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. Sometimes financial distress can lead to bankruptcy. Financial distress is usually associated with some costs to the company; these are known as costs of financial distress, to reduce and renegotiate its delinquent debts in order to improve or restore liquidity and rehabilitate so that it can continue its operations.
Replacement of old debt by new debt when not under financial distress is referred to as refinancing If the replacement of debt occurs under financial distress, it is also referred to as debt restructuring.
Out-of court restructurings 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. Alternate reasons for restructuring include a change of ownership or ownership structure, demerger, or a response to, also known as workouts, are increasingly becoming a global reality.[citation needed]
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Motivation
A debt restructuring is usually less expensive and a preferable alternative to bankruptcy Bankruptcy is a legally declared inability or impairment of ability of an individual or organization to pay its creditors. Creditors may file a bankruptcy petition against a business or corporate debtor in an effort to recoup a portion of what they are owed or initiate a restructuring. In the majority of cases, however, bankruptcy is initiated by. The main costs associated with a business debt restructuring are the time and effort to negotiate with bankers, creditors, vendors and tax authorities. Debt restructurings typically involve a reduction of debt and an extension of payment terms.
In the United States, small business bankruptcy Bankruptcy is a legally declared inability or impairment of ability of an individual or organization to pay its creditors. Creditors may file a bankruptcy petition against a business or corporate debtor in an effort to recoup a portion of what they are owed or initiate a restructuring. In the majority of cases, however, bankruptcy is initiated by 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 bankruptcy filings.[1]
Debt-for-Equity Swaps
In a debt-for-equity swap, a company's creditors A creditor is a party that has a claim to 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 or service to the second party under the assumption (usually enforced by contract) that the second party will return an equivalent property or service. The second generally agree to cancel some or all of the debt Debt is that which is owed; usually referencing assets owed, but the term can also cover moral obligations and other interactions not requiring money. In the case of assets, debt is a means of using future purchasing power in the present before a summation has been earned. Some companies and corporations use debt as a part of their overall in exchange for equity In accounting and finance, equity is the residual claim or interest of the most junior class of investors in assets, after all liabilities are paid. If valuations placed on assets do not exceed liabilities, negative equity exists. In an accounting context, Shareholders' equity represents the remaining interest in assets of a company, spread among 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 functions without the intention or threat of liquidation for the foreseeable future, usually regarded as at least within 12 months. 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 is a chapter of the United States Bankruptcy Code, which permits reorganization under the bankruptcy laws of the United States. Chapter 11 bankruptcy is available to every business, whether organized as a corporation or sole proprietorship, and to individuals, although it is most prominently used by corporate entities. In contrast,.
Debt-for-equity swaps and the subprime mortgage crisis
Further information: Subprime mortgage crisis solutions debateDebt-for-equity swaps are one way of dealing with sub-prime mortgages. A householder unable to service his debt on a $180k mortgage for example, may by agreement with his bank have the value of the mortgage reduced (say to $135k or 90% 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 $135k.
Bondholder haircuts
A debt-for-equity swap may also be called a "bondholder haircut." Bondholder haircuts at large banks were advocated as a potential solution for the subprime mortgage crisis The subprime mortgage crisis is an ongoing real estate crisis and financial crisis triggered by a dramatic rise in mortgage delinquencies and foreclosures in the United States, with major adverse consequences for banks and financial markets around the globe by prominent economists:
Economist Joseph Stiglitz Joseph Eugene Stiglitz is an American economist and a professor at Columbia University. He is a recipient of the Nobel Memorial Prize in Economic Sciences (2001) and the John Bates Clark Medal (1979). He is also the former Senior Vice President and Chief Economist of the World Bank. He is known for his critical view of the management of testified that bank bailouts "...are really bailouts not of the enterprises but of the shareholders 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.[2]
Economist Jeffrey Sachs Jeffrey David Sachs is an American economist and Director of the Earth Institute at Columbia University. One of the youngest economics professors in the history of Harvard University, Sachs became infamous for implementing economic shock therapy throughout the developing world and in Eastern Europe, and subsequently for his work on the challenges has also argued for bondholder 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."[3]
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 further support confidence in the recapitalized institution.
For example, one of the largest U.S. banks owed its bondholders $267 billion per its 2008 annual report.[4] 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 defendants A defendant or defender is any party who is required to answer the complaint of a plaintiff or pursuer in a civil lawsuit before a court, or any party who has been formally charged or accused of violating a criminal statute. (Note that American lawyers and judges often pronounce the word slightly differently than is common in standard American 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 co-operation 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.
Debt restructuring in individual jurisdictions
Switzerland
Main article: Insolvency law of Switzerland The insolvency law of Switzerland is the law governing insolvency, foreclosure, bankruptcy and debt restructuring proceedings in Switzerland. It is principally codified in the Federal Statute on Debt Enforcement and Bankruptcy of 11 April 1889 (as amended) as well as in ancillary federal and cantonal lawsUnder Swiss Switzerland , officially the Swiss Confederation (Confœderatio Helvetica in Latin, hence its ISO country codes CH and CHE), is a federal republic consisting of 26 cantons, with Bern as the seat of the federal authorities. The country is situated in Western Europe[note 4] where it is bordered by Germany to the north, France to the west, Italy to 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
Not uncommon in Western states, the majority of debt restructuring within the United Kingdom, certainly in the commercial sector are 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 administrators appointed.
Corporate Restructuring As the incidence of corporate failures has increased in part due to the 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, a downturn in trading performance is identified typically through management accounts or as a result of revised management projections. This triggers a gathering of lenders (and perhaps other stakeholders), in anticipation of a breach of financial covenants or a crisis of liquidity In business, economics or investment, market liquidity is an asset's ability to be sold without causing a significant movement in the price and with minimum loss of value. Money, or cash on hand, is the most liquid asset. An act of exchange of a less liquid asset with a more liquid asset is called liquidation. Liquidity also refers both to a.
The lending group (typically comprising corporate finance divisions of banks) will normally commission a review of the business and its financial position and outlook. This will normally be undertaken by a corporate advisory group such as PriceWaterhouseCoopers PricewaterhouseCoopers is one of the world's largest professional services firms and the largest of the Big Four auditing firms. It was formed in 1998 from a merger between Price Waterhouse and Coopers & Lybrand, both formed in London or Deloitte Deloitte Touche Tohmatsu Limited is one of the largest professional services organizations in the world and one of the Big Four auditors, along with PricewaterhouseCoopers, Ernst & Young, and KPMG. This will form the basis of any restructuring of facilities.
The lending group will typically appoint a Corporate Restructuring Officer or 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
References
- ^ Buljevich, Esteban C.,Cross Border Debt Restructuring: Innovative Approaches for Creditors, Corporate and Sovereigns ISBN 1-84374-194-6
- ^ [1]
- ^ Jeffrey Sachs-Our Wall Street Besotted Public Policy
- ^ Wells Fargo-2008 Annual Report
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Mon, 26 Jul 2010 07:46:06 GMT+00:00
Financial Mirror He also said hypothetical discussions of debt restructuring were counterproductive and that euro-zone institutional framework has to be strengthened to ...
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BioFuel Energy seeks debt restructuring as it makes Q1 loss
