As many parts of the United States begin to focus on recovering from the profound impact caused by the COVID-19 outbreak, businesses are looking to minimize the pandemic’s toll on their financial performance. Given the potential magnitude, borrowers and lenders alike should carefully consider the treatment of lost revenues resulting from the coronavirus under both the related credit documentation and applicable accounting rules before adjusting for such items in connection with the calculation of consolidated net income and EBITDA.

EBITDA (or “earnings before interest, taxes, depreciation and amortization”) is a fundamental concept in the leveraged lending market and a key measurement of a borrower’s financial performance. The concept is typically used as a component of many financial maintenance covenants and as a governor to permit (or prohibit) borrowers from taking actions such as incurring additional indebtedness or making certain restricted payments.

Consolidated net income represents the company’s net performance (i.e., revenues minus costs and expenses) over a specified period on an after-tax basis and serves as the starting point for calculating EBITDA. A number of adjustments (including adjustments for interest, taxes, depreciation and amortization) are made to consolidated net income to arrive at EBITDA under the related credit documentation. There can be a wide variety of adjustments, or “addbacks,” across credit facilities, but one common addback permits an adjustment to EBITDA for “extraordinary,” “unusual,” “infrequently occurring” or “non-recurring” losses. This provision has caught the attention of many borrowers seeking to mitigate the decrease in revenues over the first half of 2020 but is likely to provide only limited relief.

Middle market credit agreements start from the general premise that adjustments to EBITDA are permitted only to the extent that such amounts reduced consolidated net income. Accordingly, the absence of revenue reduces the “top line” amount of revenue on the income statement rather than reducing the “bottom line” amount of consolidated net income. Certain credit facilities may include exceptions for specified addbacks (such as addbacks for the cost savings or for losses expected to be covered by business interruption insurance), but the addback for extraordinary losses does not typically fall within these exceptions.

Virtually all middle market credit agreements are also premised on the idea that consolidated net income is calculated in accordance with generally accepted accounting principles (or “GAAP”). A decrease or loss of revenue does not in and of itself reduce consolidated net income, as it is not considered a loss under GAAP for which an adjustment is permitted. GAAP accounting rules are admittedly complicated, but the accounting treatment by public companies can serve as an instructive parallel when considering the appropriate treatment under GAAP for “extraordinary” or “unusual” losses.

Recent SEC guidance regarding disclosure considerations of public companies related to COVID-19 reinforces existing rules regarding the presentation of non-GAAP financial measures in respect of COVID-19.1 Several leading accountancy firms have articulated the view that the presentation of estimated lost revenues or profits would be an inappropriate non-GAAP financial measure and potentially subject to challenge by the SEC, even as they recognize the ability of companies to adjust for certain unusual charges clearly related to COVID-19 that are separate from, or incremental to, normal operations. Such a position is consistent with public company reporting from natural disasters such as Hurricane Katrina, where lost revenues and earnings were not allowed to be presented as a GAAP measures.

Accordingly, some borrowers may seek to avail themselves of more modest EBITDA adjustments rather than adding back lost revenues resulting from the pandemic. Certain charges, such as additional cleaning costs and so-called “combat pay,” may be appropriate if directly related to the COVID-19 outbreak. Adjustments for asset impairment charges or for discontinued operations may also be appropriate, but companies should ensure that all GAAP requirements are met prior to taking such adjustments. For example, impairments of good will and intangible assets must be tested when a “triggering event” occurs. Similarly, only disposals of business that represent strategic shifts that have a major impact on the company’s operations and financial results may be reported in discontinued operations. As we look into the future, we expect borrowers to carefully consider potential addbacks for revenue lost due to COVID-19 and future pandemic outbreaks as they negotiate new credit facilities, and we have begun to see such requests in the syndicated loan market.

For more information about the topics raised in this Legal Update, please contact the authors or any other member of Mayer Brown’s Banking and Finance practice. For additional perspectives regarding COVID-19’s impact on leveraged lending transactions, please see Mayer Brown’s COVID-19 webpage. Our team of experienced lending lawyers is continuing to monitor ongoing developments with respect to COVID-19 and expects to provide additional updates as they arise.


1 See CF Disclosure Guidance: Topic No. 9 (Coronavirus (COVID-19), March 25, 2020.