09 Jun

The CityUK's recapitalisation group wrote to the Governor of the Bank of England saying that the level of unsustainable debt held by U.K. private non-financial corporations could be between £90 billion to £105 billion by March 2021, with lending from the Coronavirus Business Interruption Loans Scheme (CBILS) contributing up to £20 billion of that sum.

One member of the group has said the government would be better off converting loans it has already guaranteed into equity stakes or an equity-type security if loans are unsustainable.  The group said that to address this potential level of unsustainable debt, firms will probably have to raise new equity and restructure debt.

The recapitalisation group issued an Interim Update Report on 8th June 2020 in which it revised its estimates and recommendations for recovery and dealing with the Covid-19 accumulated debt.

So, where does all that new debt leave businesses? 

Repayment and Interest: Taking a commercial loan during Covid-19, whether government guaranteed or not, means it has to be repaid on its terms. That may be in a few months or many years from now. Interest in all probability will be payable on the loan. In some cases, like the CBILS loans, interest is deferred for a period of time while it is underwritten by the Government. 

Cashflow: Cash and cashflow is king. It's not generally possible to pay back loans with anything other than money at the bank (but see below options). Borrowing more money to pay back loans is sometimes possible and even sensible. If cash balances are not sufficient to meet interest and / or repayment terms, then there is going to be trouble. This is what CityUK's team is talking about- unsustainable debt is where a business simply can't meet its financial obligations to lenders. 

The Government Guarantee: This does not help borrowers- it's there to help the lenders. In other words, banks can call on the guarantee if they don't get repaid their Covid-19 loans. This is really only a kind of backstop  because, to make a successful claim on the Government, lenders must first have taken all possible steps to recover the money from their business customers. 

Cash-strapped?: There are a number of options open to businesses which are at risk of being unable to pay their loans:

Convertible Loans: There has been quite a lot of talk about the possibility of converting some of the Covid-19 business loans into equity as a method of helping out with the unsustainable debt issue. The terms of convertibility have to be agreed between a lender and a borrower and will cover such matters as:

  • Class of share on conversion: the class of shares issued to the lenders is commonly the most senior class  Typically, these will be "preferred shares" which carry preferential rights compared to the ordinary shares on a liquidation and sale of the company.
  • Discount: The loan will usually be converted to shares at a discount to the price per share on an agreed valuation of the company in order to compensate for the risk the lender have taken with their money. This discount can be anything between 5% and 30% and is a key term to be agreed.
  • Interest rate: Convertible loans usually accumulate interest in the same way as normal loans. Interest rates on a convertible loan are usually between 4% and 10%.
  • Conversion event: The loan will become convertible on an agreed event, such as on a specific date or if there is a loan interest payment or repayment default.
  • Debt extinguishment: In a debt for equity swap no cash or other resources are received or receivable. Instead, what is ‘received’ is the extinguishment of the debt. So, when the borrower issues its shares to the lender, the loan ceases to exist (or at least so much of it as is converted to equity).
  • Lenders as shareholders: most lenders don't want to become shareholders in their customers' businesses and for good reason. It means that they have to take more of an interest in their commercial activities and most lenders are not set up to do this.
  • Exits: The main and often the only way a lender which has converted into a shareholder can get its money back is through (preferential) dividend payments, or on sale of the shares. This means that lenders often have to stay as shareholders for a number of years, which can be inconvenient to all concerned, but it may well be better than having to place the company into an insolvent liquidation.

These are the Future Fund Convertible Loan Key Terms Final Version designed for SMEs who need financing. The Government announced on 19th April 2020 its plans to launch in May a Future Fund” designed to ensure UK high-growth companies and startups across the UK receive enough investment to remain viable during the Coronavirus pandemic. 

Write-Offs: If loans are not converted into some form of equity or written-off in part of completely by lenders, then there are other options.

Legal Steps:

Take advantage of the Government's relaxation of the wrongful trading laws. There will be a temporary 3-month suspension of the wrongful trading rules that penalise directors if they allow their company to trade while it is insolvent. This suspension lasts until the end of June.

Enter into company restructuring in order to protect the business from its creditors.This is a specialist area outside the scope of this blog post, so we provide links below on a series of topics for further reading, including in our Business Essentials section:

PWC's Insolvency In Brief Guide 
Options on Corporate Insolvency
Corporate Insolvency
Corporate Insolvency- Practice Guide
Creditors' Voluntary Liquidation 

Creditors Applying to wind up a company
Compulsory Liquidation

Creditors' Rights against a company
Court Judgments for debts
Dealing with your company's debts
Statutory Demands

Property & Insolvency
Practice Guide

Search Company Insolvencies
The Gazette 

Administration Explained
Administration is a formalised procedure where an insolvency practitioner is appointed as the administrator by a company directors, the company itself, its creditors or the Court. Legal actions against the insolvent company (including receivership and winding up petitions) are stayed for about eight weeks, while the administrator prepares and proposes a plan of action to creditors. An administrator assumes control over all an insolvent company's assets and business operations, and must act in the best interest of all the creditors, to try to repay as much to them as possible.
What is Administration?
Find a registered Insolvency Practitioner

Receivership Explained
Receivership is a right that a creditor has under an agreement (usually through a legal charge in a loan agreement) with the company that owes it money. The right is to appoint a Receiver over some or all of the company's assets or property, with a view to selling them off to recover the debt. The Receivership appointment trigger is usually the continued non-payment of money due to the creditor. Receiverships frequently, but not always or necessarily, end with a company being wound up.It depends on the ability of the Receiver to recover what is due to the appointing creditor and the ability of the company to continue to trade. Directors must give up their control & administration of a company once a Receiver is appointed.

Differences between Administration & Receivership
"Perhaps the most important point to have in mind regarding the distinction between administration and receivership is that the former still involves options and opportunities on the part of the insolvent company, whereas the same can’t really be said of the latter." The Gazette

Company Voluntary Arrangement (CVA) explained
A CVA is a legally binding agreement with a company's creditors that allows an agreed proportion of its debts to be paid back over time. For a CVA to be binding, 75% of the voting creditors must support the proposal. A CVA allows the company to continue trading with the directors in control, but they are monitored by a supervisor, who must be be a licensed insolvency practitioner. CVA's usually continue for 3-5 years.
CVA guidance

Company Voluntary Liquidation (CVL) explained
A creditors’ voluntary liquidation (CVL) is a procedure in which the company's directors choose to voluntarily bring the business to an end by appointing a liquidator (who must be a licensed insolvency practitioner) to liquidate all of its assets. This differs from a compulsory liquidation, which is forced upon an insolvent company via a winding up order made by the Court. The following 4-step guide describes how a creditors’ voluntary liquidation works and how it affects the company and its directors:
CVL guidance 


By the publications team at: Contracts-Direct.com

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