A financial restructuring involves a company which is in financial difficulty agreeing with its stakeholders to reorganise its liabilities so that its business can survive (though not necessarily the company itself). It will typically involve cost-cutting measures, the divestment of unprofitable businesses and refinancing. It may also involve an insolvency process (e.g. administration) or formal restructuring (e.g. CVA) but this is not inevitable.
Introduction
Businesses confront the most significant challenge in a generation as their markets shrink, change or disappear. Having navigated the initial phase of the crisis implementing a series of cost saving and liquidity measures, companies are now progressing to the next phase. For most, including many who were strong heading into the crisis, this next phase will be the most challenging as businesses look to replace lost revenues and “future proof” their organisations.
The likelihood therefore is that we will increasingly see companies undertaking not just a financial restructuring - where a business looks to reschedule or refinance its financial arrangements - but simultaneously a business restructuring root and branch reviews of all aspects of their operations to “future proof” their businesses against the post-pandemic world.
The first part of this Article examined the wide range of matters which fall for consideration in the context of those broader business restructurings. In this second part we explore the options, implications and processes involved in a financial restructuring.
Preliminary Steps
Preliminary Steps
Typically the lender ’s choice is restructuring or an insolvency process. Where the solvency of the business is in issue lenders will generally recognise that they will achieve better returns through a restructuring than by instituting formal insolvency proceedings.
Any proposed restructuring will be based on the premise that:
There is inherent value in the company's business.
The company's short and long term plans are sound.
The restructuring has the support of the company and its principal creditors (or, in the case of a CVA or scheme of arrangement, at least the statutory majorities required).
In terms of the business’s management, it is safe to say that in the current trading environment there will be a premium on experience. Consequently businesses and their stakeholders will use the opportunity to review and strengthen management teams.
Company’s objectives
The directors must first identify the objectives of any restructuring i.e. what they hope to achieve from it (i.e. the “end game”). As mentioned in the current climate this will likely include not merely sourcing new financing but as adapting the business to the new world order.
In broad terms the goals of a financial restructuring will typically involve relieving financial stress, generating cash, reducing costs and increasing profitability and reduce long term liabilities (e.g. pensions).
These objectives will often involve short-term (e.g. preventing security enforcement) and long-term goals (e.g. compromising debts).
This preliminary exercise will represent the board’s conclusions about the business’s mid- and longer-term prospects and their vision for the future of the business. Experience will be invaluable and directors will be well advised to draw on relevant skills within and outside the organization to ensure that their conclusions and recommendations are as well informed as possible.
Information
Up to date reliable information is essential to any restructuring. The company’s board should ensure that they have a sound understanding of the business’s fundamentals e.g. its company’s financial position and capital, funding and operational structures and identify its key stakeholders.
If the company has operations in other jurisdictions then local counsel and other advisors will need to be engaged as early as possible. The efficiency of that aspect will be fundamental to the success or otherwise of the wider process.
The quality of that data will be vital. No restructuring will be possible unless the stakeholders have clarity and confidence about the company's financial position and faith in the reasonableness of the directors’ projections (see Process).
Key Stakeholders
The company needs to identify its key stakeholders as early as possible i.e. those creditors with a genuine economic interest in the company and restructuring. To do that the directors must identify the “value break” in the business’s capital structure - the point above which a stakeholder ’s claim is "in the money" (and so the stakeholder has a genuine economic interest in the restructuring) and below which a stakeholder is "out of the money" (and has no economic stake).
Similarly, understanding the order in which the company must return assets to its various stakeholders is fundamental to a restructuring strategy.
Options
The business in conjunction with its advisers should evaluate the full range of restructuring options. These will typically include:
debt for equity swaps
amended or extended facilities
new money
disposals possibly via an accelerated M&A process
a formal restructuring process e.g. a CVA
Contingency Planning
The progress of any restructuring may not run as the parties intend. Depending upon the context (urgency of the situation and solvency of the business) it would be prudent for the business to develop a Plan B (e.g. a pre-pack administration or accelerated M&A process) alongside its restructuring negotiations which can be swiftly implemented if the restructuring fails for any reason.
A contingency plan should be capable of being implemented without the consent of the uncooperative stakeholders and may involve the implementation of a formal insolvency process in at least one jurisdiction.
Process
The restructuring process will be influenced by a number of factors:
urgency – are there any time critical issues which must be addressed
size and sophistication of the business (real estate portfolio, workforce, key suppliers and customers, cross border aspects)
solvency of the business
complexity of existing funding, security and capital structures and proposed funding arrangements
whether stakeholders are supportive.
Directors would be well advised to delegate management of the process (e.g. to a committee of directors and senior management) to ensure that the day-to-day running of the business continues to be supervised. The ability to keep one eye on the ball (the present) and another on the “end game” (objectives) will be key.
The main steps to the process of implementing a restructuring will usually involve negotiating (i) a standstill agreement and (ii) a restructuring agreement, and, depending on the number of lenders, establishing a steering committee of key stakeholders.
A standstill agreement provides a moratorium (standstill period) freezing the position of creditors while the business negotiates with key counterparts and stakeholders. The agreement prevents the creditors from taking any enforcement action against the company during that period. During the standstill period stakeholders will typically:
review the company's projections and other financial information (this due diligence will serve as a platform for the restructuring negotiations).
assess the company's management
consider the viability of the company
prepare an insolvency model (identifying projected returns for creditors in the event of an insolvency).
The form of Restructuring Agreement will of course depend on the circumstances. Typically it will amongst other things deal with the following:
the repayment of creditors and the extension or amendment of existing facilities
new money
liquidity measures - cash conservation (controls on what the company can do with its cash and cash generation (e.g. an agreed disposal programme).
Directors’ Duties and Liabilities
Directors of companies in financial difficulty face a number of issues including:
what can they do to keep the company in business without committing an offence or incurring personal liability (see below)
when they must cease trading.
Directors are under a duty to act in the best interests of the company. However, once they form the view that the company is insolvent their duty is to act primarily in the interests of the company's creditors. Amongst other things the directors should:
consider the potential impact on creditors of all the decisions they take with regard to the management of the company
monitor and review the financial state of the company continually
seek external advice
There are a limited number of circumstances in which directors may incur personal liability. An analysis of these is beyond the scope of this article but in brief these include wrongful trading fraudulent trading and misfeasance or breach of fiduciary duty. There is also the question of director disqualification in certain circumstances. The government has announced the suspension of the wrongful trading provisions retrospectively from March 1st to 30th June and these measures are addressed in the new draft UK insolvency bill (see New Legislation).
Cross Border Restructurings
Where the assets of the business are located in more than one jurisdiction a range of different issues arise. The first is to understand which laws apply in the relevant jurisdictions and their effect (a number of countries have enacted laws attempting to harmonise the process of cross-border insolvencies). The EU Insolvency Regulations apply to insolvency proceedings of businesses whose centre of main interest is situated in an EU member state. The regulations continue to apply to the UK during the transition period.
Engaging local counsel early will be key to help identify issues - e.g. local security and priority rules and the impact of the restructuring on any key contracts - and to co-ordinate the implementation of the restructuring in those territories.
We have extensive experience of working with our associate offices throughout the EU. Good working relationships between advisors across jurisdictions are key to an efficient process.
Corporate Insolvency and Governance Act 2020
The Corporate Insolvency and Governance Act 2020 entered into force on 26 June 2020. It sets out the detail of the UK Government’s reforms to the existing restructuring and insolvency regime as part of its response to the economic crisis caused by the COVID-19 pandemic. The Act includes temporary measures intended to support businesses as they deal with the crisis as well as permanent changes which reform of the UK’s insolvency and restructuring regime.
This legislation will transform the interaction of creditors with businesses in financial difficulties and will be relevant to any discussions concerning a financial restructuring.
Our briefing considers in more detail the Act and its likely impact.
