Current economic challenges, including inflation, higher interest rates and continuing supply chain issues, are already impacting the liquidity of many businesses around the world. The causes include (i) reduced customer visits/revenues, (ii) voluntary or forced closures, (iii) supply chain disruptions impacting raw materials/parts/inventory or provision of services, (iv) slower pay on accounts receivable, (v) in some instances, restrictions or reserves on access to asset-based revolving lending facility or other lines of credit or non-renewal of lending facilities on their maturity date and (vi) expiration of government loan and liquidity programs from the beginning of COVID-19 pandemic and ongoing losses burning up cash on hand remaining from those programs.
It is unclear how long the current economic trends will continue for, and it is likely they will get worse before the economy begins a recovery. Below we discuss some techniques that can be considered from the customer/retailer, vendor/service provider, owner/operator and lender perspectives. It is helpful to know all of these sides to understand negotiating dynamics and potential future scenarios.
Line of credit borrowings
Certain borrowers who are not in default have been borrowing on lines of credit to assure future liquidity, although there are usually additional interest carry costs associated with doing that. Certain lenders have at least considered not lending on loans in default or imposing additional reserves or lowering borrowing base advance rates. In contrast, in certain jurisdictions, some lenders are actively increasing availability, deferring payment due dates and/or providing advance waivers of default arising from the present economic challenges. Sometimes this is done with the strong encouragement of government regulators and/or because the lenders hope things will get better sooner rather than later and do not want to force otherwise-timely paying borrowers into default prematurely. In any event, borrowers should also consider whether drawing down lines of credit may trip financial covenants in other debt obligations.
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Term loans
Certain term loans entered into at lower interest rates and often on a covenant lite basis have upcoming maturity dates and may need to be refinanced at current higher interest rates and with more traditional financial and other covenants. For borrowers in certain challenged industries or who are highly leveraged already, refinancing on viable going forward terms may be challenging.
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Trade credit terms
It is common for entities with liquidity issues to pay trade goods and services providers on longer than contractual terms. Sometimes trade and services providers will work with their customer for reasons such as wanting a channel for future sales. Sometimes they (or their trade credit insurers behind them) will insist on a return to preexisting credit terms. If they are particularly concerned about a customer filing for an insolvency proceeding soon, they may seek to demand cash in advance or cash on delivery terms, which can both limit building future credit exposure to the customer and limit exposure for return of payments received in a future insolvency proceeding as a preference. For creditors with a sizeable balance, they sometimes will insist on a pay down of that past due balance over time (e.g., current order as COD, plus some percentage more towards the past due balance or a promissory note for the past-due balance); how important the vendor is to the customer and how easily a substitute vendor can be found may impact whether the creditor has the leverage to get that from its customer.
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Critical vendors and other vendors
With limited cash on hand, some customers will sort through which sole source, certified (such as in the automotive or defense industries) or other hard-to-replace vendors it will pay first while payments to other creditors are delayed. Even critical vendors may not get paid in full or on time—just favorably enough to keep them supplying the critical goods or services.
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Monetizing accounts receivable
For customers with limited cash, frequent follow up on receivables may result in payment or an additional discount for early payment may be offered. Factoring eligible receivables or credit insurance when available at a reasonable cost are other alternatives to monetize accounts receivable.
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Potential preference exposure in a future bankruptcy or insolvency filing
Certain payments or transfers received immediately prior to an insolvency filing may be subject to potential claw back in the proceeding. For instance, in the US, payments within 90 days of the filing made to non-insiders (one year to insiders) may be subject to a preference action demand or suit, subject to certain defenses, such as the payment being in the ordinary course of business or there being an unpaid new value defense. Many other countries have similar provisions to the US, although the specific time periods may vary. There are ways to structure pre-filing arrangements to minimize future risk from preference and other avoidance actions.
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Reclamation, priority claims and replevin
There may be remedies, especially for suppliers of goods (but generally not services), recently delivered on credit. For instance, in the US, the Uniform Commercial Code provides for a right to reclaim goods delivered within 45 days on credit, provided certain requirements are met (such as the goods still being in inventory and not resold at the time of the reclamation demand). Certain countries also provide a priority for goods delivered on credit just before the commencement of an insolvency proceeding. Priority claims might also be given under applicable law or contractual “retention of title” terms in other countries. Quick remedies, such as replevin, to seek to obtain the return of such goods may be available when customers refuse to voluntarily return goods in response to a pre-filing reclamation demand.
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Insurance
Companies facing financial challenges, or in industries known to be challenged generally, may find it harder to renew their primary or excess insurance coverages or finance-related premiums. Starting the renewal process earlier than you might otherwise is prudent, particularly if some of your insurers will not renew or want to materially increase the premium or reduce the coverage. In a future wind-down scenario, the company may not want to renew for a full year or get a refund of certain premiums paid, especially if those premiums were not financed. Some businesses are exploring whether business interruption or other insurance may be available to cover some of their losses.
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Eviction and lockouts
Some landlords are working with their tenants who cannot pay rent on a current basis. For other landlords, they are not or may not have the discretion to do so (for instance, certain REITs). Where the landlord acts on a lease default, the length of the commercial eviction process varies considerably from country to country, and even in different courts within each country. Tenants should also consider any interim remedy the landlord may have to lock the tenant out and what access the tenant would need to certain personal property, files or computer servers that may be onsite.
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Foreclosure
Foreclosure procedures differ by jurisdiction and within most federal jurisdictions, by state, province or region. For foreclosures on most tangible and intangible property foreclosures in the US, it is generally non-judicial under Article 9 of the Uniform Commercial Code and can occur on as little as 10 days’ notice to the borrower and other secured creditors of record. Other countries have adopted similar legislation (such as the Personal Property Security Act) which also provide for relatively quick foreclosures on personal property. For real property, some states in the US are non-judicial (mainly deed of trust states) and relatively quick (around 60 days is not uncommon) and other states are judicial and contested foreclosures can take years, especially if there are also mechanics liens or other lienholder’s rights on the property. Mortgage lenders in the US often seek appointment of a receiver for the real property while the judicial foreclosure is pending. In other jurisdictions, the rules and timing for real property foreclosures can vary greatly.
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Collection suits and prejudgment attachment
Collection suits tend to take a while to get to judgment, particularly if the defendant asserts any defenses or affirmative defenses. If instead a collection agency is used, some commercial account payors simply ignore the collection agency reach-outs or simply try to buy time. In most jurisdictions, getting any kind of prejudgment attachment on assets is difficult and may require posting of a bond or some other type of undertaking.
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Forbearance and workouts
Some borrowers have proactively been reaching out to their lenders for forbearance or loan amendments for payment, covenant or other defaults which have occurred or are anticipated to occur soon. In other cases, the lenders initiate these discussions, although it is harder to do so in covenant lite deals where there is no present default. There may be less flexibility for certain publicly held bonds or securitized debt held in a REIT or otherwise to negotiate short-term modifications, especially for payment defaults. Some lenders may ask for forbearance fees, additional collateral or guarantees, acknowledgments and/or releases as part of any forbearance or amendment agreement. Others may simply provide for more informal unilateral amendments that are in effect for a specified period (such as policy announcing the lender will not act on payment defaults in the next 60 days). Some loans may be been transferred to the workout department of the lender or a special servicer which may have a different approach to the defaulted loan.
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Alternative lenders
Various alternative distressed lenders and funds may be approached about their willingness to consider refinancing existing creditors (or perhaps buying those existing debt positions at a discount) or providing debtor-in-possession, rescue and similar financing for a formal process, perhaps on a priming basis to existing liens.
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Trade compositions and payment plans
For smaller companies where the number of creditors is manageable, the customer may propose creditor-by-creditor payment plans to provide short term liquidity or an overall composition with its trade creditors to pay them over time and/or at a discount.
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In-court reorganization proceedings
Most in-court formal reorganization proceedings provide for some sort of stay or injunction against creditor enforcement actions and remedies to allow time for the filing entity to buy time and reorganize. Some of these proceedings allow for the entity to restructure its operations and its debts and perhaps emerge under existing ownership and/or management. A pre-packaged or pre-negotiated reorganization can allow emergence more quickly and with more certainty. This may include a debt for equity swap or other reduction in debt levels which will result in a less leveraged business going forward. In jurisdictions that have yet to implement reorganization proceedings based on the debtor-in-possession model, it still may be possible to effect a prepackage sale to minimize going concern value erosion (e.g., via the appointment of administrators in the UK).
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In-court sale processes
Increasingly, a formal insolvency proceeding is used to sell some or all of the business operations on a free and clear basis to new ownership, usually pursuant to an auction or other marketing procedures run by insolvency professionals.
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Orderly liquidation
Formal insolvency proceedings can also be used to liquidate operations over time to achieve higher values than an immediate shutdown. Many brick-and-mortar retailers have pursued orderly liquidations in recent years.
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Fire sale liquidation
Where there is no financing for one of the longer insolvency processes above, a fire-sale liquidation can be pursued with immediate cessation of operations and quick sale of whatever assets remain. Realizations on asset sales tend to be significantly less in fire sale liquidations, but they can avoid interim operational or wind-down burn.
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Cross-border businesses
Many businesses operating in multiple countries where coordinated or ancillary proceedings will likely be needed to effectively address all the business assets and creditors. Those jurisdictions which have established cross-border regimes are likely to act as hubs for such proceedings.
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Out-of-court wind-down or dissolution
As was common in the dot.com bust of 2001, some businesses simply close their doors and do not pursue any formal insolvency proceeding. Customers who rely on those businesses for goods or services (i.e., IT type services or source code) should have an advanced contingency plan or alternative providers for critical suppliers they need, at least short-term.
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Involuntary or creditor commenced proceedings
In most jurisdictions, there are mechanisms for unpaid creditors to commerce an involuntary insolvency proceeding or receivership. The standards for creditors to successfully commence those proceedings differ from jurisdiction to jurisdiction, and in some jurisdictions there can be costs or damages for an involuntary proceeding that is improperly commenced.
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Jurisdiction for any formal insolvency proceeding
Depending on where entities in the affiliated-entity tree are formed or have assets, there may be a variety of different jurisdictions which may be considered for the insolvency proceeding. Some potential jurisdictions may be more company friendly than others. It may also be possible to change the Centre of Main Interest prior to commencing a proceeding.
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Fiduciary duties and trading while insolvent
If the entity is insolvent or cannot pay its debts as they become due, there may be fiduciary duties owed to creditors. Certain jurisdictions also have a trading while insolvent doctrine which can among other things result in a risk of personal liability for directors and officers. However, some countries, such as Australia, have already moved to relax these rules.