Terms of a loan – set in stone?

The issue.

As an attorney working in restructuring, I hear a recurring complaint from bank's restructuring departments: "Debtors admit financial difficulties far too late. They ring the alarm bell only once the entire house is on fire."

Doubtless, there are many reasons for this, ranging from the unwillingness to accept the facts, to the conviction that the troubles can best be managed internally. Yet one main obstacle is the lack of adequate proceedings to restructure debt outside of judicial insolvency proceedings. In most jurisdictions covered by Schoenherr, the only way for a solvent restructuring is out of court negotiations and the consent of all relevant creditors. There have been success stories but still, out of court restructurings face serious challenges, not at least the necessity of a unanimous agreement for all involved creditors.

Then, why not use insolvency proceedings?

While the introduction of insolvency proceedings was a big step towards providing a legal framework to foster a business-friendly legal environment these proceedings offer very little to a debtor that merely wants to restructure its debt. First, insolvency proceedings frequently require that the debtor is actually insolvent. Being forced to wait until actual insolvency, hinders timely opening of proceedings and therefore reduces the chances for success. Second, insolvency proceedings frequently force a debtor to hand over control of its business to an administrator. Debtors will usually avoid surrendering control of the business for as long as possible. And third, insolvency proceedings involve all creditors, including customers, suppliers and employees. Involving only the financial creditors is normally not an option. Such proceedings will therefore inevitably have a significant negative impact on the debtor‘s future business, diminishing the chances of successfully continuing the business.

The solution.

All of these concerns could be addressed by introducing a legal framework for restructuring proceedings. In order to qualify as such, proceedings should include at least the following elements:

(i) There should be no requirement that the debtor is or claims to be insolvent or in any pre-stage of insolvency.

(ii) The debtor should be allowed to stay in control of its business. As an alternative, debtors could be obliged to engage a restructuring expert as an external advisor, such as an insolvency lawyer or anauditor.

(iii) The proceedings should be confidential until confirmation of the restructuring plan. This element is crucial in order to avoid any negative repercussions for the debtor's business.

(iv) There should be no requirement to involve all creditors – the debtor should have the option to restructure only certain classes of its debt.

(v) Adopting an agreement should not require 100 % consent but only a majority vote in order to reduce the risk of small hold-out creditors sabotaging the restructuring.

(vi) The final agreement should be confirmed by a court in order to safeguard interests of any dissenting creditors.

The proposal by the European Commission for a directive on preventive restructuring frameworks, second chance, and measures to increase the efficiency of restructuring, insolvency and discharge procedures, is a good start. It can only be hoped that the directive will be enacted soon and properly implemented by local legislators. Because under the status quo – as shown in the table on pages 20 to 23 – the debtor only has the choice between muddling through and a unanimous agreement.

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This article was up to date as at the date of going to publishing on 10 December 2018.