While not necessarily suited to all situations, informal debt restructuring workouts—a method of restructuring the assets and liabilities of debtors in financial difficulty without judicial intervention—can often serve as a useful alternative to formal insolvency proceedings if certain essential pre-conditions are in place. They also offer a number of important advantages to debtors and creditors alike, which makes them a prudent first course of action to pursue.
1) Flexibility and adaptability
One of the most significant advantages of an informal workout is the level of flexibility in negotiating terms and agreements. Formal insolvency laws often impose strict limits on the contents of an agreed plan, and may set other non-negotiable restrictions such as limits to creditor payment delays or thresholds for minimum credit recovery. However, in an informal workout, creditors and the debtor can reach agreements with a variety of provisions that better suit the concerned parties, including elements that may not be possible under traditional bankruptcy law.
2) Ease of negotiation
Out-of-court workouts often provide a better environment for negotiations, both between debtor and creditors and amongst creditors themselves, given that the tone of informal meetings tends to be less confrontational in nature. Furthermore, because procedural rules for informal workouts are either very light or non-existent, the parties in the workout are free to decide for themselves how they would like negotiations to proceed.
3) Timing
In situations of corporate financial difficulty, time is of the essence. Letting too much time go by before working out a solution can cause value erosion for creditors and debtors alike, and can ultimately result in a liquidation of the business. Formal proceedings are often slow and subject to considerable delays, while outside a court setting, negotiations can proceed much more quickly, and thus the situation can often be resolved sooner.
4) Confidentiality
Formal insolvency proceedings can be very public and are thus subject to unwanted attention and speculation. Informal workouts, however, are much more private processes and therefore offer all parties more protection from unwelcome scrutiny. In addition, the greater privacy of informal workouts can, in some cases, improve the ease of negotiations because there is less external pressure weighing on the case.
5) Less damaging to reputations
In addition to protecting reputations through the greater confidentiality, out-of-court restructuring workouts are generally free of much of the stigma that usually surrounds formal bankruptcy proceedings. In fact, when debtors reach agreements with creditors through informal workouts, such announcements are often viewed as a positive development by the markets and other interested entities.
6) No changes in management
Under some legal systems, the debtor company’s management team is routinely displaced when the company enters into formal insolvency proceedings. This can make it difficult for a debtor company to continue to do business while its addresses its financial difficulties. In an informal workout, however, the debtor’s management remains in place, and no formal controls are placed upon their activity.
7) No changes to rights of parties
This advantage particularly concerns creditors that can benefit greatly from having fewer or no changes to their rights. For example, informal workouts allow such things as interest payments to creditors, creditors’ rights to enforce their security, and the continuation of contractual relationships with the debtor—all factors that are not possible in a formal bankruptcy process.
8) Lower cost
Formal insolvency proceedings often have high costs attached, particularly financial costs. But there are also costs in terms of time, energy, and reputation. Informal workouts are generally less costly, both in terms of transaction costs and time costs, even when there are numerous advisors and creditors to coordinate.
9) Lack of regulatory consequences
Informal workouts are beneficial to debtors because these procedures don’t generate the regulatory impact that formal proceedings do. By merely entering into formal bankruptcy proceedings, debtor companies may face termination of a licence or authorization, or a ban on the procurement of public administration contracts. This makes it nearly impossible to continue doing business during and after insolvency.
However, because informal workouts do not have the same kinds of regulatory consequences, debtors will not necessarily run the risk of being unable to do business following the restructuring proceedings. This factor may have considerable influence over a debtor company’s decision to use an informal workout rather than formal bankruptcy to resolve its financial difficulties.
However, because informal workouts do not have the same kinds of regulatory consequences, debtors will not necessarily run the risk of being unable to do business following the restructuring proceedings. This factor may have considerable influence over a debtor company’s decision to use an informal workout rather than formal bankruptcy to resolve its financial difficulties.