority of operational PropCos that receive rental income (or payment in lieu) from third parties.
Whilst the eligibility criteria and the FAQs set out a general overview as to whether a Scheme is applicable, the nature of the Schemes means that it is necessary to exhibit eligibility to an accredited lender (as the availability of the Schemes is not automatic and the accredited lender retains the lending decision). Satisfying an accredited lender that the criteria have been met, along with demonstrating through historical accounts that the relevant Scheme criteria have been satisfied, therefore appear to be the most significant challenges to an entity operating in the real estate sector participating in the Schemes.
Additionally, it should also be noted that there are a number of practical issues that need to be considered on a case by case basis. For example, given the nature of many PropCo structures, there are likely to be existing credit arrangements and any participation in a Scheme will need to function within any existing framework by, for example, being part of the relevant "permitted financial indebtedness" regime and/or complying with the terms of any intercreditor arrangements. We would note an important difference between CBILS and CLBILS on this point, with CLBILS requiring that the facility must be at least pari passu with other senior obligations (including secured and/or super-senior obligations) of the borrower (or, in respect of residential development facilities, of the development) and be secured on a pari passu basis with all collateral taken by any lender from the borrower (or, in respect of residential development facilities, from all collateral forming part of the relevant development and from all further collateral that the lender would take in accordance with its policies). No such requirement appears in CBILS, which likely reflects the lower maximum amount of a CBILS loan (£5m compared with £25m or, depending on turnover, £50m in CLBILS), which raises the possibility of such debt being advanced on a subordinated basis into an existing financing structure. Orrick provided further commentary and detail of these practical considerations in a previous client alert accessible on the CLBILS here and wider financing-related considerations here.
In conclusion, the real hurdles to having commercial real estate debt within the Schemes are whether the PropCo can demonstrate that it meets the CBILS/CLBILS eligibility criteria in terms of turnover/trading/revenue history and satisfying an accredited lender that it has met those criteria. Based on our discussions with real estate debt funds seeking to capitalise on the opportunities around the 80% government guarantee in the context of the Schemes, we expect CBILS and CLBILS-specific commercial real estate debt to come into sharper focus over the coming months.