Financial Distress, Bankruptcy Planning, and Restructuring Options

✦ Financial distress occurs when a company cannot meet its debt obligations or fund operations without external support, often triggering strategic, legal, and financial interventions.

✦ Effective planning involves early warning signals, stakeholder negotiations, and a clear assessment of restructuring alternatives.

✦ Tools include out-of-court workouts, covenant resets, debt-for-equity swaps, asset sales, or formal bankruptcy filings under Chapter 11 or equivalents.

✦ Successful restructurings preserve value, protect going-concern operations, and realign the capital structure to future cash flow potential.

We’ll explore how to diagnose financial distress, evaluate restructuring paths, and execute recovery plans that balance creditor claims, operational continuity, and shareholder impact.

1. Identifying Financial Distress Early

✦ Liquidity symptoms: 

• Falling cash balances 

• Draws on revolvers or delays in vendor payments 

• Covenant breaches or risk of default

✦ Operating triggers: 

• Declining revenue or margins 

• Unprofitable contracts or overleveraged acquisitions 

• Disruption from regulatory, supply chain, or litigation events

✦ Market signals: 

• Credit rating downgrades 

• Rising bond spreads or declining stock price 

• Auditor going-concern warnings

✦ Early identification allows more restructuring options and higher recovery rates.

2. Financial Distress vs. Insolvency

✦ Financial distress: Temporary cash flow shortfall or debt pressure—may be reversible.

✦ Insolvency: Legal state where liabilities exceed assets or obligations can’t be met when due.

✦ Most restructuring efforts aim to resolve distress before reaching insolvency.

3. Restructuring Objectives

✦ Stabilize liquidity and preserve core business operations.

✦ Reduce debt burden to match future cash flows.

✦ Address unviable assets or business units through sale or closure.

✦ Negotiate creditor concessions (principal reduction, maturity extension, lower interest).

✦ Rebuild capital structure to support sustainable performance.

4. Out-of-Court Restructuring Tools

✦ Amend-and-extend: Modify loan terms (e.g., extend maturity, reduce rate).

✦ Covenant relief: Renegotiate leverage or coverage tests.

✦ Debt-for-equity swap: Creditors exchange debt claims for ownership.

✦ Asset sales: Raise cash by selling non-core units or receivables.

✦ Bridge financing: Inject interim liquidity while restructuring proceeds.

✦ Requires 100 % or majority consent, depending on debt documents.

5. Formal Bankruptcy Options (e.g., U.S. Chapter 11)

✦ Used when out-of-court solutions are not feasible or too slow.

✦ Debtor-in-possession (DIP) financing keeps operations running.

✦ Automatic stay halts creditor collection efforts.

✦ Company proposes a plan of reorganization, subject to creditor class voting and court approval.

✦ Pre-packaged bankruptcy: Negotiated plan filed with petition to shorten process.

Advantages

• Binding process for all creditors

• Reject or renegotiate contracts

• Access to DIP capital and stay protections

Disadvantages

• Legal complexity and high cost

• Brand and vendor disruption

• Equity often wiped out

6. Creditor Negotiation Strategy

✦ Classify creditors by seniority: 

• Secured vs. unsecured 

• Trade vendors, lease holders, bondholders, banks

✦ Understand their priorities and legal rights.

✦ Use waterfall analysis and valuation to show expected recoveries.

✦ Build consensus with key creditors to avoid litigation and value destruction.

7. Valuation in Restructuring

✦ Reorganizing requires a credible enterprise valuation to assess: 

• Recovery value 

• Impairment testing 

• Creditor allocation hierarchy

✦ Common methods: 

• DCF (based on revised projections) 

• Comparable company and precedent transactions 

• Court-appointed or third-party valuation reports

✦ Equity holders may be subordinated if debt claims exceed valuation.

8. Restructuring Support Agreements (RSAs)

✦ Pre-negotiated term sheets between debtors and key creditor groups.

✦ Outline restructuring terms, treatment of claims, and governance post-reorg.

✦ Improve speed, reduce court disputes, and increase plan confirmation certainty.

9. Stakeholder Communications

✦ Transparency builds trust with creditors, employees, and investors.

✦ Use financial advisors and restructuring counsel to support dialogue.

✦ Secure board backing and document decisions for governance protection.

✦ Public companies must manage disclosure obligations carefully during distress periods.

10. Post-Restructuring Considerations

✦ Clean capital structure with reduced leverage and realistic covenants.

✦ Governance changes, including new board members or creditor oversight.

✦ Focus on profitable growth, working capital discipline, and rebuilding stakeholder confidence.

✦ Use learnings to improve risk management, forecasting, and scenario planning.