What Are the Options for Distressed Companies to Avoid Bankruptcy?

Companies facing financial distress have several options to avoid bankruptcy, which can often lead to liquidation or severe reputational damage. The Insolvency and Bankruptcy Code (IBC) in India provides avenues for restructuring and resolution, but there are also other strategies and legal options available to help a distressed company return to financial stability. The earlier these options are explored, the higher the likelihood of successfully averting bankruptcy.

Options for Distressed Companies to Avoid Bankruptcy

Corporate Debt Restructuring (CDR)

Debt restructuring involves modifying the existing debt terms to make them more manageable for the company. This could include reducing the interest rate, extending the repayment period, or converting a portion of the debt into equity.

Companies in financial distress can negotiate with lenders and other creditors for better terms through Corporate Debt Restructuring (CDR) programs, which aim to give the company more time to meet its obligations.

CDR can also involve fresh financing to stabilize the business and help it return to profitability.

Restructuring the Business or Operations

A business turnaround plan focuses on improving internal operations, reducing costs, and streamlining inefficient areas of the business. The company can initiate changes in its product lines, workforce management, and cost structure to return to profitability.

This restructuring might also involve selling non-core assets or divesting from underperforming segments to free up capital and refocus on profitable areas.

Negotiating with Creditors

A distressed company can engage in direct negotiations with its creditors to reach a mutually beneficial agreement that may include debt forgiveness, debt-for-equity swaps, or a restructuring of the debt to make it more manageable.

Under the Insolvency and Bankruptcy Code (IBC), a company can work with creditors to reach a pre-packaged insolvency solution, where a resolution plan is prepared in advance to help avoid full insolvency proceedings.

Voluntary Liquidation

If a company is unable to turn around its financial position but wants to avoid forced liquidation, it may opt for voluntary liquidation. This is a legal process under the IBC where the company voluntarily initiates liquidation proceedings, but the company may choose to settle its debts and wind up the business on its terms rather than undergoing a forced liquidation.

In voluntary liquidation, the company's assets are sold to settle debts, and the company ceases operations, but it is a more controlled and deliberate process than being forced into bankruptcy.

Seeking Alternative Financing

Companies in financial distress may seek to raise funds through alternative financing options such as venture capital, private equity, or bridge loans. These options can help inject liquidity into the company and buy time for resolving financial issues without resorting to bankruptcy.

This can also include short-term loans or working capital financing to manage immediate cash flow concerns while the company pursues a longer-term solution.

Sale or Merger with Another Company

Mergers and acquisitions (M&A) can provide distressed companies with an opportunity to survive through combining with a stronger company or by selling assets to a competitor or a company with the financial resources to revive the business.

A strategic sale of part of the business or assets to a buyer who can bring in new capital or operational expertise can help preserve value, reduce debt, and keep the company afloat.

Pre-Packaged Insolvency

A pre-packaged insolvency involves the company preparing a resolution plan in advance and negotiating with creditors before filing an official insolvency petition. The plan is ready when the company files for insolvency, making the process faster and more organized. This is a recent development under the IBC, aiming to provide distressed companies with a more efficient resolution mechanism.

Government Support and Relief

In some cases, the government may provide financial relief in the form of subsidies, grants, or tax relief to distressed companies, particularly those in key industries (e.g., small and medium enterprises (SMEs), manufacturing sectors). This assistance can help companies avoid bankruptcy and recover from financial difficulties.

The government may also allow for extended repayment periods or introduce schemes to aid distressed businesses, especially during economic downturns or unforeseen events like the COVID-19 pandemic.

Insolvency Resolution and Restructuring Under IBC

If none of the above measures are successful, the Insolvency and Bankruptcy Code (IBC) offers the Corporate Insolvency Resolution Process (CIRP), where creditors, the debtor, and a resolution professional work together to come up with a resolution plan. If the plan is accepted by the Committee of Creditors (CoC), the company avoids liquidation.

The process involves a moratorium that prevents creditors from taking legal action against the company while the resolution process takes place. The company has the chance to reorganize and propose a plan to repay debts and return to profitability.

Debt-for-Equity Swap

In some cases, creditors may agree to swap the debt they are owed for an ownership stake in the company. This can reduce the overall debt burden and allow the company to continue operations while giving creditors a chance to recover some value through equity.

This solution works best when the company has future growth potential, and creditors are willing to accept ownership as payment rather than forcing the company into bankruptcy.

Example

Consider ABC Ltd., a manufacturing company, facing a significant decline in revenues due to market conditions. The company owes substantial debt to its creditors and risks bankruptcy.

Option 1: Debt Restructuring: The company negotiates with creditors for better repayment terms (lower interest rates, extended repayment period).

Option 2: Business Turnaround: The company refocuses on its core profitable products, reduces overhead costs, and automates certain processes to improve efficiency.

Option 3: Mergers or Acquisition: ABC Ltd. explores merging with a financially stronger company, offering potential synergies and capital infusion.

By implementing these measures, ABC Ltd. successfully avoids bankruptcy and regains financial stability.

Conclusion

Distressed companies have several options to avoid bankruptcy, ranging from debt restructuring and business turnaround strategies to seeking alternative financing or engaging in voluntary liquidation. The Insolvency and Bankruptcy Code (IBC) also provides frameworks like pre-packaged insolvency and Corporate Debt Restructuring (CDR) for companies to avoid forced bankruptcy. The key to success lies in timely intervention and proactive management to resolve financial challenges before they escalate.