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The Federal Reserve has been on overdrive this month, dispatching economic tools to buoy companies during the coronavirus pandemic. But the central bank’s inherently arms-length role in supporting businesses during crises means its new lending programs could leave out some of the more troubled retailers facing insolvency. 

The Main Street Lending Program, which the Fed outlined this month and which is expected to provide up to $600 billion in loans to businesses, reflects that tension. In theory, the program casts a wide net, targeting companies with up to 10,000 employers, or those with revenues of under $2.5 billion. 

But these loans come with the Fed’s condition that eligible businesses would have had to be in good financial standing before the pandemic. That spells doubt for companies facing insolvency now, even if that’s a result of the pandemic, attorneys said. The loan proceeds also cannot be used as debtor-in-possession financing, for instance, which helps fund companies’ operations during their Chapter 11 restructuring proceedings.  

“The Fed will need to walk a very careful line so that it’s not extending credit in violation of its own authority, but that it still provides a much needed source of capital to businesses who are currently struggling,” said Seth Ashby, a partner at Varnum LLP, where he leads the business and corporate services team. 

In general, the Federal Reserve may not lend into the economy directly. In emergency situations, the Fed may assist the economy and open up programs that involve direct lending, but there are conditions.

The MSLP is a function of the $2 trillion Coronavirus Aid, Relief, and Economic Security Act that Congress passed last month, and it is expected to formally launch in the coming weeks.

It is one of a suite of lending programs meant to help tide over companies during government-mandated shut downs to contain the spread of COVID-19, the contagious respiratory illness rippling across the country. In the U.S. alone, there are some 560,891 confirmed cases of the illness, according to the Johns Hopkins University tally.  

The $600 billion MSLP is being funded in part through a $75 billion investment that the Treasury is making in a new entity established by the Fed, which comes from the $2 trillion CARES Act stimulus package. But the Fed would provide the other $525 billion, which is not part of the stimulus.

The specifics of the MSLP’s implementation are still being worked out, and there is a comment period until April 16 for companies to ask more questions and offer feedback.

But it appears to impose some key restrictions for businesses that would receive them, capping executive compensation, and restricting stock buybacks as well as capital distribution to shareholders, as articulated in the CARES Act. Companies also cannot use MSLP loans to pay down their existing debt. 

But it could give retailers some breathing room, particularly with their other existing secured lenders. These loans provide a potential source of capital to use to push back on secured lenders who might otherwise be pressuring for a surrender of collateral, or so called “capitulation transactions,” which are essentially liquidations, said Ashby. 

“This type of assistance provides headwinds to senior secured lenders, but it remains to be seen how strong of a headwind this will be,” he said.

“The timing of the funding available is unclear, and secured lenders will do what they can to force their borrowers to preserve cash and to preserve the value of the collateral,” he added. “Senior Secured lenders are going to have the ultimate leverage over their borrowers.” 

What the MSLP means for retaining employees is also not clear. Unlike the Paycheck Protection Program, which rolled out earlier this month and was devised explicitly to help companies spend on payroll costs, the MSLP only requires that companies make “reasonable” efforts to maintain their workforce.

But what that means, and how it will actually be enforced, especially if it’s a representation a company makes at the time it is obtaining the loan, remains to be seen, attorneys said. 

“Lenders don’t normally call defaults based on representations being untrue at the time they were made at closing,” said Adam Wolk, a partner in the New York office of Mayer Brown’s banking and finance practice. “At the same time, there may be reasons the Fed would want to track companies’ compliance with these representations.”