What Debt Restructuring Is All About
Debt restructuring is a process that allows a company or a business facing liquidity problems to renegotiate the debt so as to reduce the distress, restore or improve its liquidity and allow it to operate normally. Debt restructuring may involve extension of the payment terms of the loans or reduction of the debt. This approach is less expensive compared to seeking bankruptcy orders. It only requires time and effort to successfully negotiate with the bank, the vendor, the tax authority or the creditors to find a workable way for the outstanding debt to be repaid.
In the US, filing for bankruptcy may cost up to $50,000 in court and legal fees. The fact that only a few firms are able to survive Chapter 11 bankruptcy filing means that most firms opt for debt restructuring rather than bankruptcy filing. Debt restructuring is the best option to many firms. It is referred to as debt mediation and is a business to business process that can be applied to unpaid taxes, default on mortgages and loans and also credit card defaults. It is one of the methods that is commonly used to refinance the company’s activities especially when direct borrowing is limited. It is cost effective for small businesses and can be used to avoid litigation.
Large corporations have many companies that provide restructuring while small firms have just a handful of firms that can work for them on this front. Most of the debt restructuring firms work for debtor clients and charge their fees based on their level of success. Debt situations that are handled in debt mediation include delinquent property, lawsuits and judgment, equipment rentals, business loans, loans for bad credit situations, mortgages, disputed bills, capital payments and problem debts. In the case of debt –for equity swap the creditor agrees to cancel part of, or all the debt in exchange for equity in the company. This kind of agreement occurs when a large company runs into serious financial trouble that results in a scenario where the company is taken over by the principle creditor.
This can happen where the remaining debt and the assets are so large that it may not make business sense for the creditors to drive such a company into bankruptcy. In such a case, the creditors may opt to take control of the business as a going concern. Because of this, the original shareholding in the company is reduced. The debt-for –equity swap is therefore, one of the methods of dealing with sub-prime mortgages.
The laws governing debt restructuring vary from country to country. For instance the Swiss law allows for the process to occur out of court or could be court mediated. The law provides for partial waiver of the debt or liquidation of the assets belonging to the debtor by the creditors. In the UK, debt restructuring is undertaken on a collaborative basis between the creditors and the borrowers. The court may involve itself in the mediation and appoint the administrators. In Italy, it may occur out of court but the law provides for partial waiver of the debt and mandatory liquidation of assets to repay the few privileged creditors.