For companies that find themselves in financial difficulties, the inability to service debts is often seen as the final staging post on the road to insolvency. But not being able to meet payback obligations does not make insolvency inevitable.
In recent years, there has been a noticeable policy shift towards trying to keep more defaulting businesses out of formal insolvency procedures.
Perhaps the most obvious sign of this was the passing of the Corporate Insolvency and Governance Act in 2020 (CIGA 2020). The Act made headlines for the temporary debt relief measures it introduced in response to the COVID-19 pandemic. But it also made significant and permanent changes to insolvency rules aimed at smoothing the path for corporate debt restructuring. It’s three key articles were:
- The introduction of a new free-standing repayment moratorium;
- A formalised restructuring process;
- Limitations on creditors’ ability to terminate contracts if a supplier becomes or is in danger of becoming insolvent.
Debt restructuring is now widely viewed as beneficial to all parties. For the debtor, reaching an agreement on reorganising their liabilities so they are more manageable allows them to continue trading with full control over the business, without entering administration or a CVA.
For creditors, debt restructuring often protects the returns they get on their investment better than pushing for insolvency would. Insolvency carried a certain stigma with it and companies that enter insolvency proceedings often experience a sharp decline in value, even if they continue trading.
Corporate debt restructuring can take the form of a private contractual agreement between a company and its creditors, or it can follow the procedures set out in the CIGA 2020. Here are four steps common to most restructuring processes.
Establishing a Steering Committee
When a company starts to struggle to meet its debt obligations, it usually affects more than one creditor. Debt restructuring is usually led by a steering committee made up of representatives of all major creditors, who work as one body to agree a plan that serves all of their interests.
Implementing a Standstill Agreement
A standstill agreement is a legal mechanism for gaining relief from debt liabilities. It will usually involve creditors agreeing not to demand payment or pursue further action (e.g. insolvency filings) for a specified period of time.
With regards to debt restructuring, the purpose of a standstill agreement is to create the time and space for avenues for reorganising a debt to be investigated and discussed, without the threat of further action hanging over the debtor.
The CIGA 2020 made provision for a statutory 20-day moratorium on all debt enforcements following default, which in certain circumstances can be extended to 40 days without the agreement of creditors. The legal right to claim this moratorium sits apart from the option to negotiate a standstill agreement.
Conducting Due Diligence
Once the debtor has the reassurances of a standstill agreement in place, the next step is to investigate the viability of restructuring their liabilities. This will involve a number of different factors, including reviewing company accounts, getting an external valuation of the business, looking at strategic business plans and forecasts, and also determining whether the repayment interests of all the creditors can be aligned.
Agreeing on the Restructuring Approach
Debt restructuring can take a number of different forms. Options include:
- Rescheduling debt repayments, often to lower each instalment by extending the repayment period.
- Covenant waivers, or agreeing to allow the debtor to operate outside the limits of the financial covenant signed when the loan or line of credit was initially agreed.
- Swapping debt for equity, i.e. giving creditors a stake in the business in exchange for reduced repayment liabilities.
- Equity injections, perhaps in the form of additional loans and / or investments from existing creditors to help the debtor overcome what are perceived as temporary challenges and return to a stronger trading footing.
It is up to the steering committee to agree a restructuring approach and define specific terms that are acceptable to all parties. If this can be done, these will then be drawn up into a contractual agreement which will determine the debtor’s obligations going forward.
If you are a business struggling to repay debt, get in touch with our team of experts to get no obligation professional advice about your options.