“Many businesses turn to debt restructuring in which it renegotiates its debts in order to improve and restore liquidity and continue its operations”
One of the main difficulties a business faces is the inability to pay its debts as and when they fall due. In this scenario, many businesses turn to debt restructuringin which it renegotiates its debts in order to improve and restore liquidity and continue its operations.
A business can convert its short term debt to long term debt, being debt repayable at some date in the future. This therefore makes the debt no longer immediately ‘due and payable’ hence eliminating it from being caught under the strict insolvency definition.
Debt restructuring normally comprises either or both a reduction of debt and an extension of payment terms. The debt restructure is possible for both secured and unsecured creditors.
A debt restructure could also involve a debt-for-equity swap where the company’s creditors agree to cancel some or all of the debt in exchange for equity in the company.
When a company enters into agreements with its creditors, such as entering into a payment arrangement, it must ensure that its cash flow and future profits will enable the company to repay the debt in question, and in addition, meet all of its other current and future debt. It is no use for a business to enter into a payment arrangement to simply prolong its existence.
There are also two major risks when a business enters into an informal debt restructure, with its unsecured creditors.
The first risk is that as the arrangement is informal, any agreement would only bind one creditor, not all creditors.
Secondly, entering into repayment arrangements opens up a can of worms for the payee if the business is subsequently liquidated. Pursuant to the Corporations Act 2001, a Liquidator has statutory rights to recover payments that are deemed preferential once it is established that at the date of making the repayments the company was insolvent and the creditor knew of the company’s financial difficulty and received more than they would have in a Liquidation.
