Debt Restructuring or Recovery – Which Route to Pursue, Why & How?
Financial distress can devastate a business and be costly for lenders. In this guide we will explain the differences between debt restructuring and debt recovery and which option is better for lenders. We also discuss the role of an independent financial advisor and how one may help both lenders and borrowers in distressed situations.
Watch out for the red flags
Cash flow is the glue that holds most companies together. But the liquidity of a company can be undermined for a variety of reasons. Classic examples of that include:
Over-expanding with too many egoistical projects where the only objective is to make a bang instead of making profits – and the hope that there is a correlation between the two. Or onboarding too many projects simultaneously without sustainable funds to finance them all.
Keeping doing what they are doing but failing to respond to a change in either consumer behaviours, psychology or shifts in the marketplace that leads to a reduction in market share.
Failing to embrace and cope with changes in technology, geopolitical factors and operational processes.
It is important for lenders to look out for early warning signs of borrowers’ financial distress and respond accordingly to mitigate the default risk. The red flags for lenders to look out for include:
Turnover of key management of a company.
Downgrade in a company’s debt rating.
Delayed issuance of audited financial statements.
Major litigation being brought against a company.
Adverse geopolitical and regulatory measures in the areas where a business is operating.
If you do spot any of these red flags, all hope is not lost. However, it is vital that you act swiftly and decisively. Left unchecked, the consequences could be serious and easily lead to:
Difficulties in meeting the interest payments and/or repayment of any loan principal.
A breach of covenants that could potentially trigger cross default on other debt obligations.
Debt restructuring vs debt recovery: the options explained
What is debt restructuring?
Debt restructuring, as the name suggests, is altering the terms and conditions of existing loan agreements. In default, the first course of action for lenders is to engage an independent financial advisor (IFA) to perform an initial review of the business. This will determine whether debt restructuring is feasible and, if it is, the IFA will assist the borrowers to produce ‘stand still proposals’ together with reliable cash flow projections and the budget for lenders’ consideration.
Many corporations will already have up-to-date cash flow projections and the budgets as part of their financial documents. Despite this, it is still necessary to engage an IFA to assist in review of these documents. The projections, forecasts and budgets prepared by the management often tip towards an optimistic view and tend to assume that business is as usual and fail to accurately reflect the cash position and business performance of an organisation that is in a distressed situation.
IFAs are experienced in identifying the problematic assumptions and scenarios used in the production of any projections. They can correct them to produce more reliable and realistic outcomes and supplement them with sensitivity analysis to give the lenders a better picture in different scenarios. More importantly, the lenders usually have no control over a business and lack sufficient information in respect of the business to make informed decisions unless an IFA is engaged to assist the lenders with reviewing and ascertaining the feasibility of the business and its restructuring plans.
Debt restructuring can offer a breathing space for a company to come up with other means of meeting its obligations, such as the disposal of key assets or operations, and use the proceeds to repay the debt. However, it is a short term/temporary arrangement with a key limitation. A company in distress does not always have projects that generate cash or have spare assets to pledge or sell to raise funds.
What is debt recovery?
Debt recovery can be another option for the lenders. Debt recovery is the collection of bad debts through exercising the contractual rights on the securities, such as an appointment of receivers.
For lenders, an appointment of receivers is a more concrete and straightforward debt collection process. It can be more appealing to lenders because it is relatively less complicated for the receivers to estimate the ‘realisable value’ of the business’ assets and the estimated timeline based on the nature and marketability of the assets. From this, lenders can make an informed decision on which options to pursue.
When the estimated recoveries may not be enough to pay off the debts, lenders will also need to consider other available legal remedies such as a petition to bankrupt or liquidate a borrower if the business has reached the point of no return.
A petition to wind up a company is, nevertheless, the last resort, but it is not without advantages, which include stopping the trading/bleeding immediately and putting the liquidators in place to orderly wind down a business to ensure all creditors’ interests are preserved and taken care of. The liquidators also have the statutory powers to investigate into the affairs and transactions of the company to uncover any hidden and/or dissipated assets and to realise (through legal remedies) such assets that may not be recovered otherwise for the benefits of the creditors These realised assets, net of liquidation costs, would then be distributed to ordinary unsecured creditors on a pari passu basis.
The benefits of third-party expertise
Successful recoveries heavily rely on the execution of carefully designed and formulated plans and strategies by a group of highly trained and experienced qualified accountants, lawyers and insolvency practitioners. Cross-border debt recovery across jurisdictions is particularly challenging because the laws and rules vary greatly from country to country.
With international experience as insolvency practitioners and forensic accountants, a track record of asset recoveries across different jurisdictions, and significant onshore and offshore expertise, Perun Consultants’ team has decades of experience in helping borrowers and companies through periods of difficulties and vulnerabilities. We can help lenders to mitigate exposure and maximise recoveries from any distressed loans. Contact us to find out more.