During the COVID-19 pandemic, many businesses have experienced severe financial stress, and some may have delayed or missed loan payments as a result. Debtors who have become delinquent due to the pandemic may wish to ask lenders about restructuring their loans, rather than filing for bankruptcy.
Debt restructuring as an alternative to Chapter 11
In the process of out-of-court debt restructuring, a public or private company informally renegotiates its outstanding debt obligations with creditors. The resulting, legally-binding agreement allows the distressed company to reduce its debt, extend its maturities, change its payment terms or consolidate its loans.
Compared to filing for Chapter 11 bankruptcy, debt restructuring is far less demanding—and less expensive. In addition, lenders are often more open to a restructuring than they are to taking their chances in bankruptcy court.
General and troubled debt restructuring: What’s the difference?
Out-of-court debt restructuring can occur in two ways:
1. General
A general debt restructuring allows the distressed company time to regain financial stability by extending loan maturities, lowering interest rates, and consolidating debt. General restructuring ensures that creditors will receive the full amount owed, even if it’s paid over a longer period—as such, creditors tend to prefer this kind of restructuring.
General restructuring is suitable for companies that have strong financials overall but are facing a temporary crisis—such as the loss of an important customer or the departure of a key team member. The changes to debt structure in a general restructuring can either be permanent or temporary—and if changes are permanent, creditors will likely push for compensation in the form of higher equity stakes or increased loan payments.
2. Troubled
In this type of debt restructuring, creditors are required to write off a portion of the company’s outstanding debt and must accept these losses permanently. Usually, the creditor and debtor reach a settlement instead of the debtor filing for bankruptcy.
This solution is suitable when companies simply can’t pay their debts at current interest rates and when their only alternative is bankruptcy. However, creditors may receive some compensation in the form of increased equity shares in the business.
Due to the COVID-19 pandemic, many are asking the Financial Accounting Standards Board about how to apply accounting guidance on debt restructurings. Because of this, the Board recently published an educational staff paper to help borrowers sort through the details.
Contact us for help with debt restructuring
Need help reporting restructured loans in your company’s financial statements? Contact us today—we stay on top of the latest developments in debt restructuring and can assist you in making decisions around this complex accounting topic.