Impact of coronavirus on loans in Italy

Initial reaction

Reactions have been mixed, with praise for the much needed relief and widespread concern around the complexity of the scheme and ensuing disclosure and reporting duties. The Italian Banking Association and SACE S.p.A. issued guidelines setting out the procedure and forms for the SACE guarantee. This protection is limited to new money loans, and cannot be used to finance corporate acquisitions or refinance existing debt, although up to 25% of the covered loans can be used to discharge overdue repayments of principal falling which were prevented by the COVID-19 outbreak. As at 19 May 2021, still in place moratoria on loans for a value of EUR 146bn, while more than EUR 168bn is the value of the requests to the SME Protection Fund. EUR 23,6bn is the overall volume of loans secured by SACE, which has been definitely very appreciated by businesses struggling to raise funds. 

The framework defined so far remains fluid, as the Italian authorities continue to devise special legislation to restore the economy and contain the impact of the pandemic, whilst the restrictions of movement of people and goods are lifted as the vaccination campaign progresses. The impact of COVID-19 on loan transactions also needs to be addressed as a matter of general contract law, and we consider the main implications below. 

Payment obligations absolute

Generally, a Borrower's obligations to pay interest and to repay principal under a loan agreement are not conditional on the Borrower's financial condition, and must be performed as an absolute obligation, often supported by collateral available to the lender in priority to unsecured creditors.

Force majeure in Italian law

However, under Italian law¹ a debtor is not responsible for contract breach in circumstances where the performance of an obligation is prevented by supervening impossibility not imputable to the debtor (impossibilità sopravvenuta non imputabile al debitore), broadly akin to the concept of force majeure in international commercial practice.

Italian Courts have been reluctant to recognise this exemption for payment obligations, on the grounds that a shortage of cash cannot strictly speaking be regarded as an objective impossibility. At least in theory, a debtor can source funding from another lender or sponsor, the supervening impossibility resulting thus temporary (and not final, without prejudice to the contractual obligations in force). This traditional view has been debated before the Italian courts addressing payment defaults by businesses affected by shortage of cash in the wake of 
COVID-19. Most judgments stem from short-track proceedings for urgent or interim relief, and it is too early to draw consistent guidance. Different courts have taken different views, as many have upheld the principle that pacta sunt servanda, while others have ruled for a debtor's right to re-negotiation of contract terms in light of the contraction of business, especially in the lease of real estate engaged in commerce and trade. Certain sectors also benefit from special legislation, such as the interim moratorium and a price reduction on lease payments for gyms and leisure facilities.

Impact of the latest legislative measures on this analysis

The measures include general declarations of a state of force majeure (in a Government order which probably lacks the legislative rank required to regulate loans to private sector businesses), and 'exceptional occurrence' and 'serious disturbance' for the purpose of EU rules on State aid.

It could be argued that the existence of these legislative measures supports the argument that a borrower should be exempt from performance of its payment obligations, at least in proportion to its loss of revenues ensuing from COVID-19. The borrower would also be excused from the need to demonstrate causation between the virus and its loss of revenues in the aftermath.

Italian Courts usually regard a binding order from an authority which prevents the performance of a debtor's obligation as sufficient force majeure. So the various containment orders issued by central and local authorities during this health emergency might of themselves provide sufficient grounds for affected borrowers to be exempt from liability under their loans (in other words, their payment obligations could be suspended with no liability for default interest on overdue sums).

Re-negotiation duty in the light of the Supreme Court official intervention

At the advent of the crisis, some commentators advanced the possible extension of a duty to re-negotiate the contractual contents notwithstanding the absence of a specific clause authorizing thereto. Such a defensive approach was to be linked with the intention to better protect the borrower as the weak contractual party and to somehow re-balance the opposite obligations to be performed by the parties.

In an unprecedented step, the Italian Supreme Court² has contributed to the debate³ on the treatment of contract obligations in the face of the disruption brought by the pandemic.  In a report, the Court expressed its evaluation of the general obligation, under Italian contract law, to apply good faith (buona fede) in all phases of negotiation, execution, implementation and performance of a contract. According to the Supreme Court, this principle should support the existence of a duty to review an existing contract, and re-negotiate its terms to afford the parties a similar balancing of interests as existed at the time they were agreed.

Can a Lender accelerate?

Lenders would probably be prevented from accelerating or terminating loans on the grounds of the increased credit risk or loss in revenues ensuing from COVID-19. As mentioned, in most circumstances a borrower may be exempted from complying with its payment and operating obligations on grounds of impossibilità sopravvenuta to comply with the contractual obligations, and the same argument would probably apply to any form of material adverse effect (MAE) trigger, most financial ratios and other indicators of a borrower's general creditworthiness.

Termination for breach unlikely

Quite apart from the debate on force majeure, Italian Courts are fairly conservative when it comes to questions of contract termination on grounds of breach. There are findings that an express termination clause (clausola risolutiva espressa, which in theory would allow a party to terminate a contract on the occurrence of a given event) should not permit termination where the occurrence of the sanctioned event is not imputable to the negligence (colpa) or wilful misconduct (dolo) of the other party. Also, an express termination clause is not, in itself, sufficient to declare the termination of a contract on the occurrence of the sanctioned breach, and the termination requires the breach to be material in respect of the overall balance of interests (economia del contratto) in the contract.

Cancellation of commitments 

Government's recent measures require lenders to stand behind their commitments for loans to micro businesses and SMEs until 30 June 2021. 

In the absence of this regulation, general contract law would allow lenders to cancel commitments for loans or bank credit facilities in case of a material deterioration in the condition of the borrower's assets, or the collateral provided. Where permitted under the COVID-19 measures, a lender could probably cancel a loan commitment under a term sheet or arrangement mandate which is still subject to documentation, syndication or due diligence.

Again, where permitted under the COVID-19 measures, for committed facilities made available under existing loan agreements, most lenders would have sufficient grounds to cancel (or at least delay) new utilisations on the basis of COVID-19. This is though subject to the Italian law doctrine of wrongful breach of lending (interruzione abusiva del credito), preventing lenders from cancelling available credit abruptly or otherwise unreasonably. The cancellation of a commitment during the health emergency would need to be limited to what is strictly necessary, supported by analysis of the borrower's financial condition, and must allow sufficient notice for the borrower to mitigate the impact on its business.

What's next?

When reviewing potential contractual remedies, lenders and borrowers owe each other an obligation to act in accordance with good faith. Italian law applies this duty to the performance of all contracts, and even to pre-contractual negotiations, including at mandate or term sheet stage. If a lender's behaviour were to be questioned, a Court would review this earnestly against the background of the pandemic.

In each case, the impact of the COVID-19 measures on existing contracts, as well as of force majeure on loan commitments and contracts, depends on the documented terms, date of execution, and the location and status of the parties. We express our views above in very general terms, on the understanding that no one-size-fits-all assessment can address the current uncertainty, and any review of a lender's or borrower's legal position requires a specific analysis of that position.

References

1 Articles 1218 and 1256 of the Italian civil code.

2 Supreme Court of Cassation, Ufficio del Massimario, Report No. 56 of 8 July 2020.

3 Court of Milan, 24 July 2020 contra Court of Rome, 15 January 2021.

Authored by Carlo Massini, Alessandro Nicolini, and Umberto Cairello.