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How Corporations Restructure Unsustainable Debt Levels

By Spodek Law Group | February 20, 2024

How Corporations Restructure Unsustainable Debt Levels

Corporations may find themselves carrying unsustainable debt levels for a variety of reasons – economic downturns, poor financial management, overly ambitious expansion plans that don’t pan out, or unexpected events like lawsuits or supply chain disruptions.

Why Debt Levels Become a Problem

When a company takes on too much debt compared to its assets and cash flow, it can quickly face financial distress. As interest payments eat up more and more of the company’s operating income, it has less money to invest in growth, pay employees and suppliers, or weather further economic storms.

Restructuring Options for Heavy Debt Burdens

If a corporation realizes it has unsustainably high debts compared to assets and income, it can pursue various restructuring options to reduce debts to more manageable levels:

Debt Refinancing

Refinancing existing debts to secure lower interest rates or longer payment terms is typically the first option pursued. Banks and creditors may be willing to refinance debts if they believe the company is fundamentally sound and the issues are short-term.

Asset Sales

Selling off non-core assets like real estate, subsidiaries or business units is commonly used to pay down debt. However, selling assets can reduce future revenue potential so is usually paired with other restructuring efforts.

Equity Offerings

Issuing new shares or equity helps bring in funds from investors without increasing debt levels. However, existing shareholders will be diluted unless they participate in the new offerings.

Debt-Equity Swaps

Creditors can be offered equity stakes in the company in exchange for reducing the debts owed to them. This lowers interest expenses without requiring asset sales.

Spin-Offs

Creating a new independent company from a division and offering shares in that company is another way to raise capital to pay off corporate debts.

Debt Buybacks

If bonds or other debts are trading at big discounts to face value due to bankruptcy fears, companies can buy back debt at a discount and reduce obligations.

Voluntary Debt-For-Debt Swaps

Much like debt buybacks, corporations can offer to swap new bonds for existing bonds trading at distressed prices at an agreed exchange ratio. Investors exchange their risky bonds for new ones at lower face value.

Filing for Bankruptcy Protection

As a last resort, filing for Chapter 11 bankruptcy protection halts debt payments while companies negotiate with creditors. Debts can be reduced, payment terms extended, or converted to equity under court supervision.

The Corporate Debt Restructuring Process

Once decided to reduce debt levels, corporations assemble a restructuring team – typically involving the CEO, CFO, general counsel, restructuring advisors, accountants and external legal counsel. The early stages focus on:

  • Risk assessment – Identify short-term liquidity needs and risks so urgent issues can be addressed quickly.
  • Stakeholder analysis – Figure out which creditors/contract parties are most important to keep satisfied.
  • Review of all debts and contracts – The company catalogs all debts, payment terms, covenants, collateral conditions and other contractual obligations that may be affected.

Outcomes of Successful Debt Restructurings

Companies that restructure debt burdens before insolvency can generally avoid Chapter 11 and maintain control vs being taken over by creditors. Outcomes typically include:

  1. Lower Interest Costs – Interest expenses are lowered through refinancing, lower principal owed, and creditors converting debt to equity. This frees up operating income.
  2. Longer Debt Maturities – Stretching out bond repayment schedules via swaps or amendments reduces short-term liquidity crunches.
  3. Improved Credit Ratings – Ratings agencies upgrade credit ratings after restructuring, enabling access to lower-cost financing.
  4. Higher Stock Valuations – Investors typically reward restructurings by bidding up stock prices after announcement.

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