Roschier Insights Webinar: Key takeaways for distressed companies
In a recent webinar, attended by some one hundred participants, our experts discussed the economic distress faced by many companies in the current climate, where the pandemic is severely impacting businesses. Manne Airaksinen, Paula Airas, Jonne Järvi and Mika Ohtonen addressed the possibilities, risks and liability of a distressed company from the perspective of corporate law, financing, tax and insolvency law under the heading “Kun rahat eivät riitä” (“When there is not enough money”).
- Ensure you have up-to-date information, as an early reaction is key
In situations where insolvency is imminent or there is a risk of insolvency, it is extremely important to have up-to-date information on the company. The board and management should ensure accurate and sufficient information is available to enable them to recognize and address risks. Issues to be looked at include the normal financial data, the cash situation and potential cash pool arrangements, covenants and other obligations relating to financial arrangements, shareholders’ agreements, liabilities, and security, including knowledge of who the main creditors are. Mapping the situation from the perspective of the company, owners and finance providers/creditors is key.
Insolvency risk significantly increases liability risks, both criminal and corporate. Insolvency risk also brings the recovery framework closer to companies. To address risks, information is necessary, but equally important is to keep a record of the reasoning behind the decisions made based on the information and circumstances at the time. The board is subject to the “business judgment” rule, and, especially in distress situations, the board’s decision must be guided solely by what benefits the company. The interest of the corporate group of which the company is a member is not an acceptable excuse for deviating from the business judgment rule, if creditors may end up bearing the cost.
- Options exist to improve the financing situation
Distress situations may be addressed in various ways. Especially in situations where there is a small number of main creditors, or where there is a lender syndicate, a voluntary restructuring may be the preferred alternative for the main interested parties, namely the company, owners, management and main creditors. Whether or not the business continues is often dependent on retaining the key employees at the company, and therefore management incentive programs feature among the elements of a successful restructuring.
The first steps in a voluntary restructuring include negotiating a standstill with the creditors, as well as typically imposing additional reporting obligations on the company and conferring supervisory rights on the creditors. There is a broad scale of solutions, including debt haircuts, decreasing and/or capitalizing interest, changes to the repayment profile, converting debt into capital, new funding through share issues or loan instruments, and divestments.
Which of these alternatives is chosen depends on e.g. whether the financial problem is one of liquidity or solidity (or both), and the need to balance the interests of various creditors and other parties. Debt conversion is a method often used to reduce the amount of debt and to balance out the “hit” between creditors and owners. It confers certain tax benefits compared to a pure debt haircut, since it does not impact revenues, and previous losses may still be used as a tax asset.
A formal corporate restructuring is a process which enables all debts of the company to be addressed in a structured manner. The proceedings are public, which is not the case in a voluntary restructuring. Company, supported by 20 % of its creditors has the lowest threshold of entering the proceedings (but other means also exist). In the proceedings, the restructuring administrator in cooperation with the company and in negotiations with the creditors, seeks to find a solution which could be approved and confirmed as a restructuring program. Secured debt capital is protected, but otherwise debt may be cut or reorganized flexibly. Due to the protection of secured debt, a formal restructuring allows for more alternatives for funding structures with a significant share of unsecured debt.
Formal restructuring proceedings also enable leases and employment agreements to be terminated on shorter notice than would normally be the case. Also means of carrying out a voluntary restructuring, such as a debt conversion, are available in connection with a formal restructuring. The average time for these proceedings is 11 months, but may be significantly shorter or longer, depending on the circumstances and the size of the business.
- Plan A and Plan B may work best together
Voluntary restructuring negotiations and a potential formal restructuring both take time, which needs to be funded in some way. Neither provide a quick fix for the situation where the business has already run out of cash. Thus, it is important to react and open discussions early enough, although the situation is far from pleasant.
A thorough mapping of the situation allows the company to identify possibilities and limitations, which also enables informed discussions to take place with creditors and other interested parties. Forecasts and alternative scenarios, potentially encompassing elements of both voluntary and formal restructurings, or the two as alternatives, are likely to improve the company’s chances of success in the negotiations.
In formal restructuring proceedings, control may be exercised by a larger group of creditors than in voluntary restructuring negotiations, which may benefit some creditors more than others. Further, restructuring programs in formal restructuring proceedings may be approved on the basis of relatively limited creditor support. Thus, a credible plan B in the form of e.g. formal restructuring proceedings may also be helpful in negotiating a solution under plan A.