Using Collateral As Leverage In Debt Restructuring Deals
What Is Collateral?
Collateral refers to assets that a company pledges to a lender to secure a loan. If the company defaults, the lender has the right to seize and sell the collateral to recoup their losses. Common types of collateral include:
- Real estate – factories, office buildings, land
- Equipment – machinery, vehicles, computers
- Inventory & receivables – raw materials, finished goods, unpaid customer invoices
- Intellectual property – patents, trademarks, copyrights
- Securities – stocks, bonds
Companies use their most valuable and liquid assets as collateral to get better loan terms from lenders. The stronger the collateral coverage, the lower the interest rate since it reduces the lender’s risk.
Using Collateral As Leverage
When a distressed company has to restructure its debts, its collateral can be useful bargaining chip. Here are some of the key ways collateral can provide leverage:
If a company defaults, secured lenders have the right to seize and sell pledged collateral. However, going through the foreclosure process takes time, often 6-12 months. During this period, the company can continue using the collateral in its operations.
By drawing out negotiations and blocking surrender of assets, the company can retain control and get concessions from lenders who want to expedite matters. Essentially, the threat of operational disruption from losing collateral can motivate compromises.
Sweetening Liquidation Value
In bankruptcy, secured lenders have priority claims up to the value of their collateral. So maximizing liquidation proceeds strengthens their hand versus unsecured creditors.
Distressed companies can offer to invest in maintaining, enhancing or preparing assets for sale to improve expected recovery values. This “runway” funding helps lenders and justifies cooperation on restructuring terms.
Companies can negotiate to swap out collateral as part of amended loan agreements. For example, pledging more valuable or liquid assets instead of obsolete equipment. Upgrading collateral coverage allows reduced debt principal and payments.
Lenders are often open to exchanging collateral if it reduces risk exposure or provides more downside protection. It can be a useful bargaining tactic for debt relief.
Limiting Blanket Liens
When credit conditions tighten, lenders often demand blanket liens on all business assets rather than specific collateral. This erodes a company’s financial flexibility over time.
To preserve untapped borrowing capacity, companies can bargain to narrow or carve-out major assets from blanket liens during restructuring talks. Freeing up collateral preserves options to raise capital from new lenders down the road.
Utilizing collateral to gain leverage in debt negotiations requires thoughtful planning:
- Valuations – Get updated appraisals of key assets to quantify bargaining chips and offer appropriate collateral to lenders.
- Title Review – Carefully examine property titles, liens and intercreditor agreements to understand limitations and renegotiation flexibility.
- Operational Impact – Model expected business disruptions from losing access to different types of collateral during a prolonged foreclosure process.
- Lender Priorities – Determine which assets different classes of creditors prefer to seize versus keeping operating in a restructuring.
- Regulations – Account for effects of bankruptcy laws, industry regulations and accounting rules on using collateral as leverage with lenders.
Looking at a few examples illustrates how collateral can be deployed to achieve better debt restructuring outcomes:
A mid-sized manufacturer of automotive parts got overleveraged expanding capacity just before the 2008 financial crisis. As auto sales plunged, the company struggled to service its debts. Management decided to negotiate principal reductions with its secured lenders to right-size the balance sheet.
The company had pledged its manufacturing plants, equipment and inventory as collateral to multiple bondholders and banks. Realizing lenders did not want the hassle of seizing assets, management offered to invest in upgrading and preparing the equipment for liquidation. This incentive helped convince creditors to write off nearly 30% of the loan balances owed.
Retail Chain Turnaround
A national retail chain experienced declining sales and profits as consumer shopping habits shifted online. The company closed underperforming store locations but still struggled to pay interest and maturing debt. After reporting losses for three quarters, management entered restructuring talks with its senior bank lenders.
The company had pledged its owned real estate, inventory and accounts receivable as collateral. By dragging out negotiations and blocking lender site access, the retailer retained leverage to keep operating stores. Offering to swap out poor performing properties for higher-value locations also brought banks to the table. By providing updated appraisals and a credible turnaround plan, management convinced lenders to convert 30% of debt to equity and relax borrowing covenants.
Biotech Cash Crunch
A developmental stage biotech company ran into a cash crunch after its lead drug candidate failed FDA trials. With over $100 million in debts coming due, the CEO opened urgent restructuring talks with its venture debt holders. The loan agreements contained blanket liens on all corporate assets and IP.
The CEO put together a new prospectus showing promising early results on an alternative drug compound. By offering to pledge the new IP as collateral while limiting existing blanket liens, management induced lenders to extend maturities on 60% of the company’s obligations. This flexibility allowed operations to continue while executives formulated a revised growth strategy.
As these examples show, effectively utilizing collateral to gain leverage requires understanding lender priorities, having updated valuations, and crafting win-win proposals. With thoughtful preparation and negotiating tactics, companies can use their assets to dramatically improve restructuring outcomes.
For more on utilizing collateral in debt restructurings, check out the following resources:
- How to Use Collateral to Negotiate Debt – Reddit thread discussing tactics large corporations have used in restructuring deals
- Improving Liquidation Recoveries – Quora posts by turnaround experts on enhancing collateral value
- Preparing for Bankruptcy – Avvo article on collateral strategies to gain leverage in Chapter 11 cases
- Corporate Workout Negotiations – Overview by LawInfo attorneys of using collateral as leverage in out-of-court restructurings
- Secured Lender Rights – FindLaw analysis of limiting secured lender control over collateral during business turnarounds
I hope this overview has helped explain how companies can utilize their pledged assets to gain important bargaining leverage with lenders in debt restructuring situations. Let me know if you have any other questions!