What is Out Of Court Restructuring?
Out of court restructuring is an alternative process to a court-supervised proceeding such as a proposal or bankruptcy. As its name suggests, out of court restructurings are not supervised by the Court and generally result from negotiations between a debtor and major creditors to adjust the terms of their debt. A central principle of an out of court restructuring is that it will be subject to the approval of affected stakeholders (including persons not expressly involved with the negotiations). Thanks to the efforts of the Province of Alberta, most out of court restructurings now benefit from Mediation and Restructuring Assistance Program (the "MRAP"), a program to assist under Canadian insolvency law.
Similar to other Canadian restructurings, an out of court restructuring is often proposed in the shadow of a filing under the Companies’ Creditors Arrangement Act ("CCAA") or the Bankruptcy and Insolvency Act ("BIA"). In both CCAA and BIA filings, debtors are subject to a stay of proceedings . This prevents creditors from initiating or continuing with collection proceedings against a debtor once a filing has been made. The goal of such filings is to provide breathing room for a debtor to either complete a restructuring or liquidate its assets. The restructuring options available vary between a CCAA or BIA proceeding and an out of court restructuring. For example, in a CCAA or BIA proceeding, a debtor has access to a stay of proceedings throughout the duration of the restructuring, which can include a claims process and voting on a proposal. An out of court restructuring does not have a stay of proceedings (although some aspects of MRAP provide for a stay of proceedings). This can make it difficult for a debtor to obtain approval for a restructuring if some creditors believe they would receive a greater benefit from a CCAA or BIA proceeding.
The fundamental out of court restructuring principles are that they should be:
Both the MRAP and the United Nations Commission on International Trade Law ("UNCITRAL") Legislative Guide on Insolvency Law recognize these fundamental principles.
Benefits of Out Of Court Restructuring
For a variety of reasons, companies sometimes prefer to avoid court-based proceedings when restructuring their debts or dealing with creditors. Out of court restructuring can be less costly than court-based restructuring for both companies and creditors. An outline of costs avoided follows.
The significant reduction in time between the decision to restructure and having final agreements in place is a major factor when weighing the advantages of out of court restructuring versus court-based procedures. When parties are in agreement and act in good faith, an out of court restructuring will be substantially quicker than a court-based procedure (consider the "fast track" schedule for a Uniform Commercial Code "elevator" case in a large bankruptcy).
The ability to maintain confidentiality and privacy is a major benefit of out of court restructuring. Out of court restructuring is private and may, with appropriate protections, allow a company to exclude certain creditors from the process, which is not an option in court-based proceedings. Protecting sensitive information is essential to protecting a company’s business interest, especially where the company has research and development projects that are not yet commercial or has proprietary information regarding pricing, profit margins, etc.
Steps in Out Of Court Restructuring
Out of court restructuring typically involves a negotiation process beginning with a proposal or proposals from creditors and/or stakeholders. A plan for out of court restructuring will often entail the following steps:
- First round of negotiation – proposed restructuring. The proponent of out of court restructuring will usually start with a written proposal. Many times, that proposal will be a term sheet that incorporates the key elements of a restructuring plan that the proponent believes would be reasonable, either under the facts of a specific case or based on experience in similar situations. The first round of negotiation may also include the proponent providing financial modeling prepared by professionals reflecting how the proposed restructuring plan would work under various scenarios. The proponent would provide the forecasts to creditors for review and analysis.
- Due diligence by creditors. Creditors and stakeholders will likely want to conduct due diligence on the debtor (and sometimes on other constituents), especially if debt is to be written off as part of the plan. Even unleveraged companies can have meaningful operational, tax and other issues that might affect the value of the company and the so-called "recovery rates" of various constituents. Consequently, creditors will likely ask for an investment narrative and for access to a variety of information such as historical financials, budgets, forecasts, accounts payable, accounts receivable and any long-term projections. Typically, creditors will also ask for any valuations already obtained about the debtor or its assets.
- Second round of negotiation – modifications. After reviewing data provided, creditors will come back with their modifications to the plan. Sometimes, the second round of negotiation can lead to a deal that meets with the approval of all stakeholders but, more typically, it results in some sort of modification.
- Third round of negotiation – finalizing. Once modifications are put in place, a third round of negotiations will sometimes close the deal. It is important for the proponent to listen and to be open to addressing any material issues raised by creditors. But, if the proponent believes strongly that the plan meets the needs of all stakeholders, it is important not to lose sight of overall objectives by trying to make adjustments to please everyone.
- Letter of intent. After various iterations of the restructuring plan, the proponent may finally get to a point where the main elements of the restructuring plan are agreed upon. If that is the case, formal documentation could start with the proponent and its advisors preparing a letter of intent. The LOI would outline the key aspects of the proposed restructuring plan and could also propose a time table or details for its implementation, such as, for example, changes to various credit agreements and incorporation of the term sheet into the debtor’s borrowing base reporting system.
- Agreement. With a letter of intent in place, the next step would be to agree on definitive documents. The debtors’ advisors will likely prepare a restructuring agreement and related documents, such as new credit documents, credit agreement amendments, indenture amendments, intercreditor agreements, a budget, a "roll-up" of post-petition loans, term sheets, waivers or amendments to prepetition credit or loan documents.
- Post-agreement steps. After completing negotiations, a variety of tasks must still be completed. Many times, the plan must be implemented within the existing credit facility and information systems. So, lenders’ agents will need to update procedures and procedures. Also, debtors should work to make pro rata reductions of each lender’s commitment or pro rata increases of the interest rates for each class of debt. In addition, amortization of loans may be reset, debtors’ borrowing base reporting may need to be updated and unpaid principal under revolving credit facilities may need to be scrubbed. Finally, lenders will want to consider re-evaluating financial projections for the debtor in light of the restructuring plan.
Stakeholder engagement in a restructuring
In order to reach an agreed restructuring solution, there are various stakeholders involved in the process. It is important to identify the stakeholders so that they are properly engaged and their support and participation are secured from the outset. A common mistake by any restructuring party is failing to identify who the key stakeholders are and to engage them at an early stage.
Depending on the size and ownership structure of the business, there may be a number of groups of stakeholders. The most common stakeholders are: Having identified who the stakeholders are, it is important to consult and agree with them a process to be followed to reach an out of court restructuring solution. That process should then be published and followed. Fundamental to that is the appointment of a skilled adviser who has experience in advising businesses through the restructuring process. Key stakeholders should be involved to ensure that they understand the process to be followed and that they provide their input and support as the process moves along. It is useful to develop a credibility with the business’s stakeholders so that they will participate and contribute to the process of reaching a deal. What may often happen is that it is the role of the business to insist on a deal but it would not be unusual for primary lenders to refuse to agree to any such deal unless secondary lenders and other stakeholders have also agreed to it. In terms of timing, the key stakeholders should be consulted as soon as possible after a problem has arisen which puts the business’ financial status in question. They need to be committed and bought into a process which will enable the business to survive, so the longer the process goes on without seeking agreement with key stakeholders, the more costly it becomes. It is important to remember that the objective of the business could be to restructure its debt and not necessarily to save the business, even if that may be the outcome.
Legal aspects of an Out Of Court Restructuring
Out of court restructurings can have major legal implications for companies. Such restructuring may result in betrayal of key stakeholders who are not included or fully informed in the decision-making or negotiation process leading up to the restructuring. If trust is broken, this could result in a line of arguable claims or litigation against a debtor’s management, or directors and officers. For secured creditors, their security and enforcement rights will be impacted for better or for worse and they can frequently negotiate stronger control provisions in their security documentation at this time, just as unsecured creditors do in the case of a formal restructuring.
A company looking to enter into an out of court restructuring should be aware of certain regulatory requirements in Canada. There are government agencies in Canada that monitor corporate restructurings, particularly those that involve the health of retirement plans and collecting payroll taxes (for example, the Financial Services Regulatory Authority of Ontario (FSRA) monitors pension fund solvency). Early in communications with stakeholders, the government agency responsible for any government protected/regulated benefit, such as a retiree pension plan, should be contacted by the restructuring company or its counsel to ascertain what requirements are needed to protect the retirees’ interests . This is one of the most useful early steps in an out of court restructuring.
The impact on employees must also be carefully considered in a restructuring, in particular existing employee (or trade union) pension plans or group benefits and life insurance plans. Legal requirements for disentangling a company from such "benefits" are often onerous. It is often difficult and costly to do so, thus companies should carefully think about and consider the full ramifications to employees of their approach to a restructuring.
The general notice information requirements applicable to a Canadian bankruptcy under federal legislation, for example, Section 157 of the BIA, do not apply to out of court restructurings. That said, the most important commercial reasons for informing creditors and other stakeholders about a contemplated restructuring (other than legal requirements) – to be able to negotiate meaningfully, to ensure that all stakeholders understand the proposed restructuring, and to maintain their trust and cooperation – also generally apply to out of court restructurings, and there has been no shortage of cases in the recent past where the lack of appropriate consultation led to a poor outcome.
Out Of Court Restructuring case studies and examples
Consider the example of General Motors’ 2009 sale of its assets to a new company (New GM) which acquired substantially all of the assets of GM and assumed none of the liabilities of GM. The Toledo Assembly Complex is a $400 million facility and 6,000 member hourly workforce that builds SUVs and half-ton pickups. This facility is owned by General Motors Company (Old GM) and is included in a long list of Old GM plants slated for sale, closure or inclusion in the bankruptcy filing. Negotiations began by reconstituted stakeholder chambers of commerce from each region where Old GM has facilities. They met with Old GM to reach a consensual resolution involving incentives to purchase Old GM properties and concessions from Old GM employees. New GM decided to move pickup production from Old GM’s assembly plant in Moraine, Ohio to the Toledo assembly complex. As part of its efforts to secure workers, New GM, along with Old GM, began to recruit new UAW members. Toledo New Auto Workers Council (TNAC) was created, comprised of six local unions representing 6,000 members and more than 1,600 salaried employees, charged with negotiating the UAW Master Agreement for Old GM workers. The TNAC negotiated a one-time $52,000 buyout for Old GM workers at Toledo Complex whose jobs were not assumed by New GM, health care coverage and a one-time $25,000 starter bonus for 2,000 employees who accepted salaried jobs with New GM. Over 2,000 UAW and salaried employees were laid off, terminated or left during the restructuring. Those TNAC members who transitioned into salaried positions with New GM received an approximate $12,000 raise to reflect federal overtime premium pay. Once the sell-off was finalized, the TNAC polled other Old GM unions to gauge interest in receiving similar transfer agreements.
Limitations and challenges
In contrast to the plethora of benefits of out of court restructuring, there are some challenges and limitations that practitioners must bear in mind when considering pursuing an out of court restructuring. First and foremost, to effect a successful out of court restructuring, it is essential to have the support of all key stakeholders. The process may be stalled or, worse yet, reversed back into formal insolvency proceedings if a key player does not participate or is not satisfied with the end result. Such key players could include an enterprise’s lenders, any affected landlords, certain significant suppliers, and even the enterprise’s shareholders in certain circumstances. Therefore, the importance of proper communication and transparency cannot be overstated. As a preliminary matter, when embarking on an out of court restructuring, the enterprise ought to determine who the relevant stakeholders are and the degree to which their consent is required. For instance, if the restructuring would require the enterprise to dilute its equity or sell portions of its business, then shareholder consent to the restructuring would be more likely required. In this case , financial progress would likely be delayed until the shareholders are on board with the restructuring. For a distressed enterprise that requires an immediate capital injection, the delay could be both disconcerting and damaging to the enterprise’s bottom line.
Further, while unlikely, the Court’s ultimate realization of the benefits availability upon the commencement of formal proceedings in favour of an enterprise following an out of court restructuring could be difficult to achieve. As we know, the benefits of debt availability, by way of filing under the CCAA, are only available to those enterprises that file for such protection, at which time they also benefit from the statutory stay of creditor proceedings. Because the enterprise does not file, while it may reap the benefits of an out of court restructuring in the short term, in the long term that same enterprise risks losing out on the benefit of the stay of proceedings, or having to re-notice its creditors. In addition, in order to realize the benefits of the stay of proceedings, the enterprise may be required to commence a formal proceeding, resulting in increased cost to the enterprise. Without such a notice, the enterprise would be vulnerable to actions by disappointed unsecured creditors seeking to recover on their loss.