Debt restructuring refresher

Australia is in a recession, which is hitting Victoria particularly hard. A broad range of businesses have seen revenues dry up during the pandemic especially in the retail sales, hospitality and tourism sectors.

There are concerns that JobKeeper, JobSeeker and pandemic leave payments could have the effect of creating many “zombie” businesses, for which a post-pandemic transition return to break-even or profitability is uncertain. Additionally, mortgage repayment and rent holidays will not be extended indefinitely.

Against this backdrop financiers will, unfortunately, need to dust off their Global Financial Crisis (GFC) debt restructuring and “bad-bank” playbooks. Indeed, the COVID-19 pandemic is likely to have a larger recessionary effect in Australia than the GFC. A rise in business insolvencies is likely to occur in Q2 FY20/21 and beyond. This article aims to set out some tips and actions financiers might consider so as to mitigate the effect of deteriorating credit.

Potential defaults and events of default: next steps

In one of our earlier alerts to financiers (26 March 2020), we outlined key considerations and tips concerning events of default, insolvency, review events and notices of demand, including relevant provisions to identify in facility documents and loan offers. Assuming a financier has determined an event of default has occurred, what should the next steps be for the financier to preserve the value of credit?

At this juncture, three important questions should be asked and answered:

1. What rights do I have?
2. How do I protect those rights?
3. Do I have confidence in the management, business plans and financial forecasts of the borrower to attempt a work-out or restructure?

Actions: Financiers should ask their lawyers to conduct a security and facility audit and summary of rights (if not already up to date) so that the they have the tools they think they have to deploy in the event of a default. Is all security properly registered on the Personal Properties Security Register or other registers and who holds signed original security and title documents? Have all extensions, variations and amendments been adequately documented? From experience, there can sometimes be undesirable gaps in security coverage and documentation, which need to be resolved. Consideration should be given to whether the financier has security over all, or substantially all, of the assets of the Obligor group, to trump the appointment of a voluntary administrator. Some more sophisticated facility agreements may have an “equity cure” provision for dealing with specific financial defaults. These should be explored with the borrower, together with the ability to request a security “top-up”.

Actions: As to question three above, financiers in this position may not have sufficient information to make a decision. Therefore, a written reservation of rights letter should be drafted specifying the defaults or review events, along with a request for outstanding information, forecasts and compliance certificates. This action has the dual effect of putting borrowers on very clear notice of the concerns of the financier and allows the financier some breathing space for further actions to be considered. All written and oral communications with the borrowers and their advisers should be carefully managed and scripted; the key here is to maintain a message consistent with any reservation of rights letters and/or default notices across the relationship management and “bad-bank” teams.

Tip: Financiers should consider whether they can appoint investigating experts or accountants to the borrower to do a deep dive into revenues, costs and forecasts. The financier would normally expect to have this right under its facility documents with costs of the experts paid by the borrower if an event of default subsists.

Intercreditor issues

The existence of competing or subordinated creditors under priority, subordination or more bespoke intercreditor agreements adds complexity to any work-out or restructuring proposals. These must be part of any security or document review. Subordinated or mezzanine creditors will have varying rights, obligations and objectives, but will be searching for a seat at the table at the earliest possible opportunity if a borrower group is in default. Senior lenders must understand and protect the parameters of its ranking; for instance, can a senior lender “turn off” payments to subordinated creditors and for how long? How long does a first ranking creditor have before it must either take action in relation to a default or allow subordinated creditors to do so?

Enforcement

A financier may decide after reviewing all the information made available to them that the credit is not going to recover with additional time, or with support from the financier or through a radical restructuring action from the borrower. If in such a case the borrower is in default but not insolvent or near insolvency, then the financier may choose to give the borrower a period within which to refinance with another financier. In the current climate, this may be problematic. If, however, the borrower’s solvency position is in jeopardy, the financier may need to enforce its security and guarantees—usually by appointing a receiver to realise its secured assets. In this alert, we are not intending to cover enforcement, receiverships, administrations and liquidations, although these may be the subject of future alerts.

Waivers and standstill deeds

Financiers may not want to pull the enforcement trigger until other avenues are exhausted, especially in the current regulatory and economic climate. Immediate enforcement action often leads to immediate and significant loss of asset and business values.

If a financier answers question three above in the affirmative, there are a range of options that they may wish to take.

For less complex financings, this may involve the preparation of a waiver and/or amendment letter to reset certain covenants or other undertakings. Three key issues to consider when drafting these documents are to:

• clearly set out the defaults (which are acknowledged by the borrower) and required borrower actions
• waive only the known and documented defaults, and
• reserve all the financier’s rights in relation to any other unknown defaults.

A condition precedent to the waiver or amendment taking effect should be the payment to the financier of a waiver fee and the payment of the costs of the financier’s legal, accounting and other experts.

A more complex and extensive corporate group in default or with a diverse group of financiers (or syndicates, with facility agents and security trustees) may require a more bespoke approach than a simple waiver letter. These are often called standstill deeds, deeds of forbearance or restructuring deeds.

Elements of a standstill agreement

Typically, such a document will involve all of the same background security and facility review work from the financier and its lawyers and investigating experts as a waiver letter but are a much more detailed blueprint for a financier approved turn-around. The document sets out all details of the defaults and the default notices, which the borrower group acknowledges. The borrower group also acknowledges that the financier has an immediate right to take any and all enforcement action available to it under its security and guarantees.

The concept of a “standstill” is that in return for completing certain restructuring actions, the financier suspends such enforcement action until:

• all such actions are completed to its satisfaction, or
• the standstill is ended by the occurrence of certain trigger events or by the expiration of a clearly defined standstill period.

As an example of actions required from borrowers, the borrower group may be required to realise assets or businesses and apply proceeds to debt reduction. Borrowers may be required to divest non-core businesses or replace business-critical contracts, key office holders or employees within a stated period. Trigger events revoking the standstill could be the occurrence of new/material events of default or non-completion of critical milestones within the standstill period.

Two further points are worth noting about standstill arrangements. Firstly, financiers should ensure that these arrangements are free from any taint of appearing to be a “shadow” director of a borrower in default, or of procuring a breach of a director’s duties. The arrangements should, in form and substance, be freely agreed (to the extent possible) by the borrower. Case law warns against financiers and their lawyers who move closer than arms-length, including such actions as drafting board resolutions for the borrower and security providers to rubber stamp.

Secondly, in syndicated financings, financiers of different ranking to the same borrower group may have security trustees and facility agents to act on their instructions. The need for a specified level of approvals from different syndicates can make the restructuring of a large corporate group a time-consuming and complex task.