Restructure when business is booming – save the financial headache

Restructuring should be viewed as a positive. Companies where the underlying business is sound should look to navigate through the restructuring environment to mitigate against unsustainable debt burdens which have been brought about by the incredibly challenging economic headwinds, the pandemic, and most recently the war in Ukraine. This rightsizing of a business can then allow for new investment and subsequent growth, and the restructuring legislation and toolkit have been designed to help sustainable businesses address the ups and downs of economic and commercial cycles.

Whilst conditions until relatively recently have been much more benign, with easy access to funding in a low interest rate environment, businesses are now facing a very different dynamic of increasing interest rates; high inflation; growing costs of borrowing; substantial increases in price in raw materials (as well as issues of scarcity); high transportation costs and energy prices, meaning that restructuring procedures will become increasingly relevant to allow businesses to address the complex combination of challenges.

Early engagement and a proactive approach to restructuring options, even for the healthiest of companies, can result in very positive outcomes for a business. Such efforts do of course also form part of directors’ duties. If a business is struggling financially and ‘in the twilight zone’ of insolvency, then there is no question that boards need to engage with stakeholders and seek the necessary financial and legal support to protect their businesses (and themselves) as their duties shift to acting in the interests of the company’s creditors.

However, even for financially robust companies, the Companies Act includes the duty to promote the success of the company and this duty always endures. Being alive to restructuring options, in both bad times and good, and considering their use to improve performance and profitability, goes to the heart of those duties.

A restructuring can mean any number of things, including taking steps to strengthen the balance sheet; reorganisation of group entities; improving operational issues, such as addressing issues within the supply chain; negotiating compromises with creditors. The UK moved a long time ago from an insolvency-based approach to more of a rescue culture and this has been developed further by recent legislation introduced in June 2020 (expedited by the pandemic), which introduced further restructuring tools, including the standalone moratorium and the Restructuring Plan.

• The moratorium may be a helpful tool for a company negotiating a restructuring or seeking to complete a transaction where it needs some ‘breathing space’. A moratorium is for an initial period of 20 days (which can be extended), and provides companies with a holiday from certain debt payments. In this window of time, management remain in charge but with a licensed insolvency practitioner acting as Monitor and there is a prohibition on enforcement action such as bringing legal proceedings or forfeiture by landlords. To enter into a moratorium: (i) the directors must state that the company is or is likely to become unable to pay its debts; and (ii) the Monitor must agree that the moratorium will likely result in the rescue of the company as a going concern.
• A Restructuring Plan allows a company to effect a compromise with creditors, including (unlike in a CVA) with secured creditors. To be used, a company must be facing (or likely to encounter) financial difficulty. The Restructuring Plan can also bind a dissenting class of creditors i.e. effect a ‘cross class cram down’ meaning that it can be used to push through a restructuring even if a company cannot negotiate this consensually with all stakeholders.

 Considerations for boards:

• Review of financial arrangements: what are your lending arrangements? Do you have a solid grasp on the financials and, particularly in this high inflationary environment, have these been effectively stress tested?
• Audit of key contracts: management of supply chain is absolutely critical at the current time:  are you clear on your rights (and who does what) should there be any issue within the supply chain? If a key supplier failed, time is often of the essence in an insolvency scenario so are you monitoring counterparties for warning signs (e.g. numerous changes in management; late or non-payment; attempts to renegotiate terms; decline in quality of goods or services; late filing or qualification of accounts)? Importantly, what’s the contingency plan?
• Impact of the pandemic, the war in Ukraine and the wider economic challenges: is the impact on the business temporary or permanent?  Have business plans been revised to address the issues; is it necessary to reforecast projections for larger than expected fluctuations in inflation, supply and energy costs and rising costs of capital?
• ESG: is the business doing all it can to improve its ESG credentials and could a restructuring be used to divest of problem assets or divisions; improve borrowing and wider contractual terms to align with ever-evolving standards; review the make-up of the board – is it sufficiently diverse and does it include the right skillsets? This can improve availability of financing and increase employee and customer satisfaction.
• Is a wait and see approach appropriate given the uncertainty, or should you get ahead of the curve?

Restructuring options are varied and always bespoke to the circumstances. Whether a restructuring is appropriate or not at this stage of your company’s journey, good corporate governance procedures, including taking specialist advice when needed and always recording decisions and rationale contemporaneously, should always be implemented and will protect directors.

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