Debt restructuring and refinancing, differences and concepts

There are usually two alternatives available:

• Refinancing or
• Restructuring

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Refinancing

The purpose of refinancing is to replace an existing loan with a new loan. Refinancing is carried out to obtain more favourable conditions. For example, lower interest rates or additional funds. Companies with good results and sufficient cash flow also refinance their debt to reduce the financial cost.

The first step is to provide the lender with financial information to compare debt to income. In other words, the lender analyses the debtor’s ability to meet its obligations. The security of the security rights offered will be evaluated. Real estate is the most common security right, but lenders also accept cash, cars, negotiable securities and so on.

Refinancing has its advantages. Direct refinancing without fresh money will provide lower interest rates and payments. If refinancing involves fresh money, you won’t necessarily get lower payments, but you will increase your liquidity to cover your needs.

Restructuring

Restructuring is usually associated with short-term cash flow stress. The causes may be cyclical or derive from a lack of financing.

Restructuring involves changing the terms of existing loans. This solution is used when the financial situation makes it impossible to comply with the terms of existing financing. The objective of restructuring is to agree new repayment schedules and conditions more in line with the existing situation in order to avoid insolvency. The aim is to move from short to long term obligations, for example.

This restructuring benefits both banks and borrowers. Restructuring of non-performing loans can reduce the burden on the debtor and delay enforcement processes.

During the enforcement period, banks often suffer losses due to legal fees. Restructuring is sometimes more advantageous for these entities than facing an enforcement process.

The financial conditions of the company’s (and, if applicable, the group’s) corporate debt will usually change. Banks will require the provision of new security rights or the strengthening of existing security rights. Most likely, this will even be extended to other debt instruments that were not guaranteed.

Although it seems obvious, companies review their conditions in the face of anticipated short or long-term difficulties.

Usually the company sits down to negotiate with its main or most relevant creditors.

The objective is:

• to jointly analyse the viability of different structures to address the lack of cash flow;
• to visualize the payment schedule;
• to examine the business plan and the actual needs in the short and medium term; and
• to identify the free assets that can be offered as security rights.

If there is a special urgency of funds, it is convenient to designate entities to act as coordinators of the negotiation. This is known as the Steering Committee.

The entity acting as the coordinator will contact the other creditor entities, following a mandate. Once this link has been established, they will receive the necessary financial information.

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Security rights in debt refinancing

In this article we will discuss what the usual security rights provided in a debt restructuring process are. Specifically, we will focus on security rights such as the mortgage and the pledge.

The Term Sheet

Prior to the conclusion of the restructuring or refinancing contract, the parties will define the terms of the contract. This document (Term Sheet) is normally not binding.

It is usually accompanied by a due diligence:

• The business plan,
• Ratio compliance,
• Debt characteristics,
• Assets,
• Burdens on assets, an so on.

Other typical terms used in these operations

Standstill Clause

The refinancing process takes time. It is not uncommon for the process to begin in the face of an impending default.

In such a situation entities usually agree on a wait for such payments or actions for the non compliance of the contract (called a standstill period). These facilities are conditional upon the completion of the refinancing.

This clause facilitates and prevents non-compliance with payment obligations from speeding up legal action or the Bankruptcy Procedure.

This delay will allow the formalisation of the refinancing. In exchange, the debtor will assume certain commitments towards the creditors concerned. That is, not to prejudice the ongoing refinancing process or alter the status of his claims.

The parties will sign a stand-by contract, in which they will regulate the following:

• Duration,
• Conditions of its validity and
• Extraordinary events that would allow the affected creditors to claim payment of the obligations subject to that wait.

Covenants and waivers

A Covenant is an essential element of a loan contract; of any loan. But this is one of the most relevant and dangerous element for borrowers.

The Waiver is the Covenant’s inhibitor. For more information, you can read the following contribution “Covenant and Waivers, What are they?”

Comfort letters

Businesses in need of financing offer creditors maximum guarantees to secure their credit. In the case of a corporate group, it is common for the parent company to provide financial support to the subsidiary applying for the loan. This is done through comfort letters and is often a condition of access to credit.

The framework of comfort letters has been shaped by case law. A distinction is made between weak letters (mere recommendations) and strong letters (generating payment obligations).

The Supreme Court (TS) has established the requirements for comfort letters:

• Clear obligatory link,
• That the parties have enough power to bind themselves,
• That there are determining expressions to conclude the transaction,
• They are applied at the level of the parent/subsidiary relationship.

The important thing is that there is a sponsor’s interest in the operation as a beneficiary. It extends to any relational framework that justifies the validity of the self-interest.

Syndicated loans

A syndicated loan differs from a regular loan in that the amount of the loan is divided among several lenders.

As there are several lenders, syndicated loans regulate(among other things):

• The relations between these lenders,
• The figure of the partner or agent (functions and powers).

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