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Debt restructuring is a process that allows a private or public company or a sovereign entity facing cash flow problems and
financial distress Financial distress is a term in corporate finance used to indicate a condition when promises to creditors of a company are broken or honored with difficulty. If financial distress cannot be relieved, it can lead to bankruptcy. Financial distress ...
to reduce and renegotiate its delinquent
debt Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, the creditor. Debt is a deferred payment, or series of payments, which differentiates it from an immediate purchase. The ...
s to improve or restore
liquidity Liquidity is a concept in economics involving the convertibility of assets and obligations. It can include: * Market liquidity, the ease with which an asset can be sold * Accounting liquidity, the ability to meet cash obligations when due * Liq ...
so that it can continue its operations. Replacement of old debt by new debt when not under financial distress is called "
refinancing Refinancing is the replacement of an existing debt obligation with another debt obligation under a different term and interest rate. The terms and conditions of refinancing may vary widely by country, province, or state, based on several economic ...
". Out-of-court
restructuring Restructuring is the corporate management term for the act of reorganizing the legal, ownership, operational, or other structures of a company for the purpose of making it more profitable, or better organized for its present needs. Other reasons ...
s, also known as s, are increasingly becoming a global reality.


Motivation

Debt restructuring involves a reduction of debt and an extension of payment terms and is usually less expensive than
bankruptcy Bankruptcy is a legal process through which people or other entities who cannot repay debts to creditors may seek relief from some or all of their debts. In most jurisdictions, bankruptcy is imposed by a court order, often initiated by the debto ...
. The main costs associated with debt restructuring are the time and effort spent negotiating with bankers, creditors, vendors, and tax authorities. In the United States, small business bankruptcy filings cost at least $50,000 in legal and court fees, and filing costs in excess of $100,000 are common. By some measures, only 20% of firms survive
Chapter 11 Chapter 11 of the United States Bankruptcy Code (Title 11 of the United States Code) permits reorganization under the bankruptcy laws of the United States. Such reorganization, known as Chapter 11 bankruptcy, is available to every business, wheth ...
bankruptcy filings. Historically, debt restructuring has been the province of large corporations with financial wherewithal. In the
Great Recession The Great Recession was a period of marked general decline, i.e. a recession, observed in national economies globally that occurred from late 2007 into 2009. The scale and timing of the recession varied from country to country (see map). At ...
that began with the
financial crisis of 2007–08 Finance is the study and discipline of money, currency and capital assets. It is related to, but not synonymous with economics, the study of production, distribution, and consumption of money, assets, goods and services (the discipline of f ...
, a component of debt restructuring called debt mediation emerged for small businesses (with revenues under $5 million). Like debt restructuring, debt mediation is a business-to-business activity and should not be considered the same as individual debt reduction involving
credit card A credit card is a payment card issued to users (cardholders) to enable the cardholder to pay a merchant for goods and services based on the cardholder's accrued debt (i.e., promise to the card issuer to pay them for the amounts plus the ...
s, unpaid taxes, and defaulted mortgages. In 2010 debt mediation has become a primary way for small businesses to refinance in light of reduced lines of credit and direct borrowing. Debt mediation can be cost-effective for small businesses, help end or avoid litigation, and is preferable to filing for bankruptcy. While there are numerous companies providing restructuring for large corporations, there are few legitimate firms working for small businesses. Legitimate debt restructuring firms only work for the debtor client (not as a debt
collection agency Debt collection is the process of pursuing payments of debts owed by individuals or businesses. An organization that specializes in debt collection is known as a collection agency or debt collector. Most collection agencies operate as agents of ...
) and should charge fees based on success. Among the debt situations that can be worked out in business-to-business debt mediation are: lawsuits and judgments, delinquent property, machinery, equipment rentals/leases, business loans or mortgage on business property, capital payments due for improvements/construction, invoices and statements, disputed bills and problem debts.


Methods


Debt-for-equity swap

In a debt-for-equity swap, a company's
creditor A creditor or lender is a party (e.g., person, organization, company, or government) that has a claim on the services of a second party. It is a person or institution to whom money is owed. The first party, in general, has provided some property ...
s generally agree to cancel some or all of the
debt Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, the creditor. Debt is a deferred payment, or series of payments, which differentiates it from an immediate purchase. The ...
in exchange for
equity Equity may refer to: Finance, accounting and ownership *Equity (finance), ownership of assets that have liabilities attached to them ** Stock, equity based on original contributions of cash or other value to a business ** Home equity, the diff ...
in the company. Debt for equity deals often occur when large companies run into serious financial trouble, and often result in these companies being taken over by their principal creditors. This is because both the debt and the remaining assets in these companies are so large that there is no advantage for the creditors to drive the company into bankruptcy. Instead the creditors prefer to take control of the business as a
going concern A going concern is a business that is assumed will meet its financial obligations when they become due. It functions without the threat of liquidation for the foreseeable future, which is usually regarded as at least the next 12 months or the spec ...
. As a consequence, the original shareholders' stake in the company is generally significantly diluted in these deals and may be entirely eliminated, as is typical in a
Chapter 11 bankruptcy Chapter 11 of the United States Bankruptcy Code ( Title 11 of the United States Code) permits reorganization under the bankruptcy laws of the United States. Such reorganization, known as Chapter 11 bankruptcy, is available to every business, whe ...
. Agreements to swap debt for equity also often occur because companies are obliged to comply, per the terms of a contract with certain lending institutions, with specified debt to equity ratios. Debt-for-equity swaps are one way of dealing with
sub-prime In finance, subprime lending (also referred to as near-prime, subpar, non-prime, and second-chance lending) is the provision of loans to people in the United States who may have difficulty maintaining the repayment schedule. Historically, subpri ...
mortgages. A householder unable to service his debt on a $180,000 mortgage for example, may by agreement with his bank have the value of the mortgage reduced (say to $135,000 or 75% of the house's current value), in return for which the bank will receive 50% of the amount by which any resale value, when the house is resold, exceeds $135,000.


Bondholder haircuts

A debt-for-equity swap may also be called a "bondholder
haircut A hairstyle, hairdo, haircut or coiffure refers to the styling of hair, usually on the human scalp. Sometimes, this could also mean an editing of facial or body hair. The fashioning of hair can be considered an aspect of personal grooming ...
". Bondholder haircuts at large banks were advocated as a potential solution for the
subprime mortgage crisis The United States subprime mortgage crisis was a multinational financial crisis that occurred between 2007 and 2010 that contributed to the 2007–2008 global financial crisis. It was triggered by a large decline in US home prices after the col ...
by prominent economists: Economist
Joseph Stiglitz Joseph Eugene Stiglitz (; born February 9, 1943) is an American New Keynesian economist, a public policy analyst, and a full professor at Columbia University. He is a recipient of the Nobel Memorial Prize in Economic Sciences (2001) and the J ...
testified that bank
bailout A bailout is the provision of financial help to a corporation or country which otherwise would be on the brink of bankruptcy. A bailout differs from the term ''bail-in'' (coined in 2010) under which the bondholders or depositors of global sys ...
s "are really bailouts not of the enterprises but of the
shareholder A shareholder (in the United States often referred to as stockholder) of a corporation is an individual or legal entity (such as another corporation, a body politic, a trust or partnership) that is registered by the corporation as the legal o ...
s and especially bondholders. There is no reason that American taxpayers should be doing this". He wrote that reducing bank debt levels by converting debt into equity will increase confidence in the financial system. He believes that addressing bank solvency in this way would help address credit market liquidity issues. Economist
Jeffrey Sachs Jeffrey David Sachs () (born 5 November 1954) is an American economist, academic, public policy analyst, and former director of The Earth Institute at Columbia University, where he holds the title of University Professor. He is known for his work ...
has also argued in favor of such haircuts: "The cheaper and more equitable way would be to make shareholders and bank bondholders take the hit rather than the taxpayer. The Fed and other bank regulators would insist that bad loans be written down on the books. Bondholders would take haircuts, but these losses are already priced into deeply discounted bond prices." If the key issue is bank solvency, converting debt to equity via bondholder haircuts presents an elegant solution to the problem. Not only is debt reduced along with interest payments, but equity is simultaneously increased. Investors can then have more confidence that the bank (and financial system more broadly) is solvent, helping unfreeze credit markets. Taxpayers do not have to contribute dollars and the government may be able to just provide guarantees in the short term to buttress confidence in the recapitalized institution. For example,
Wells Fargo Wells Fargo & Company is an American multinational financial services company with corporate headquarters in San Francisco, California; operational headquarters in Manhattan; and managerial offices throughout the United States and intern ...
owed its bondholders $267 billion, according to its 2008 annual report. A 20% haircut would reduce this debt by about $54 billion, creating an equal amount of equity in the process, thereby recapitalizing the bank significantly.


Informal debt repayment agreements

Most
defendant In court proceedings, a defendant is a person or object who is the party either accused of committing a crime in criminal prosecution or against whom some type of civil relief is being sought in a civil case. Terminology varies from one jurisd ...
s who cannot pay the enforcement officer in full at once enter into negotiations with the officer to pay by installments. This process is informal but cheaper and quicker than an application to the court. Payment by this method relies on the cooperation of the creditor and the enforcement officer. It is therefore important not to offer more than you can afford or to fall behind with the payments you agree. If you do fall behind with the payments and the enforcement officer has seized goods, they may remove them to the sale room for auction.


In various jurisdictions


Canada

Two common avenues for restructuring debt exist in Canada: a Division 1 Proposal and a CCAA filing. The former is available to both corporations and individuals who owe $250,000 or more to creditors. The latter is available only to larger companies owing more than $5 million to their creditors. A Division 1 Proposal is a last resort. Created by the
Bankruptcy and Insolvency Act The ''Bankruptcy and Insolvency Act'' (BIA; french: Loi sur la faillite et l'insolvabilité) (the ''Act'') is one of the statutes that regulates the law on bankruptcy and insolvency in Canada. It governs bankruptcies, consumer and commercial prop ...
of 1985, the option to file Division 1 is not an option to be taken lightly as, in the event that the stipulations within the proposal get voted down by creditors or not signed off by the court, one falls into bankruptcy. Division 1 proposals allow companies to be briefly relieved of lawsuits by creditors, as well as they allow companies to stop paying money to their unsecured creditors while the proposal is being reviewed. A Division 1 Proposal to restructure debts must secure 66% of the creditors' votes set in proportion to how much they are owed, and 50% plus one of all creditors votes in terms of number of creditors. On top of such democratic approval, the court itself has to approve how the debts get restructured. Withstanding all such approval, a business or individual can continue operating as normal; otherwise, a business or individual is obliged to proceed into bankruptcy filing. CCAA filings were created by the
Companies' Creditors Arrangement Act The ''Companies' Creditors Arrangement Act'' (CCAA; french: Loi sur les arrangements avec les créanciers des compagnies) is a statute of the Parliament of Canada that allows insolvent corporations owing their creditors in excess of $5 million to ...
, a piece of legislation first put forward and passed in 1933 and updated later in 1985. A CCAA filing allows a Canadian company to have a window in time (typically between 30 and 90 days) in which they can renegotiate and reorganize their debt payment plans with creditors. During this brief period, creditors cannot seize any money that is owed to them. These windows of time may be renewed multiple times over. Once a CCAA application gets finally rejected, the company in question can be forced into
receivership In law, receivership is a situation in which an institution or enterprise is held by a receiver—a person "placed in the custodial responsibility for the property of others, including tangible and intangible assets and rights"—especially in c ...
or
bankruptcy Bankruptcy is a legal process through which people or other entities who cannot repay debts to creditors may seek relief from some or all of their debts. In most jurisdictions, bankruptcy is imposed by a court order, often initiated by the debto ...
. This could happen for a number of reasons, chief among them being a failure to come to an agreement with creditors as to how to restructure the debt.


Switzerland

Under
Swiss Swiss may refer to: * the adjectival form of Switzerland *Swiss people Places * Swiss, Missouri *Swiss, North Carolina * Swiss, West Virginia *Swiss, Wisconsin Other uses * Swiss-system tournament, in various games and sports * Swiss Internation ...
law, debt restructuring may occur out of court, or through a court-mediated debt restructuring agreement that may provide for a partial waiver of debts, or for a liquidation of the debtor's assets by the creditors.


United Kingdom

The majority of debt restructuring within the
United Kingdom The United Kingdom of Great Britain and Northern Ireland, commonly known as the United Kingdom (UK) or Britain, is a country in Europe, off the north-western coast of the continental mainland. It comprises England, Scotland, Wales and ...
is undertaken on a collaborative basis between the borrower and the creditors. Should this be unsatisfactory in the first instance, the court may be asked to mediate and appoint administrators.


United States

Among the most common forms of in-court debt restructuring for firms in the United States are
Chapter 11 Chapter 11 of the United States Bankruptcy Code (Title 11 of the United States Code) permits reorganization under the bankruptcy laws of the United States. Such reorganization, known as Chapter 11 bankruptcy, is available to every business, wheth ...
and
Chapter 12 Chapter 12 of Title 11 of the United States Code, or simply chapter 12, is a chapter of the Bankruptcy Code. It is similar to Chapter 13 in structure, but it offers additional benefits to farmers and fishermen in certain circumstances, beyond th ...
bankruptcy. Under Chapter 11, firms form a plan to reorganize their credit obligations, such that they are able to continue operating while they are going through with their debt repayment plans and after they become solvent. Creditors are given promises to be paid back with firms' future earnings. The nature of these promises can be shaped in a number of ways. In situations where every single impaired creditor of a firm agrees to a settled schedule of repayment, the plan formed is known as a "consensual plan." When a certain class a firm owes does not accept a restructuring plan, said plan may still be approved pursuant to the United States Bankruptcy Code. Such plans are colloquially referred to as "cramdown plans." Chapter 11 is considered to be one of the most expensive and complicated forms of bankruptcy to file. The vast majority of Chapter 11 bankruptcy cases filed end up allowing company management to go forward running the business as usual; however, in certain exceptional cases (fraud, gross incompetence, etc.) the courts do not allow the business the privilege of simply maintaining a "
debtor in possession A debtor in possession or DIP in United States bankruptcy law is a person or corporation who has filed a bankruptcy petition, but remains in possession of property upon which a creditor has a lien or similar security interest. A debtor becomes ...
" status. In said cases, a trustee is appointed by the court to run the business until all bankruptcy proceedings are completed. Chapter 12 Bankruptcy is a form of debt restructuring in the United States available to farms and fisheries exclusively; said businesses could be family-owned or owned by corporations. The special debt restructuring rights accorded to farmers and fisheries consequent line 12 of the United States Bankruptcy Code were first granted by Congress in 1986 amid an agricultural debt crisis. Food commodity prices were caught in a downward spiral in the years leading up to 1986, pushing U.S. farmers' debts to levels above $200 billion. This 12th line of the U.S. Bankruptcy Code was initially added only as a temporary measure and remained as a temporary measure until 2005, when it became permanent. Chapter 12 was of great benefit to farmers, because Chapter 11 was often too expensive for family farms and generally only useful for sizeable corporations, while
Chapter 13 Title 11 of the United States Code sets forth the statutes governing the various types of relief for bankruptcy in the United States. Chapter 13 of the United States Bankruptcy Code provides an individual with the opportunity to propose a plan o ...
was mainly of use to individuals attempting to restructure very small debts. Farms and fisheries, being midsize and seasonal in nature, were thus in need of a more flexible legal framework through which they could restructure their debts. Firms in the United States are not limited to only using the legal system to manage debts they are incapable of repaying. Out-of-court restructuring, or workouts, constitute consensual agreements between firms and their creditors to adjust debt obligations, mainly for the purpose of evading the costly legal fees associated with Chapter 11. The decision as to whether to enter a workout or take the issue into court is, in large a part, a function of the creditors' and debtors' respective perceptions of how much can be gained or lost through a Chapter 11 proceeding. Creditors know that once Chapter 11 has commenced, a degree of negotiating leverage is lost, as judicial authorities may impose alterations of claims without regard to creditors' consent. On numerous occasions, merely throwing out the threat of filing bankruptcy has initiated the process of coming to a private agreement.


Italy

Debt restructuring within
Italy Italy ( it, Italia ), officially the Italian Republic, ) or the Republic of Italy, is a country in Southern Europe. It is located in the middle of the Mediterranean Sea, and its territory largely coincides with the homonymous geographical ...
may occur either out of court (ex article 167 of the Italian Bankruptcy Law) when a waiver or simple debt rescheduling is required, or through a court-mediated debt restructuring agreement (ex article 182/bis of the Italian Bankruptcy Law) and may provide for a partial waiver of debts, mandatory recapitalization of the debtor, or for a liquidation of certain debtor's assets to repay privileged creditors.


Germany

While being famous for its efficiency in other matter, this is not true for debt restructuring. Many German companies prefer to restructure their debts using the English scheme of arrangement proceedings because they believe that the German restructuring law is not very helpful. The main reason for this is that binding a dissenting minority is only possible under formal insolvency proceedings in
Germany Germany,, officially the Federal Republic of Germany, is a country in Central Europe. It is the second most populous country in Europe after Russia, and the most populous member state of the European Union. Germany is situated betwee ...
.


Corporate restructuring

As the incidence of corporate failures has increased in part due to current economic climate, so a more "standard" approach to restructuring has developed. Although every case has unique characteristics, the process of restructuring follows a number of important phases. Initially, declining financial performance will cause key financial covenants - for example, leverage ratios - along with the company's underlying cash position to become tight and the prospect of the company needing to restructure will become more obvious to creditors and the debtor alike. This triggers a gathering of creditors and other stakeholders, in anticipation of a breach of financial covenants, a crisis of
liquidity Liquidity is a concept in economics involving the convertibility of assets and obligations. It can include: * Market liquidity, the ease with which an asset can be sold * Accounting liquidity, the ability to meet cash obligations when due * Liq ...
, or impending debt instruments coming due that will not be able to be refinanced, all of which could be the impetus for a bankruptcy taking place if not rectified. The lending group (typically comprising corporate finance divisions of banks) will normally commission a corporate advisory group to review the business and its financial position. This will form the basis of any restructuring of facilities. The lending group will typically appoint a Corporate Restructuring Officer (CRO) to assist management in the turnaround of the business, and embracing the recommendations presented by the banking group and the corporate advisory report.


See also

*
Debt relief Debt relief or debt cancellation is the partial or total forgiveness of debt, or the slowing or stopping of debt growth, owed by individuals, corporations, or nations. From antiquity through the 19th century, it refers to domestic debts, in particu ...
* Debt settlement *
Troubled debt restructuring A troubled debt restructuring (TDR) is defined as a debt restructuring in which a creditor, for economic or legal reasons related to a debtor's financial difficulties, grants a concession to the debtor that it would not otherwise consider. As suc ...


Books

''Innovation in financial restructuring: Focus on signals, processes and tools, Vurtus Interpress, Marco Tutino and Valerio Ranciaro, 26 April 2020''


References

{{Authority control Bankruptcy
Restructuring Restructuring is the corporate management term for the act of reorganizing the legal, ownership, operational, or other structures of a company for the purpose of making it more profitable, or better organized for its present needs. Other reasons ...
Insolvency