Many businesses have experienced severe cash flow problems during the COVID-19 pandemic. As a result, some may have delayed or missed loan payments. Instead of filing for bankruptcy in court, delinquent debtors may reach out to lenders about restructuring their loans.
Restructuring vs. Chapter 11
Out-of-court debt restructuring is a process by which a public or private company informally renegotiates outstanding debt obligations with its creditors. The resulting agreement is legally binding, and can enable the distressed company to reduce its debt, extend maturities, alter payment terms or consolidate loans.
Debt restructuring is a far less extreme and burdensome (not to mention less expensive) alternative to filing for Chapter 11 (reorganization) bankruptcy protection. And lenders often are more receptive to a restructuring than they are with taking their chances in bankruptcy court.
Types of restructuring
There are two basic types of out-of-court debt restructuring:
1. General. This type of negotiation buys the distressed company the time needed to regain its financial footing by extending loan maturities, lowering interest rates and consolidating debt. Creditors typically prefer a general restructuring because it means they’ll receive the full amount owed, even if it’s over a longer time period.
General restructuring suits companies facing a temporary crisis — such as the sudden loss of a large customer or the departure of a key management team member — but have overall financials that are still strong. Debt structure changes can be permanent or temporary. If they’re permanent, creditors are likely to push for higher equity stakes or increased loan payments as compensation.
2. Troubled. A troubled debt restructuring requires creditors to write off a portion of the distressed company’s outstanding debt and permanently accept those losses. Typically, the creditor and debtor reach a settlement in lieu of bankruptcy.
This solution is appropriate when a company simply can’t pay its current debts at current interest rates and the only alternative is bankruptcy. Creditors may receive some compensation, however, with increased equity shares in the business or, if it’s acquired, in the merged company.
During the COVID-19 pandemic, the Financial Accounting Standards Board has received many questions about how to apply the accounting guidance on debt restructurings. So, it recently published an educational staff paper to help financially distressed borrowers work through the details.
Thinking about debt restructuring?
We are on top of the latest developments in this nuanced accounting topic. Contact us to help report restructured loans in your company’s financial statements.