How Companies Restructure Debt: 6 Tools From Forbearance to Chapter 11

Debt restructuring is mostly paperwork, and the paperwork is written by whoever is owed the money. That is the practical difference between the tools a company can use, more than their names: who drafts the document, what the company must admit in it, and what a court would later make of those admissions if the restructuring fails and a case is filed anyway.

How companies restructure debt, then, is a question about six kinds of documents, running from a short letter in which a lender agrees to wait to a confirmed plan that binds creditors who never agreed to anything. They are taken below in the order a company usually meets them.

1. A Forbearance Agreement Buys Time and Asks for Admissions

A standstill or forbearance agreement is the first instrument most lenders offer after a default. The lender agrees not to enforce its remedies for a stated period. The company, in exchange, gives something, and the list of things it gives is where the reading should start.

The lender's draft will usually ask the company to acknowledge the default, confirm the balance, waive defenses it might have raised, release claims against the lender, accept tighter reporting, and sometimes add collateral or a fresh guaranty from the owners. A forbearance is a lease on the lender's patience, and like a month-to-month lease on a storefront in a mall losing its anchor tenant, it is renewed only while the landlord sees no better use for the space.

The added collateral deserves a second look for a reason owners rarely consider when they sign, which is that the Bankruptcy Code defines a "transfer" to include "the creation of a lien," that section 547(b) lets a trustee or debtor in possession avoid a transfer made to a creditor on account of an existing debt, within 90 days before a petition (one year for an insider), while the company was insolvent, if it left the creditor better off than a Chapter 7 liquidation would, and that the Code presumes insolvency during those 90 days, so that a lien granted in a forbearance agreement to secure an old loan can become, if the forbearance fails and a case follows within the window, one of the first things a trustee examines.

None of that makes forbearance a mistake. A company with a credible plan to refinance or sell may need exactly those weeks. The admissions are the price, and they are meant to be permanent.

2. Amend and Extend Changes the Calendar, Not the Balance

An amendment pushes out the maturity, resets financial covenants the company has breached or soon will, and may convert some payments to interest only. The lender charges for it in fees, rate, collateral, or reporting. The document is an amendment to the existing credit agreement, and it assumes the underlying business will recover within the new schedule.

Nobody forgives anything in an amend and extend; they move the date.

3. An Exchange Replaces the Old Claim With a New One

Where the debt is spread among several holders, the company can offer each of them a different instrument in place of its current claim: a smaller balance paid sooner, a longer note, a share of equity, a new obligation with better collateral. Each holder decides for itself whether to accept. For a small business the equivalent is less formal, a single restructuring agreement with each funder or lender that replaces the old payment terms and, if it is drafted with care, the old default provisions as well.

The document to read closest is the release. An exchange that gives a creditor a new note without extinguishing the old contract, its confession of judgment, its guaranty, or its UCC filing leaves the company owing under two documents at once, and the creditor free to choose between them.

4. A Consensual Workout Puts Every Creditor at One Table

A workout is the multi-creditor version of the same bargain, negotiated with lenders, funders, landlords, and sometimes key vendors together, so that each concession is conditioned on the others. It is where priority questions surface. Lenders who hold competing liens on the same receivables can reorder their positions by contract; New York's enactment of UCC 9-339 provides that the article "does not preclude subordination by agreement by a person entitled to priority." Nothing in it compels a creditor to agree.

The documents multiply: a term sheet, an intercreditor or subordination agreement, individual settlement agreements, lien releases and UCC termination statements, and amended guaranties. Merchant cash advance positions sit awkwardly here, since each funder operates under its own contract and debit schedule and may dispute that it is a lender at all, and it is often the funder positions that are resolved one by one, by negotiated settlement, before the bank will discuss anything.

5. A Prepackaged Chapter 11 Counts the Votes Before the Filing

When a workout has the support of most creditors but not all, the company can solicit acceptances of a Chapter 11 plan before it files. Section 1126(b) treats a vote cast before the case as a vote in the case if the solicitation complied with any applicable nonbankruptcy disclosure law or, where none applies, was made after disclosure of "adequate information" as section 1125(a) defines it. Section 1125(g) permits continuing that solicitation after the filing if the holder was first solicited before it in compliance with nonbankruptcy law.

The advantage is arithmetic. A class accepts when holders of at least two-thirds in amount and more than half in number of the claims actually voting say yes, and the plan then binds the dissenters in that class. A company that arrives at court with those ballots already counted has converted a negotiation that required unanimity into one that required a supermajority (and the creditors who declined to sign the workout, who may have been counting on unanimity as their protection, learn that the protection was always conditional on the company staying out of court, a condition the company has now withdrawn). The disclosure document must be good enough to survive the court's review.

6. A Chapter 11 Restructuring Imposes What Agreement Could Not

Where no agreement is possible, Chapter 11 debt restructuring does the work by statute. The automatic stay halts collection. Section 364 permits new financing, with court approval, sometimes secured ahead of existing liens if their holders are adequately protected. A plan can be confirmed over a dissenting class if it is fair and equitable and at least one impaired class, counted without insiders, has accepted. For an eligible small business, Subchapter V offers a version without a creditors' committee or a disclosure statement in the ordinary case.

The costs are court filing and U.S. Trustee fees, professional fees approved by the court, public disclosure of the company's finances, and the fact that the company's discharge, under section 524(e), does not release anyone who guaranteed its debts.

The Documents Come Before the Tools

How to do debt restructuring, in practice, begins with four documents the company prepares for itself before it asks anyone for anything: a weekly cash forecast for the next several months; a schedule of every creditor with balance, payment terms, and collateral; a UCC search in the company's state of organization; and an inventory of every personal guaranty the owners have signed. The forecast tells the company which tool it can afford. The lien search tells it who must consent. The guaranty inventory tells the owners what they stand to lose personally under each outcome, which is the number that tends to drive their decisions whether or not anyone says it aloud.

For businesses whose pressure comes from merchant cash advances and other funder positions, Delancey Street negotiates settlements with funders, and its first look at a file is free and held in confidence. The firm practices no law, drafts no plans, and files no cases; legal matters go to independently licensed counsel, since the company is not a law firm. A company whose creditors will not agree, or which needs the stay, should be talking to bankruptcy counsel instead. The lender's patience, whatever the document calls it, runs out on a date printed in the agreement.