Nathaniel Wendling, partner at G5 Partners
Joel Luis Thomaz Bastos, partner at TWK Advogados
Companies can get financially stretched for several reasons: economic difficulties, cash pressures, falling demand and even stress from exposure to foreign currencies, such as the US Dollar. When any of these adverse situations occur, honoring debt payments may become difficult and this sets the stage for a debt restructuring process.
But when should corporate debt restructuring process be considered? Whenever liabilities are higher than assets or when if they lack balance in relation to the company’s available cash, leading to insolvency or illiquidity. In this scenario, the company must renegotiate with its creditors, adjust the balance between liabilities and assets, as well as reorganize its cash flow. The restructuring process aims to assess the company’s financial situation and help it find breathing room to regain solvency and maintain its operations.
It is worth mentioning that if the indebted company is part of a conglomerate, it is possible to restructure the company separately since debt restructurings are carried out individually. There are situations involving intercompany debt, in which the group itself is a creditor and debtor in the company and, in this case, it is necessary to analyze the debt structure and negotiating forces. Sometimes, it makes sense to consolidate the company, especially if studies indicate this as a more assertive position for the process.
In order to identify the need for a restructuring, it is necessary to assess the company’s cash situation to confirm if there is lack of immediate cash to make payments. Thus, the restructuring process begins by negotiating with creditors first so that payment flows can be settled. From there, penalties are analyzed by severity and legal actions may follow. There are currently several companies in this phase due to the economic crisis resulting from the Covid-19 pandemic.
Company, management, and shareholders – each with their own role
Before starting a restructuring process, it is necessary to understand the identity and roles of each agent involved. These include: the company, the management team, and the shareholders. To carry out the restructuring, it is necessary to segregate each agent for better understanding of their roles.
The company plays a fundamental role as it carries the underlying assets, liabilities, cash generation and responsibilities. The management team, on the other hand, has many responsibilities, such as taking care of tax and labor liabilities.
Shareholders play a vital role in terms of equity, which is often used as guarantee by the company in times of financial stress.
Therefore, all parties need to be extra careful because, as leverage increases, the company and its shareholders may start to get confused.
There are two types of debt restructurings: extrajudicial and judicial
After understanding the role of each agent, an in-depth analysis is made to understand the company’s debt situation. Guarantees, debt profile, loan terms, etc., are all analyzed to assess what can be done.
Within this context, there are two different types of debt restructuring processes available (already considering a formal legal proceeding): extrajudicial and judicial. In the first option, the extrajudicial restructuring, the process begins at the end of the line in the sense that companies meet with their creditors to seek an agreement, which is then ratified in court. In this type of restructuring, the company can select a specific creditor category for an agreement if 60% of its debt is classified within this category. Once approved in court, the remaining 40% of the creditors are obliged to adhere to the agreement as minority participants.
Not all legal protections are offered in extrajudicial restructurings and, of course, all requirements established by Legal authorities must be formally met.
The second option, the judicial restructuring, is more complex and is only used as an alternative when no other options are available. The purpose of this process is to protect the company and suspend legal executions. Once filed, companies have a 60-day deadline to submitting a formal judicial restructuring plan. Shortly after, within 180 days from the filing of the judicial restructuring plan, the conditions contained in the plan must be approved by a general meeting. It is worth mentioning that the plan is a contract and has enforceability powers to renegotiate all outstanding debt. After this action is formalized, the company will have a new and more balanced debt profile, but payment deadlines must be strictly met.
When choosing which way to go, the best advice is to assess the company’s entire situation without denying any of the possibilities and outcomes.
What can be restructured
Overdue taxes and debt instruments containing with certain types of guarantees, such as debt with fiduciary guarantees (when a resolvable asset is transferred to a creditor right at the start), may not be included in the judicial restructuring plan.
How are debt restructurings executed?
Carrying out a debt restructuring process involves several agents: the company, the legal advisor, and the financial advisor. Each of these agents play different roles and cannot act individually as they do not have all the necessary pieces to carry out this chess game, which is quite complex.
The company has all the historical facts, relationships and understanding of the situation. The financial advisor plays a relevant role as it dives deeply into the process right at the beginning by reviewing the company’s business plan, constructing a financial model, and analyzing the company’s costs, expenses, and cash generation. The financial advisor also analyzes different scenarios to better understand the company’s strengths and studies how it can improve its institutional performance.
Debt restructurings are among the services offered by investment banks, which work to reconcile interests between debtors and creditors according to what is possible under legislation.
The legal advisor is the agent who supports the preparation of the judicial restructuring plan and deals directly with the legal and court authorities.
In summary, the judicial restructuring process is an agreement between creditors and debtors and is supervised by legal authorities, not decided by them. The company needs to understand that its gains more benefits by negotiating a restructuring plan with its creditors than by going bankrupt.
Objective of the restructuring process
The restructuring process aims to find the right balance between the company’s debts and its operational reality, always seeking to preserve the company’s operations as it generates more value ‘alive’ than liquidated.