Troubled Debt Restructuring
When a creditor makes a concession to a debtor that it would not ordinarily contemplate, a distressed debt restructuring takes place. A concession may entail changing the conditions of a loan (such as lowering the interest rate or principal owed or delaying the maturity date) or receiving payment in a way other than cash, like a share of the debtor's equity. Due to the debtor's financial issues, a restructuring may be implemented for financial or legal reasons.
A troubled debt restructuring (TDR) is described as a debt restructuring in which a creditor makes a concession to a debtor that it would not otherwise contemplate for financial or legal reasons relating to the debtor's financial issues.
Thus, in order for a debt restructuring to qualify as a TDR, two requirements must be met:
- There must be a financial hardship for the debtor.
- Due to the debtor's financial difficulties, the creditor must make a concession.
Via a private renegotiation, TDRs give the borrower an alternative to filing for bankruptcy and prevent the lender from suffering a total loss on the debt. Studies have shown that about half of TDRs are successful in delivering long-term repayment stability, that businesses with a higher proportion of intangible assets may benefit the most from private renegotiation instead of bankruptcy proceedings, and that TDRs are likely to gain popularity among managers of troubled companies in the future.
One of the following situations indicates that a debtor is struggling financially:
- Any of its debts are in default;
- The company is bankrupt;
- Its securities include delisted securities;
- It is unable to get money from other sources;
- It anticipates being unable to pay its loan;
There is a lot of uncertainty as to whether it can remain a going concern.
There are many strategies available to businesses for debt restructuring. One is a swap of debt for equity. When creditors consent to forgive some or all of a company's outstanding debts in exchange for equity (half ownership) in the company, this takes place. When the company's assets and outstanding debt are both substantial and forcing it to shut down would be counterproductive, the swap is typically the preferable alternative. If necessary, the creditors would prefer to take over the struggling company as a going concern.
Companies can restructure their debts using a variety of options at their disposal. A debt-for-equity swap is one option. This happens when lenders consent to write off all or a portion of a company's existing debts in exchange for equity (half ownership) in the enterprise. The swap is typically the favored choice when the company's assets and outstanding debt are both substantial and forcing the business to shut down would be detrimental. If control of the failing company must be taken, the creditors would prefer to do it as an operating business.
- Restructuring of troubled debt is an option for businesses, people, and even entire nations.
- The act of restructuring troublesome debt can lower loan interest rates or postpone loan repayment deadlines.
- A debt-for-equity swap, in which creditors consent to cancel some or all of the outstanding debt in return for equity in the company, may be a part of a difficult debt restructuring.