Can a Company Enter Into a Debt Restructuring Agreement Outside of Court?

Companies facing financial distress often explore options for debt restructuring to avoid formal insolvency proceedings and maintain control over their operations. Debt restructuring outside of court involves negotiating directly with creditors to modify debt terms, providing the company with more time and flexibility to repay its obligations. This informal process can help businesses avoid the complexity, cost, and potential stigma associated with formal bankruptcy or Corporate Insolvency Resolution Process (CIRP) under the Insolvency and Bankruptcy Code (IBC).

Can a Company Enter Into a Debt Restructuring Agreement Outside of Court?

Yes, a company can engage in debt restructuring outside the court system. This typically involves direct negotiations between the company and its creditors, aiming to adjust the terms of the debt, such as extending repayment periods, reducing interest rates, or in some cases, even reducing the principal amount owed.

Key Aspects of Out-of-Court Debt Restructuring

Informal Negotiations

A company can initiate discussions with its lenders (financial creditors) and other stakeholders to restructure its debts without involving a formal insolvency process.

The restructuring agreement is usually reached through informal negotiations, where both the company and creditors seek a mutually beneficial arrangement.

Corporate Debt Restructuring (CDR)

Corporate Debt Restructuring (CDR) is a common framework for out-of-court debt restructuring. This is a voluntary process where a company agrees with its creditors to revise the terms of the debt to make it more manageable. CDR usually involves financial institutions, banks, and other creditors agreeing to a new payment schedule or modifications.

This is typically done when the company faces short-term liquidity problems and wishes to avoid insolvency proceedings.

Types of Restructuring

• Rescheduling: Extending the time for repayment or deferring interest payments.
• Debt-for-Equity Swap: A creditor may agree to take ownership of a portion of the company in exchange for canceling or reducing the company’s debt.
• Interest Rate Reduction: Negotiating a lower interest rate to reduce the overall debt burden.
• Debt Forgiveness: In some cases, creditors may agree to forgive part of the debt to help the company stay solvent.

Key Parties Involved

• Company Management: The company’s management plays a pivotal role in initiating and negotiating restructuring terms.
• Creditors: Financial creditors, banks, and trade creditors must agree to the proposed terms of the restructuring.
• Advisors: Financial and legal advisors may assist in negotiating terms and ensuring that the restructuring is fair and legally binding.

Advantages of Out-of-Court Restructuring

• Cost-Effective: This process avoids the legal and administrative costs of formal bankruptcy or insolvency proceedings.
• Control: The company retains more control over the outcome, as it avoids the imposition of a resolution professional or National Company Law Tribunal (NCLT) oversight.
• Flexibility: The terms can be tailored to the specific needs of the company and creditors, without being bound by rigid legal frameworks.
• Faster Resolution: Out-of-court restructuring can be faster than formal insolvency processes, allowing the company to return to stability quicker.
• Confidentiality: Unlike formal insolvency proceedings, out-of-court restructuring discussions can be kept confidential, avoiding the public exposure of the company’s financial difficulties.

Challenges

• Lender Consent: The success of out-of-court restructuring depends on obtaining the consent of the majority of creditors, particularly financial creditors. If creditors are not willing to participate, restructuring can be difficult or impossible.
• No Legal Protection: Unlike formal insolvency processes that offer a moratorium to prevent legal actions against the company, out-of-court restructuring does not automatically prevent creditors from taking legal actions. Therefore, the company must manage any legal risks during this process.
• Uncertainty: Since the process is informal, there is no guarantee that creditors will honor the new terms, and there is a risk that negotiations may break down, leading the company into formal insolvency.

Role of Insolvency and Bankruptcy Code (IBC)

IBC can still play a role even in out-of-court restructuring efforts. If a company’s creditors agree to the restructuring terms but the company later defaults on its debt obligations, creditors can then initiate insolvency proceedings under IBC.

Companies may prefer to enter restructuring discussions outside of the formal CIRP process to avoid the moratorium and the complexities of the formal insolvency framework.

Example

Consider a distressed company, XYZ Ltd., that owes significant amounts to financial creditors, including banks and suppliers. XYZ Ltd. is unable to meet its obligations due to a temporary liquidity crunch but believes it can return to profitability with some time and restructuring.

Step 1: XYZ Ltd. initiates discussions with its creditors and presents a proposal to reschedule its debts. The proposal includes extending the repayment period by 2 years, reducing the interest rate, and offering creditors a partial debt-for-equity swap in exchange for reducing the total debt amount.

Step 2: The creditors review the proposal and agree to the terms after some negotiation. XYZ Ltd. avoids filing for formal insolvency and the creditors agree to the new terms informally.

Step 3: XYZ Ltd. implements the new repayment plan, and after 18 months, the company returns to profitability and successfully repays its debts, avoiding bankruptcy.

Conclusion

Yes, a company can enter into a debt restructuring agreement outside of the court system. This informal process, such as Corporate Debt Restructuring (CDR), provides a flexible, cost-effective way for distressed companies to manage their debts, avoid bankruptcy, and return to financial stability. However, the success of this process depends on creditor consent, the company’s ability to meet new terms, and the ongoing financial viability of the company.