One common method for businesses to reduce their liabilities is through a debt restructure, converting debt for equity. Our report presents a short overview of common structures to undertake a debt restructure, an outline of the key steps required to undertake this process and the pros and cons.
Implications of COVID-19
The moratorium on directors' personal liability for debts incurred when a company is insolvent for six months (Directors' Moratorium) may provide a current window for companies to undertake a debt restructuring before the moratorium expires. Directors must still comply with general law and statutory duties, including to take into account the interests of creditors if the company is in financial distress.
Usually, the sooner the board commences formulating a plan to deal with the solvency issues, the more potential options will be available to the company to resolve these issues. This is especially the case in the current circumstances as the restructuring often takes more time to implement than anticipated and the Directors' Moratorium period will expire all too quickly. The current expiry date of 25 September 2020 is also very close to the final deadline date of 30 September 2020 for ASX listed companies with financial years ending 30 June to issue their final audited accounts.
The restructure of the balance sheet would also be in conjunction with other steps such as reducing costs where possible, potentially receiving government assistance under various announced COVID-19 programmes, arrangements relating to the workforce, considering rent relief and seeking waivers from lender covenants, extensions to maturity dates and negotiating delays to interest payments etc.
A debt restructure which is formulated, and ideally a restructure agreement entered into, during the Directors' Moratorium period may be sufficient to enable the directors to rely on the safe harbour defence against personal liability of directors for debts incurred when a company is insolvent (Safe Harbour Defence) to enable the company to continue to trade, and the restructuring plan to be implemented, after the expiry of the Directors' Moratorium period.
There are three broad approaches to debt restructuring discussed in this report:
Debt restructuring agreed between the parties
Ideally it will be possible for a company in financial difficulties to reach agreement with key lenders and other key stakeholders such as shareholders and other lenders, if required, to the terms of a restructuring and then implement the restructuring as agreed.
Under this approach, the company would not go into external administration but would continue to trade through the restructuring process.
If it is not possible for the company to continue to trade where, for example, insolvency is inevitable or it is not possible to reach agreement with the relevant lenders then other structures would need to be considered.
Solvent creditors scheme
This is a structure where a company can continue to trade and restructure its debt through a creditors scheme of arrangement where sufficient creditors agree to the terms of the restructure at a meeting of creditors. Creditors who do not agree to the scheme are still bound by the scheme if it is approved by the Court and implemented.
This approach is often used where a company has different classes of debt outstanding such as loan notes and the holders of the loan notes receive shares in the company to extinguish or reduce the outstanding debt.
External administration - deed of company arrangement
If it is not possible for a company to continue to trade because the company is insolvent (ie. unable to pay its debts as and when they fall due) and the Directors' Moratorium has expired (and the Safe Harbour Defence is not available), then an external administrator will need to be appointed.
When a company is under administration, it can undertake a debt restructuring through a deed of company arrangement (DOCA). In some cases, the use of a DOCA may be a preferable approach, even though it involves appointing an external administrator. This is because an administrator is able to terminate onerous contracts following their appointment, such as real property leases. It is expected this may be the preferable approach in the retail sector where a business has a number of premises under long term lease which are now no longer viable. These leases could be terminated by the administrator and a smaller but viable business could emerge out of administration following the implementation of a DOCA. A DOCA can also provide an opportunity for the administrator to develop a more permanent restructure of the company, including by a creditors scheme of arrangement.
