Corporate debt restructuring is a process by which a company in financial difficulty agrees with its creditors to reorganise its debt obligations. The restructuring is designed to avoid the need for formal insolvency procedures and to maximise the value left in the company. But what is the process exactly? And what steps do you need to take to ensure you get the most out of it?
In this article we will be covering:
- What is a corporate debt restructuring?
- When might a company go through a debt restructuring?
- Why might a company go through a debt restructuring?
- Why might a creditor want a debt restructuring?
- What are the benefits of corporate debt restructuring?
- What is the process of corporate restructuring?
- What are the key terms for a restructuring agreement?
What is a corporate debt restructuring?
A debt restructuring is the process under which a company agrees with its creditors to reorganise its debts. Debt restructuring is usually implemented by way of contract between the company and its creditors, although there are also statutory procedures that may be used.
Many corporate restructurings involve implementing cost-cutting measures and a refinancing of a company’s existing debts. These cost-cutting measures may include closing unprofitable businesses and selling certain assets.
When might a company go through a debt restructuring?
Loan agreements typically include representations and warranties about the state of affairs of a company. These include statements that there has been no default under existing agreements or finance documents and that the borrower is not in financial difficulty.
Financial covenants in loan agreements set out the parameters (e.g. financial ratios) within which a borrower must operate during the term of the loan. These ratios form limits within which a lender expects a business to operate, if it is financially healthy. A lender will use these covenants to monitor the financial health of the borrower as an early warning sign of distress.
Why might a company go through a debt restructuring?
A company’s financial covenants with its lenders will typically include:
- Cashflow cover: Whether a business has sufficient cash flow to service its debt
- Interest cover ratios: Whether a company has sufficient profits to cover interest payments
- Leverage ratios: A company’s ratio of borrowing to its operating cash flow or earnings before interest, tax, depreciation, and amortization (EBITDA)
- Net worth: A minimum amount of value in tangible assets
- Working capital tests: The ratio of current assets versus current liabilities
A breach of a financial covenant requires a borrower to notify its lenders and the lenders will be entitled to exercise some control over the business. If a borrower breaches a financial covenant then a lender will be permitted to accelerate the loan and cancel any rights to draw down further funds. A breach of a financial covenant is an event of default and may trigger a debt restructuring.
Why might a creditor want a debt restructuring?
For businesses going through temporary financial difficulty, many lenders will recognise that they will obtain better returns on their investment through a restructuring than through formal insolvency procedures.
Once a company gets into financial trouble, its lenders will have considerable power over a company. A lender may threaten to accelerate its loan and cut off access to further funds. A company will want to avoid this if it is to continue trading. However, a lender may wish to avoid triggering a formal insolvency, as this will trigger defaults in the company’s other obligations and may ultimately reduce a creditor’s chances of being repaid.
A restructuring can be attractive to lenders as they stand a chance of being repaid in full, if the company is given sufficient flexibility over the terms of repayment. By contrast, formal insolvency procedures crystallise losses and can stop a business for generating revenue.
Lenders will, however, wish to establish that there is inherent value in a business, that the company’s business model is sound and that the restructuring has the support of the company’s principal creditors.
What are the benefits of corporate debt restructuring?
For a company, a corporate restructuring offers the possibility of avoiding insolvency and to continue trading. For a lender, a corporate restructuring offers the possibility of getting the highest return on their investment.
What is the process of corporate restructuring?
In a restructuring with significant bank or bondholder debt, there are typically three steps:
- Establish a steering committee
- Negotiate a standstill agreement
- Negotiate a restructuring agreement
The main creditors will normally establish a committee of key creditors to take major decisions on the restructuring. The committee will act as a general point of liaison between the borrower and the creditors. The committee will also likely appoint investigating accountants and legal advisers.
The standstill agreement prohibits the acceleration or termination of loans, the enforcement of security or the instigation of insolvency proceedings. It freezes all debts and lenders are prohibited from taking actions to improve their individual positions.
The restructuring agreement sets out the deferment or rescheduling of debt repayments, extends maturity dates and may add outstanding interest payments to the value of the debt (a capitalisation of interest). A restructuring agreement may also include a debt for equity swap where the lenders convert their debt into equity in the borrowing company.
What are the key terms for a restructuring agreement?
The key terms of a restructuring agreement will include:
- Cash conservation measures
- Cash generation
- Financial covenants
- Pricing and fees
- New money
- Security
Lenders will want to restrict what a borrower can do with its cash and will likely wish to prohibit paying dividends, capital expenditure, acquisitions or further borrowing. They will also wish to see that cash is generated from the sale of non-core assets of the borrower.
The financial covenants will set a threshold below which a lender will no longer support a borrower. This may include a financial goal that a borrower must obtain or a set of ratios that a borrower is expected to meet. The financial covenants will aim to test a borrower’s capital adequacy, liquidity and solvency.
The lenders will need to agree whether their fees will be paid in advance or at the end of the loan. Frequently there is a harmonisation of interest rates, so that the highest rate of interest becomes the standard interest rate for all loans.
Frequently, a borrower will wish to obtain new funding as part of the restructuring. The restructuring agreement will deal with how the company can expect to obtain new funding. At this point senior lenders may wish to end their relationship with the company and sell their debt on the secondary markets.
