Over the years there has been a change in the approach of lenders in dealing with customers facing financial difficulties from the traditional recovery focused approach to an emphasis on value preservation and rescue. This shift is the result of the realization by stakeholders that consensus-driven solutions often provide better outcomes for all stakeholders, especially when dealing with businesses that are viable, but for the distress.
Formal restructuring and insolvency processes still play an important role in dealing with non-performing accounts – not all situations will be appropriate for consensus-driven solutions. Where the business is not viable, even if a consensus-driven solution is reached, the business may not be able to overcome its distress and its stakeholders are likely to end up worse off. In this situation, the consensus driven solution may only end up “kicking the can down the road”.
However, while the formal legal framework for corporate reorganization (and, indeed, liquidation) will always provide a “backstop” if consensus-driven negotiations fail, decades of experience in insolvency cases tell us that consensus-driven solutions can provide better outcomes for all stakeholders.
Out-of-Court Workouts (OCWs) may be suitable for viable businesses
Out-of-Court Workouts (OCWs) in particular, have been gaining traction recently, particularly in the Sub-Saharan African region where court-based processes can sometimes be lengthy and unpredictable. OCWs are privately negotiated restructuring arrangements.
In practice, such forms of workout tend to be contractually enforced, with varying degrees of success depending on the quality of the measures put in place to address the pain points of both the company and the lenders. Properly done, these OCWs can be fast, inexpensive, flexible, confidential and informal in that negotiations among creditors are not subject to any pre-set requirements and specific terms.
In our experience, however, certain critical issues need to be considered to give OCWs the best chance of success. This experience resonates with the INSOL International Statement of Principles for Multi Lender Workouts published in 2017 and the “London Approach” spearheaded by the Bank of England and other UK Lenders in dealing with multi lender workouts in the United Kingdom in the 1970s. The aim of the London Approach was to bring multi-lender negotiations to a satisfactory conclusion.
Some critical issues need to be addressed for a successful OCW
Firstly, and most critical, steps need to be taken to arrest any value deterioration in the borrower and stabilize the business. This is challenging as it involves bringing together stakeholders who should ultimately have the same long run objective but who often take opposing courses of action in the short run to achieve those objectives.
For instance, we have observed that when faced with this type of situation, borrowers typically take actions such as seeking additional working capital funding, entering barter arrangements with creditors or suppliers (i.e. informal working capital funding) or seeking funding from alternative sources which at that stage of distress, typically tends to be at a very high cost.
This worsens both the cash flow and the indebtedness of the company and may do so in a way that is hard to track (if done off balance sheet).
Even within lender groups, due to their diverse circumstances such as their various security positions, the level of provisioning of the loans at their respective banks as well as the different personalities handling the matter, lenders may find it difficult to align on their approach.
Such situations are more easily resolved where a clear “leader” can emerge. Usually, but not always, this is a creditor with the most “skin in the game” who can be looked upon to take decisive action, or a strong leader who can bring together a “committee” of the key lenders by initiating and committing to commonly agreed milestones and objectives and winning the support of other creditors in executing and enforcing these.
Typically, in these multi lender situations, it is necessary to enter into a Standstill Arrangement which effectively freezes the lending positions of all participating creditors on the commencement date and in so doing, allows a starting point to be drawn in the sand for financial analysis and negotiations to take place.
A Standstill Arrangement is a useful tool in OCWs
The Standstill Arrangement would normally involve both the borrower and all participating creditors agreeing on a modus operandi to ensure that value in the business is preserved (e.g. avoiding auctions of business assets to improve a particular creditor’s position or actions by the borrower to adversely affect potential returns to one or more creditors).
The intention of this type of arrangement should be to give the borrower breathing room for a fixed period, during which a restructuring proposal could be formulated.
In practice, this is hard to achieve, particularly where borrowers have entered multiple bilateral agreements with no common inter lenders agreement between creditors – these end up pitting lenders against each other in zero-sum situations. In addition, depending on how early the distress was identified and how quickly parties involved have taken action, the debtor may not have a full hold on the business as creditor pressure grows and business options become limited.
“Once a comprehensive restructuring proposal is put together, multiple rounds of negotiations are likely to follow. This is the critical stage of the restructuring process and stakeholder management is key in ensuring the pace is maintained.”
Time is of the essence in restructuring scenarios
The other critical consideration in these restructuring situations is the need to close, or reduce to a minimum, the information asymmetry between lenders and the company and among lenders themselves.
This usually necessitates a commonly sanctioned due diligence, commonly described as an Independent Business Review (IBR) to provide a better understanding of the business of the debtor company to use as a basis of discussions between all parties involved in the restructuring.
Where creditors interests diverge, closing the information gap may help to identify the priorities and “deal breakers” for the different parties involved in the restructuring and once this information is on the table, help lenders to accept their own and others’ positions.
Time is of the essence in restructuring scenarios – a procedure that allows alignment to be reached quicker helps preserve value for all parties involved.
Once a standstill arrangement is in place, the onus is on the lenders to push for a speedy resolution to the situation. This means rapidly reviewing the viability of the business, assessing its debt carrying capacity and then identifying what that means for the lenders involved (the IBR).
Such a review could also determine whether there is any way to quickly improve cash flow (e.g. selling off a non-core asset or, for instance, assessing the costs and benefits of shutting down a cash negative division of the business).
It could identify many other aspects too – such as measures required to ensure compliance with a proposed restructuring proposal, additional steps lenders may wish to take to preserve value or strengthen their positions or the milestones and financial metrics that are critical to the success of the restructuring plan.
Once a comprehensive restructuring proposal is put together, multiple rounds of negotiations are likely to follow – among lenders themselves, between lenders and the company and sometimes even with creditors who are not part of the standstill process but who exercise strong influence upon the outcome of the restructuring.
This is the critical stage of the restructuring process and stakeholder management is key in ensuring the pace is maintained.
Setting up structures that allow quick decision-making is important
For lenders, it is critical to ensure that their organisations are set up to separate distressed cases from “business-as-usual” and accord them priority for decision making in these types of situations. A healthy amount of prudence and realism should be applied by all parties involved in preparing or assessing the restructuring proposals.
This part of the process is usually iterative, and parties need to provide timely feedback to improve chances of success. Chances of success are enhanced where there are fewer parties at the table – sales of debt among lenders at reasonable pricing in the early stages of a workout can help achieve this objective.
It is also much easier to achieve success where independent advisors are at the table driving the process forward and bringing impartiality and objectivity to it. Independent advisors can identify restructuring proposals that have the best chance of success overall whereas an individual stakeholder may focus on their own outcome.
Typically, evaluating the options available to lenders requires both financial analysis and analysis of the legal framework or protections available to the lenders.
Restructuring proposals usually require difficult decisions to be made and passing these messages internally may be a challenge for stakeholders. Having an independent party involved in undertaking a review, crafting a proposal and holding all parties to account in the approval and implementation of the restructuring proposal allows the company and lenders to focus on the restructuring proposal itself, rather than on tasks such as milestone tracking or follow ups for information.
Patience, effort and compromise are key to success
A restructuring proposal that does not require funding to succeed is a rarity. Particularly in our part of the world, where markets for distressed finance are almost non-existent, lenders need to work together to reach a collective view on whether and how a distressed customer should be given a financial lifeline. Having a legislative and regulatory framework that supports an OCW type of procedure helps inspire confidence in all parties at the table.
Restructuring processes are fragile and require effort, patience and compromise to succeed. However, where properly done, the payoff can be commensurate to the effort as they result in the preservation of viable businesses and can provide better outcomes than recovery-oriented procedures – particularly in current market conditions where security values are uncertain.
Using OCWs, especially where these principles or the London Approach is employed to improve distressed lending situations, can facilitate rescues and help give these types of restructuring processes the best chance of success.
Article by Malvi Chavda & Fredrick Wakhungu. The authors are Senior Manager, Business Recovery Services and Associate, Business Recovery Services – PwC Kenya respectively