Experience has shown that businesses can survive insolvency and return to financial health and often the key to this is through a restructuring of its debts.
Below, we’ll explore what this term means, and how this may be relevant to your business
Corporate Debt Restructuring: Definition
Business debt restructuring is the reorganisation of an insolvent firm’s liabilities to return it to a position of liquidity, allowing it to recover and can continue to trade.
Depending on how severe the company’s problems are, restructuring should result in a clear plan that the business must stick to, agreements must be reached with creditors and a number of other measures taken to achieve a successful turnaround.
Why Would a Business Need to Restructure its Debts?
The effects of Covid-19 have made many businesses more vulnerable to insolvency even though the government provided extensive support for many. This has included restricting winding up petitions to allow firms longer to recover. But, propping firms up cannot continue indefinitely and increasingly, firms will need to return to trading independently.
So it is likely that the coming months will see many businesses needing to restructure and even those which were more insulated from the pandemic will still face many pressures in these uncertain times.
Breaching loan agreements are one of the most obvious reasons why restructuring is necessary. If the company is reliant on loans and has defaulted on payments, then it will have broken financial covenants, which show the parameters in which the business must operate. These could include being unable to cover interest payments, not having sufficient cashflow or having insufficient assets to cover liabilities.
How Likely are Banks to Agree to Business Debt Restructuring?
Much will depend on whether the lender sees the company as having a viable future. However, lenders will also know that if a company can be turned around, then this is likely to be a better result for all concerned and longer term, loan repayments will be recouped. Entering liquidation, which means an immediate halt to trading, could mean lenders lose out substantially.
What are the Benefits of Business Debt Restructuring?
Business debt restructuring should be about a common goal. For directors, it can a time when they can benefit from expert advice, including turnaround experts and legal and accountancy professionals, who want to bring about recovery,
Dealing with mounting debts and creditors can be extremely challenging for directors and so a restructuring opportunity may well be seen as a lifeline.
They will also benefit from some breathing space, as restructuring should involve a standstill agreement, where creditors agree not to pursue debts until the plan is put together.
What is Included in Business Debt Restructuring?
On reaching agreement, the debt restructuring could mean a range of measures, such as extending loan terms or a debt for equity swap, where lenders substitute their debt for equity in the company.
It could well be that further borrowing is allowed but under different conditions and at better rates. The lenders may seek additional security, taken as charges that are registered at Companies House. It is likely that interest rates will be harmonised so that the company will find repayments more manageable, although there may be extra fees built in to be paid at the end of the loans.
The lenders may also seek to become more actively involved in the company in terms of limiting what can be done with borrowed money. So, this could mean focussing on its core activities, rather than embarking on riskier new ventures. They may also want to see some assets sold off. It is possible a new ceo may be brought in to introduce a new strategy and there could be a redundancy programme.
A business debt restructure may be the final chance for the company to return to profitability. New financial covenants will set a threshold that the business must stay above and there will be a number of targets and the company will be required to provide regular financial updates.
Types of Business Restructuring
A company may work largely with its lenders to restructure its finances, focusing on its loan obligations.
Alternatively, the business may opt for a Company Voluntary Arrangement (CVA) – this is where the firm has substantial debts but it is still believed to have a future. The CVA uses future lending to cover current debts and the business negotiates a legally biding payment plan with its creditors. A CVA will on average last three to five years and will be managed by an insolvency practitioner.
Administration allows a set time for a business to find a way forward, including finding a new buyer. An insolvency practitioner take charge and their aim will be to find the best option for creditors, by avoiding, at least until the end of the agreed period, liquidation.
What is the impact of the Corporate Insolvency And Governance Act 2020?
This new law, which was introduced in part to minimise the damaging effects on business from the pandemic, contains a number of measures to allow companies to restructure if necessary.
This includes a moratorium which most companies to have 40 business days without creditor approval and 12 months with it. It means that secured creditors cannot enforce or appoint an administrator and also stops other creditors taking action. The moratorium is overseen by an insolvency practitioner.
The law also allows business to use The Restructuring Plan,, which is a court-regulated arrangement that allows a company to restructure its debts. Its aim is to reach a compromise between the company and creditors and/or shareholders, who have voting rights, and it has similarities to an existing court enabled measure, called Schemes of Arrangement. Currently, this has been used on larger companies, but as it becomes more established, it may become more common with the SME sector. A Restructuring Plan can contain various options, such as debt-for-debt or debt-for-equity swaps, refinancing, debt rescheduling or waivers, or a combination of these.
Business debt restructuring is nothing new, but if insolvency cases rise, as is expected, then this is an area where more companies will be seeking guidance to see if it holds relevance and a potential solution to their situation.