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Business Rescue: A Common Language for Borrowers and Lenders

Posted on 19 November 2020

The problems and challenges thrown up by the COVID-19 pandemic and subsequent lockdowns will be unfamiliar territory for many companies, large and small.

One of the most pressing issues for many will be managing their financial creditors. Many businesses carry debt as part of their day to day working capital arrangements or for funding investments, acquisitions and capital expenditure. In addition to these voluntary debts, many businesses have now become involuntary debtors under various government loan schemes and many more have accumulated deferrals under leases, supplier contracts and with HMRC.

All creditors are different, but financial creditors are well versed, and experienced, in dealing with distressed borrowers. This note aims to remind borrowers of some well-established principles which help to inform the attitudes and approach of financial institutions and their professional advisers when dealing with distressed borrowers and, when properly used, can be very helpful.

Relationship v Restructuring 

Managing financial creditors in times of stress can be a difficult process for even the most experienced of management teams. In normal times, most financial institutions will assign relationship managers to individual borrowers. In larger lending relationships where there may be several financial institutions participating in the capital structure, facility agents will administer the loan relationship on a day to day basis in accordance with the terms of the facilities agreements. However, when borrowers start to breach the terms of their loan and facility agreements, the position can be very different.

Most financial institutions still retain dedicated and specialist teams for dealing with borrowers in financial distress or who are likely to breach financial covenants or other lending terms. These teams are often described as "work-out" or "restructuring" teams and achieved prominence in the aftermath of the 2008 financial crisis for their methods of dealing with distressed borrowers. Since then, many financial institutions have upgraded their practices, policies and management for distressed borrowers and re-badged their work out teams as "business support" services. However, the fundamental tension remains: financial institutions are motivated to minimise their losses. Minimising losses and supporting distressed businesses are often difficult objectives to reconcile.

For borrowers, dealing with a lender's work-out team is very different to dealing with long standing relationship managers. The rules of the game and the relationship between lender and borrower will change in times of distress. For financial institutions, credit funds, restructuring advisers, financial advisers and lawyers involved in restructuring and work-out, there are well established principles which will often guide behaviour and decision making. These principles are less familiar to borrowers and their management teams whose experiences and expertise are geared more towards managing a healthy business. If ever there was a time to become familiar with the principles governing relationships between borrowers and lenders in times of distress, it is now.

An Established Framework for Business Rescue

The Bank of England originally formulated a set of guiding principles to encourage borrowers and lenders to work together through times of crisis. These principles became known as the London Approach. The essence of the London Approach was summed up in a single precept: bankers who take on a relationship in good times share some responsibility with the rest of the banking community to contribute to an orderly management of crisis. The world where debt finance was provided through a network of commercial banks conveniently regulated and guided by the Bank of England has long since passed. However, the spirit of the London Rules survives and is now reflected in the INSOL Statement of Principles for a Global Approach to Multi-Creditor Workouts II (the "Principles"). These Principles reflect the fact that the landscape of debt finance is no longer the preserve of large UK banks, but also includes many foreign institutions, insurance companies and alternative lenders, credit funds, investment banks and holders of high yield notes.  Many of these lenders will be subject to different legal and regulatory regimes, and the Principles provide an established framework for lenders of all kinds to engage with borrowers and find a common approach to dealing with debt.

In practice, whether a workout is multi-creditor or bilateral, domestic or international, the Principles (or some of them) will become relevant for most businesses as they deal with the aftermath of the debt and disruption in a post COVID-19 world.

The INSOL Principles

The Principles are not legal rules, they are statements of best practice. However, they are regularly referred to by governments and financial organisations around the world. They apply equally in all jurisdictions, and they reflect established behaviours and standards for dealing with distressed businesses. They are a helpful baseline for the many businesses who will grapple with the complexities of reshaping their businesses, balance sheets and relationships in a post COVID world. The principles do not dictate creditor behaviour but they do, in most situations, reflect and guide accepted norms and market conduct. There are eight principles which individually clarify and illuminate different aspects of the workout process.

  1. The Standstill Period
    The first principle is that where a borrower is in financial difficulty, all relevant creditors should cooperate with a view to giving the borrower a period of time (known as the standstill period) during which information about the borrower can be obtained and assessed and rescue proposals formulated. A standstill period can also take the form of a waiver agreement. A waiver agreement has much the same effect, but in addition to a contractual moratorium there will be a time limited waiver of events of default. This can avoid problems with cross defaults and signing off annual accounts if an event of default is outstanding on an accounting reference date.

    A standstill or waiver period is often formalised in a standstill or waiver agreement. The effect is to provide a contractual moratorium for borrowers for a limited period of time. This is essential to allow borrowers time to continue trading whilst dealing with its financial creditors and collating information and data necessary to formulate a more comprehensive restructuring solution.

    Whatever form it takes, the standstill or waiver period is the process by which parties give themselves time and breathing space. This is essential to allow all parties to better understand the problems of the business and the solutions and compromises which may be available. If a solution can be identified, it will also give time to implement a longer term fix through a consensual debt restructuring agreement or a more formal process such as a scheme of arrangement, restructuring plan, company voluntary arrangement or other mechanism. 

  2. No Enforcement
    During the standstill period, lenders should refrain from enforcing their claims against the borrower or from taking any action which would reduce their exposure to a borrower. This would include enforcing security, exercising set-off rights or demanding cash cover for existing exposures, exercising rights to mandatory prepayments or calling for additional guarantees and security. The aim is to preserve the status quo whilst a longer term solution is agreed.

    The exception to this Principle is that lenders will continue to be able to sell their debt to third parties. This is now common in the debt markets and provides a mechanism for mainstream financial lenders to exit a borrower relationship in times of difficulty. This can be destabilising for borrowers and other financial creditors as distressed investors are often less inclined to hold term debt to maturity. The most important protection for borrowers is that any waiver or standstill agreement should bind any third party buying the debt in the same way as any lenders selling their debt. Any failure to do so will allow distressed investors to enforce claims and security and other rights and destabilise the rescue process. 
  3. Borrower Conduct
    Where a borrower has debt arrangements with more than one financial institution, it is common practice that none should be favoured or preferred after the date of a standstill or waiver agreement.

    A borrower should not take any action which might affect the prospective returns to lenders, either collectively or individually, compared with the position as at the standstill date. This would include, for example, making scheduled or voluntary prepayments or providing additional guarantees, security or collateral to one lender at the expense of others.

    Maintaining the status quo between different lenders or groups of lenders is essential to achieving stability whilst problems are worked through. A financial institution will need certainty that its exposure and potential losses will not increase relative to other financial creditors after any standstill or waiver agreement.
  4. Lender Co-ordination
    The Principles state that the interests of lenders are best served by co-ordinating their responses to a borrower in financial difficulty. This can be achieved through the use of co-ordination committees or steering committees, which have the effect of giving lenders some kind of representation in discussions with borrowers although this is less relevant for smaller and mid-sized businesses with fewer lenders.

    To the extent this kind of coordination is necessary, there are standard form documents to formalise the arrangements between a borrower and a lender committee and as between lenders themselves. For borrowers, care is needed as any coordination committee will need professional advice often from finance and legal advisers. The costs of such advice which will be for the account of the borrower, and such costs and expenses can quickly escalate with very little control or oversight available to borrowers.
  5. Access to Information
    Equality and quality of information is another key principle in work out discussions with lenders. A borrower should allow lenders and their advisers' access to information regarding the borrower's assets, liabilities, business and prospects. This is seen as essential to enable lenders to evaluate a borrower's financial position and any proposals put forward to lenders.

    The problem for many borrowers is that lenders often require more detailed information and analysis than is usually available. One of the most efficient ways to deal with this is to engage financial advisers who are used to collating, analysing and presenting detailed financial information in a lender friendly form. This will often include weekly cash flow forecasts, regular updates on trading activity, initiatives to carefully manage cash and liquidity, restrictions on dividends, disposals, acquisitions and a revised business plan. From a borrower's perspective, there will be a financial cost to this process but, by using a restructuring adviser that has relevant expertise and credibility, it will provide a seal of approval on the quality of information provided. This is important for lenders who will ultimately need to seek credit approval for any eventual work out or restructuring proposal and the ability to rely on good quality information is an important part of that process.
  6. Restructuring Proposals
    Any proposals for resolving financial difficulties should reflect the relative positions of lenders as at the date when a standstill or waiver was agreed. No lenders should be preferred or favoured above others. The exception to this in practice is where some lenders agree to provide new money to fund a restructuring, and others do not. The "new" lenders will almost always require super senior status for their new money and they may also include terms which have the effect of enhancing the ranking of their pre-standstill debt relative to "old" lenders.

    New lenders may also seek new or additional guarantees and security that are not available to "old" lenders but ultimately, this process is one of negotiation and compromise between lenders and will form the basis for any inter-creditor agreement which may be required.
  7. Equality of Information and Confidentiality
    Information obtained by lenders concerning assets, liabilities and the business of the borrower and any proposals for resolving its financial difficulties should be made available to all lenders and should be treated as confidential information.

    The issue of confidentiality is critical for borrowers. At these difficult times it is unhelpful that information about financial distress or difficulty may become known to customers, suppliers, credit insurers or competitors. For borrowers with publicly traded shares or debt some of this information may also be subject to market abuse regulations.

    There are ways to minimise the disclosure and circulation of confidential information through time limited disclosure protocols, non-disclosure agreements, disclosure channelled through professional advisers, and web based data sites which can be viewed but with restrictions on downloading and copying business sensitive information.
  8. New Money Priority
    If additional funding is provided by any lender during any waiver or standstill period or under any rescue or restructuring proposals, such additional funding should be accorded priority status compared to other claims and debts as at the standstill date.

    This is a well-accepted principle and will often involve additional restrictions on "old" money lenders exercising rights under their debt documents as regards mandatory prepayments, rights to additional guarantees and security and rights to accelerate and enforce their debt claims ahead of any new money.

    Again, these issues will often be the subject of intense negotiation between lenders as part of any inter-creditor agreement in the restructuring process but, as a point of caution, it is also a process that can take time and delay a restructuring agreement. Borrowers need to factor this into their time lines for completing any restructuring negotiations and related documentation.

Practical Guidance

Lenders are more likely to be familiar with these Principles than borrowers. The Principles were originally designed to deal with multi-creditor workouts but have over time become increasingly accepted standards of best practice (at least in part) in small and mid-market restructurings by many financial institutions. Lessons have been learnt by financial institutions in the aftermath of the 2008 crisis and in the post COVID world. The fallout from debt and interruption to normal trade requires banks and borrowers to adopt a cooperative and flexible model based on mutual assistance and co-operation. The Government has made business rescue a central theme in the recent Corporate Insolvency and Governance Act 2020 which is helpful but banks and credit funds are well versed in supporting distressed businesses and the most important lesson for borrowers is to start these discussions early before time and money run out.

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