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Debt Restructuring

Debt Restructuring

Debt restructuring is a process wherein a company or an entity experiencing financial distress and liquidity problems refinances its existing debt obligations in order to gain more flexibility in the short term and make their debt load more manageable overall.

Reason for Debt Restructuring

A company that is considering debt restructuring is likely experiencing financial difficulties that cannot be easily resolved. Under such circumstances, the company faces limited options – such as restructuring its debts or filing for bankruptcy. Restructuring existing debts is obviously preferable and more cost-effective in the long term, as opposed to filing for bankruptcy.

How to Achieve Debt Restructuring

Companies can achieve debt restructuring by entering into direct negotiations with creditors to reorganize the terms of their debt payments. Debt restructuring is sometimes imposed upon a company by its creditors if it cannot make its scheduled debt payments. Here are some ways that it can be achieved:

• Debt for Equity Swap: Creditors may agree to forgo a certain amount of outstanding debt in exchange for equity in the company. This usually happens in the case of companies with a large base of assets and liabilities, where forcing the company into bankruptcy would create little value for the creditors. It is deemed beneficial to let the company continue to operate as a going concern and allow the creditors to be involved in its operations. This can mean that the original shareholder base will have a significantly diluted or diminished stake in the company.

• Bondholder Haircuts: Companies with outstanding bonds can negotiate with its bondholders to offer repayment at a “discounted” level. This can be achieved by reducing or omitting interest or principal payments.

• Informal Debt Repayment Agreements: Companies that are restructuring debt can ask for lenient repayment terms and even ask to be allowed to write off some portions of their debt. This can be done by reaching out to the creditors directly and negotiating new terms of repayment. This is a more affordable method than involving a third-party mediator and can be achieved if both parties involved are keen to reach a feasible agreement.

Debt Restructuring vs. Bankruptcy

Debt restructuring usually involves direct negotiations between a company and its creditors. The restructuring can be initiated by the company or, in some cases, be enforced by its creditors. On the other hand, bankruptcy is essentially a process through which a company that is facing financial difficulty is able to defer payments to creditors through a legally enforced pause. After declaring bankruptcy, the company in question will work with its creditors and the court to come up with a repayment plan. In case the company is not able to honour the terms of the repayment plan, it must liquidate itself in order to repay its creditors. The repayment terms are then decided by the court.

Debt Restructuring vs. Debt Refinancing

Debt restructuring is distinct from debt refinancing. The former requires debt reduction and an extension to the repayment plan. On the other hand, debt refinancing is merely the replacement of an old debt with a newer debt, usually with slightly different terms, such as a lower interest rate.

How Debt Restructuring Works

Some companies seek to restructure debts when they’re facing bankruptcy. They might have several loans are structured in such a way that some are subordinate in priority to other loans. The senior debt holders would be paid before the lenders of subordinated debts if the company were to go into bankruptcy. Creditors are sometimes willing to alter these and other terms to avoid dealing with a potential bankruptcy or default. The debt restructuring process is typically carried out by reducing the interest rates on loans, by extending the dates when the company’s liabilities are due to be paid, or both. These steps improve the firm’s chances of paying back the obligations. Creditors understand that they would receive even less should the company be forced into bankruptcy and/or liquidation. Restructuring debt can be a win-win for both entities. The business avoids bankruptcy and the lenders typically receive more than what they would through a bankruptcy proceeding. Individuals can restructure their debts in various ways as well, but be sure to check the credentials and reputation of any debt relief service you’re considering with your state’s attorney general or consumer protection agency because not all are reputable.

• The creditor company should prepare a roadmap for the process. The strategy should include the expected time necessary to recover the debts, the terms of loan repayment, and watching the financial performance of the debtor.

• The decision of the financial institution regarding it depends on whether the debtor has invested in the company, holds shares with the company, or is a subsidiary of the company.

• If there is conflict within the company’s board of directors regarding the process, then it is advisable to ask for help from a third party. However, third party mediation should not be necessary if the debtor is a subsidiary of the company.

• Making a cash flow projection is also important to the process. It is advisable not to include uncertain cash flow estimates in the plan.

• The debtor’s financial situation should also be considered, when making a plan. The debtor’s ability to repay the loan depends on the financial management, so the financial company needs to look into the debtor’s roadmap for repaying loans. If the debtor is another company, then changing the key people associated with it, like the director, board of directors or chairperson might help.

Debt Consolidation

A debt consolidation is not a loan but rather the process of restructuring a debt to be repaid over three to five years. To file for a consolidation, a debtor must have a consistent source of income. A debtor’s income and their amount of debt will determine their owed monthly payment. A debt consolidation can cut the total amount of debt owed, which in turn eliminates additional interest.

In a debt consolidation, the courts organize a person’s debts into three categories:

• Secured debts: Debts with collateral such as a car loan or mortgage

• Priority debts: Debts designated by the bankruptcy code as a high-priority debt payment, including some tax debts, spousal support and child support payments

• Non-priority debts: Payday loans, credit cards, medical debts and other debts without collateral

Advantages Of Debt Management Over Debt Restructuring.

• No new loans: Because a debt management program does not involve taking out a new loan, it may be easier to protect your credit score.
• Less cost: While debt restructuring deals can be quite costly, the cost of a debt management program with ACCC is minimal as a non-profit; we’re committed to keeping our fees as low as possible.
• Debt Consolidation is the process that allows borrowers to refinance and/or turn multiple smaller (high-interest rate) loans into one single loan. “This makes it more convenient for borrowers to pay off their loan in a shorter amount of time and if it’s a lower interest rate, then also with lower monthly payments,”.
• Debt Restructuring is the process in which a debtor and creditor agree on an amount that the borrower can pay back. “The debtor then works with a credit counsellor to speak with creditors in an attempt to get out of the debt owed.”

There are many reasons why a company may become financially distressed. Once it reaches a point of insolvency, however, management may consider a restructuring of the company’s financial obligations in order to restore the company back to financial health. The restructuring could proceed informally, through a consensual restructuring, or through of a court-supervised reorganization under chapter 11 of the Bankruptcy Code. In most instances, the distressed company should first attempt to negotiate a consensual restructuring of its major obligations.

Out-of-Court Restructuring

An out-of-court restructuring or “workout” is a non-judicial process through which a financially troubled company and its significant creditors reach an agreement for adjusting the company’s obligations. A successful workout generally requires the participation of the company’s lenders, major suppliers, and depending on the circumstances, other organizations or entities such as unions or governmental agencies. Identifying and agreeing on the source of the company’s problems and the potential solutions may take time. Indeed, it is not uncommon for the company’s management to hold a different impression of the company’s financial problems than the one held by the company’s creditors. Any restructuring entails substantial demands on the time of the company’s management. In a workout, management must focus primarily on devising a viable restructuring plan and preparing a business plan and supporting projections, which likely will need to be presented to creditors.

Management also will be involved in negotiating the terms of the agreed restructuring plan and, further down the line, on implementing such plan. When successful, a consensual out-of-court restructuring signifies a willingness by the company’s creditors to work with the company to solve its financial problems. It similarly reflects a judgment by knowledgeable parties that the company can be put on sound footing outside of bankruptcy. More importantly is the fact that a workout can usually be accomplished more quickly than a chapter 11 restructuring. One factor that strongly influences the extent to which creditors are willing to compromise out of court is the company’s ability to commence an in-court bankruptcy proceeding. Because workouts must be viewed against the backdrop of a potential bankruptcy filing, each interested party is compelled to evaluate whether an out-of-court restructuring is more favourable than the likely outcome in a bankruptcy case. Creditors and equity holders must keep in mind that, if a bankruptcy case is filed, they generally lose some bargaining strength, as they become subject to the authority of the bankruptcy court and the provisions of the Bankruptcy Code allowing non-consensual modification of claims and interests. Many times, it is the company’s ultimate threat of filing for bankruptcy that forces the parties to an agreement.

In-Court Restructuring

Unlike the consensual out-of-court restructuring process, chapter 11 forces all creditors and equity interest holders into a public, court-supervised forum that must proceed according to an intricate set of rules under the Bankruptcy Code. By way of example, any activity of a company in bankruptcy that is not in the ordinary course of business or any settlement by a company with its creditors must be approved by the bankruptcy court, after notice to all interested parties. One or more of the interested parties, whether they are not a party to the transaction itself has the opportunity to challenge the proposed initiative or settlement. During a bankruptcy reorganization under chapter 11, the company normally continues to run its business as a debtor-in-possession. However, the management may owe fiduciary duties to the company’s creditors, once the company becomes insolvent and proceeds down the path of chapter 11. In contrast, when a company is solvent, management normally only owes a fiduciary to the company’s shareholders. As a result of this shift in obligations, it is sometimes difficult for management to identify predominantly where its obligations lie.

In a chapter 11 bankruptcy, the company’s obligations are restructured pursuant to a plan of reorganization, if such plan meets the numerous requirements under the Bankruptcy Code and is approved by the bankruptcy court. Among other things, the plan must provide that each creditor receives at least as much as it would have received in a chapter 7 case unless the creditor agrees to a different treatment. There are also two paths to confirm a chapter 11 plan, consensually or through “cram down.” A consensual plan is one in which all classes of impaired creditors vote to accept the plan. If one class rejects the plan, the plan can still be confirmed pursuant to certain provisions of the Bankruptcy Code. This latter approach is commonly referred to as a “cramdown.” There are situations in which restructuring in chapter 11 is the best option for a troubled company. One such situation arises when the company faces numerous lawsuits or a judgment that could destroy the company’s business. In such instances, the company is likely to obtain relief by filing for chapter 11, in order to obtain the benefit of the automatic stay, which is akin to a statutory injunction imposed in favour of the company against all creditors. Chapter 11 also can improve a company’s immediate cash position. Once a company is in bankruptcy, it is generally prohibited from making payments on pre-bankruptcy obligations.

In addition, interest ceases to accrue on the unsecured and under secured debt of the company. As a result, the company’s cash flow often improves after commencing a bankruptcy case. The Bankruptcy Code also provides mechanisms under which a debtor can obtain financing after its bankruptcy filing. Among other things, the Bankruptcy Code allows a lender to obtain super priority liens and/or claims against the company’s assets. These special protections serve to encourage lenders to provide funding that they otherwise might not provide outside of bankruptcy. Chapter 11 further provides a company with broad powers to renegotiate its contracts and leases. Under the Bankruptcy Code, a debtor or trustee can reject or assume a contract or lease, or can assign the contract or lease to a third party, despite contractual provisions prohibiting such assignment. Implicit within this authority is the ability to modify existing contractual terms.

Pre-packaged or Pre-negotiated Plans of Reorganization

Recognizing the benefits and drawbacks inherent in both the workout and chapter 11 scenarios, parties have availed themselves of procedures that facilitate obtaining the best of both worlds while minimizing their respective disadvantages. In pre-packaged chapter 11 cases, the company negotiates a plan of reorganization and solicits votes on its plan before the commencement of its bankruptcy case. In this fashion, the company can obtain the benefits of both a workout and the chapter 11 process, while significantly reducing the amount of time spent in bankruptcy. A company may secure the votes of creditors prior to filing bankruptcy through a plan support agreement, commonly referred to as a “lock-up” agreement. A lock-up agreement between a creditor and a company is an agreement whereby the creditor becomes legally bound to vote for the plan of reorganization so long as certain key plan provisions are included. In addition to pre-packaged plans, another framework that is used with frequency is the “pre-negotiated” chapter 11 plan. Similar to a pre-packaged case, in a pre-negotiated case the company negotiates with its major creditor constituencies and knows what groups tend to support its plan prior to filing bankruptcy. Unlike a pre-packaged case, however, the company does not begin the creditor approval process on its plan until after it has filed bankruptcy and obtained the bankruptcy court’s approval of its solicitation material. Although pre-negotiated cases may last a little longer than pre-packaged cases because the solicitation process occur post-filing, pre-negotiated cases still expedite a voluntary reorganization under chapter 11. One significant factor that has caused companies to start negotiating with creditors earlier than in the past is the new limitation on a company’s ability to exclusively propose a plan of reorganization during a bankruptcy case. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) limits the time period in which a company has to propose its chapter 11 plan. A company now must propose its plan within 120 days of filing or risk losing the exclusive right to propose such plan to other interested parties, like lenders or committees. For cause, the bankruptcy court may extend the company’s exclusive period for up to 18 months. A survey of the significant bankruptcy cases filed after BAPCPA reflects that many companies have chosen to negotiate their restructuring plans well before filing bankruptcy, thereby allowing them to obtain approval of their plans almost immediately after filing. Recent examples, like CIT and the Texas Rangers also suggest that this appears to be the trend.

Restructuring and Insolvency Law

Restructuring and insolvency lawyers act for clients (either individuals or companies) in financial difficulties. Restructuring is usually the first stage in the process of agreeing a way forward with creditors in order to manage repayment of the debt, without the client becoming insolvent.

What Do Restructuring And Insolvency Lawyers Do?

As a restructuring lawyer, you may be acting for either debtors or creditors. The work you undertake would be non-contentious and involve negotiating agreements and repayment schedules to enable the creditor to pay off the debt without becoming insolvent. As an insolvency lawyer, you may be acting for either debtors or creditors, but the work will be contentious. Insolvency lawyers are engaged in all stages of the insolvency process, from negotiating company voluntary arrangements, to administration and receivership. They are also engaged in the liquidation stage, where the individual or company’s assets are taken to pay off the outstanding monies owed. The precise nature of the work will depend to large extent on the type of firm you work for and the clients you represent.

Having an interest in the world of business and finance is a pre-requisite for this area of law. In order to advise clients on every aspect of restructuring their business, you will need to have very good levels of commercial awareness and excellent persuasive communication skills in order to deal with people in difficult situations. Strong communication skills are need when negotiating with debtors or creditors (depending on which side you are acting for), litigating on your client’s behalf or working alongside other professionals involved in the process, from liquidators to accountants. This is an academically demanding area of law, covering many different fields such as banking, commercial and litigation. You will need to be able to absorb large volumes of paperwork and make accurate judgement calls quickly.

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Michael R. Anderson, JD

Ascent Law LLC
8833 S. Redwood Road, Suite C
West Jordan, Utah
84088 United States

Telephone: (801) 676-5506

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