By Prosper Melomey, Bridgewater Advisors Limited Partner & Licensed Insolvency Practitioner
This is a summarised article of that which was published in the Maiden Edition of the national insolvency journal, Corporate Insolvency and Restructuring Journal.
Introduction
The reality of corporate failure or demise is not much of a problem than the ability to predict or diagnose it early enough to take necessary measures to protect value or take the requisite actions when faced with corporate failure. With regards to predictability and diagnosis, distress is easily predicted in certain micro and macro circumstances.
For instance, in the context of Ghana, the threat to business survival and growth exacerbates in an economy, which aside being affected by the COVID-19 pandemic and the contagion of the Russia-Ukraine war, is also confounded with a downgrade in ratings by international rating agencies, high inflationary pressures, highly depreciating currency and increasing interest rates.
Ghana’s current macro-economic challenges significantly increases the risk of non-performance of loans issued by commercial banks and the possibilities of companies becoming distressed. A company at a distressed position becomes reasonably unlikely to be able to pay its debts as they fall due and is likely to become insolvent within the immediate ensuing period.
The fate of failing companies
Traditionally in the Ghanaian jurisdiction, a distressed or failing company’s fate lay in liquidation, which implied a permanent end to the company and distribution of its assets to claimants, since the liabilities of the company far exceeds it assets and the company is unable to pay debts as and when they become due. This course of action, though still a possible option, however, poses threats of job losses and its ripple effects, and generally loss of government revenue through taxes.
The Corporate Insolvency and Restructuring Act, 2020 (CIRA) has ushered in a rescue culture where the possibility of restructuring comes in as an alternative path to dealing with distress scenarios by either making adjustments to a distressed company’s operations or adjusting its balance sheet with the objective of restoring the business to financial health.
The ultimate aim in the business rescue process is to preserve business value which consequently inures to the benefit of the wider economy through business restoration and job preservation. Therefore, restructuring could be considered a preferred course of action for a financially distressed company.
The rescue culture
Unlike official liquidations where creditors initiate the process by court application, an administration (restructuring) can be initiated on a voluntary basis by the directors of a distressed company or by a court application brought by creditors or a person holding charge over significant assets of the company. This places the company, its management, and assets under temporary supervision in order to implement a business rescue plan.
In the course of this process, the company (borrower) enjoys breathing space through a standstill agreement between the borrower and its creditors restraining creditor enforcement actions. Hence a moratorium on legal proceedings against the company is imposed.
This is however on the assurance that restructuring is the feasible way forward and agreed upon by all stakeholders (at watershed), given that the structure of the restructuring deal is dedicated to identifying where the value lies in the borrower’s business through a thorough business and financial analysis, valuations, revised forecasts, and business planning.
The rescue options
The options in a restructuring program can either be an operational restructure or a financial restructure. These are distinct routes in restructuring, but they do have a point where they cross paths. An attempt to restructure financially will have effects on the operations of the company, and an operational restructure will have effects on the financials of the company.
Operational restructuring
The journey through an operational restructure examines the company and its business model by identifying areas where the company floundered and how those areas can be improved while bearing in mind the general and specific economic context.
The focus in the operational restructuring process is to restore the profitability of the business by improving the products, service offering, and day to day operations of the company.
Conventional in an operational restructuring plan is carving the best way to achieve efficiency through rationing parts or the entire business, reviewing costs against revenues to recommend cost reductions where appropriate, identifying and providing solutions to gaps in skills of management team, selling or closing down underperforming and non-core areas of the company, and analysing the company’s products and services to determine their contribution to profit.
Financial restructuring
The alternative route which is the financial restructuring path, journeys through the financial lines of the company with the aim of improving the value of the company and retaining the confidence of creditors, shareholders, investors, and other stakeholders.
This route employs varied strategies in order to strengthen the balance sheet of the company and restore the company. Key in financial restructuring is debt restructuring which seeks to rescue the company from defaulting on its existing debts by providing a less expensive alternative to bankruptcy to the benefit of both the borrower and the lender.
A debt restructuring might include a debt rescheduling or waiver, debt-to-equity swap, reducing interest rates on loans, and extending liability payment dates. This improves the company’s chances of staying in business and meeting its obligations since creditors get to understand that they would receive less should the company be forced into bankruptcy or liquidation. This tends to be a win-win for both borrowers and lenders.
Debt restructuring approaches can lead to the preservation of existing equity or a dilution of existing equity.
Equity preservation: Existing shareholders generally prefer a waiver or debt rescheduling rather than, for instance a debt-to-equity swap or new equity injection, where their equity may be diluted or totally extinguished.
The debt rescheduling or waiver can be achieved by altering the repayment profile of the debt by adjusting repayment instalment amounts, negotiating with bondholders to take a “haircut” .i.e., a portion of their outstanding interest payments or balance written off, and extending the final maturity date of the loan. For this to be acceptable, lenders will have to acknowledge that the distressed position of the borrower is a temporary one and accepting a rescheduling or waiver will only increase the likelihood of the debt being repaid.
In the event that the borrower can establish a clear plan with supporting argument, new debt could be applied for from either existing lenders or new lenders so as to support the restructuring plan of the business.
Where another lender steps in, existing lenders would need to agree to a standstill agreement while new funds are lined up. This new fund if used for operational restructuring will qualify as Post-Commencement Financing (PCF) which is classified as Class A debt and takes priority over all other creditor claims including secured and preferential class and shall be paid in full first.
Equity dilution: Other debt restructuring approaches involve reducing the debt-to-equity ratio of the distressed company in order to put the distressed company in a better position to meet financial obligations going forward.
This is done through, for instance, new equity injection or recapitalisation, where a company seeks to change the proportions of debt and equity make up of its capital structure. In the face of difficulty, raising additional equity might be an attractive solution especially where it is viewed that the business is viable but is suffering temporarily.
A caution for existing shareholders is that they stand the risk of holding a smaller share of the company if they do not participate in the new round of equity issues.
Another possible approach is a debt-to-equity swap which allows financial creditors to receive shares (part ownership) in the distressed company in return for a reduced or cancelled debt claim. This reduces the liabilities on the company’s balance sheet but of course dilutes the equity of existing shareholders. This swap is a preferred option when both the outstanding debt and the company’s assets are significant.
Other restructuring considerations
Transfer to “New Co.”:
A varied approach from the above is for all debt and equity stakeholders to agree to transfer the distressed company’s performing assets or business lines to a newly formed company in return for a reduced or cancelled debt claim by financial creditors who may take debt or equity (or both) in the new Company.
Schemes of arrangement:
There are also other complex restructuring approaches that involve different tiers of debt and equity parties who agree to settle in a manner that differs from the traditional approaches described earlier.
Some of these circumstances may give rise to court-sanction approaches between the company and its creditors covering anything that could otherwise be agreed between the parties. This allows a compromise to be implemented with the support of all interested parties. However, the valuation approach used here estimates the business value as if the scheme of agreement would not happen.
Pre-packs:
In a less cumbersome scenario where there is significant appetite for the acquisition of the business or its core assets, a “pre-pack” approach may be suitable. This is where the sale of the business or assets of the company is negotiated before the appointment of administrators and completes either immediately upon – or shortly following – the appointment.
Conclusion
The approach considered in restructuring a distressed company depends on the circumstances, the interests of the parties involved, and the results of a thorough business review. A debt rescheduling for instance will have the benefit of avoiding existing debt being accelerated or cross-defaulted into any other financial agreements that the borrower may have.
While lenders may tend to be more attracted to an equity dilution approach as increased equity will generally provide better protection to the debt holders in the business and can offer lenders more reward to reflect the increased risk involved in lending to a borrower that is, at least temporarily distressed.
