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Private equity firms and credit lenders are increasingly encountering portfolio companies and borrowers facing financial distress. Non-performing investments can significantly impact returns and require a proactive approach to preserve value.
In challenging circumstances like these, affected stakeholders should be mindful of the steps they can take to protect their interest.
Use all tools available
Don’t wait until the absolute last minute to consider your spectrum of options. If a company has lost too much revenue and now has too much debt, early action will ensure a broader range of options remain available to restructure, rescue or assist the company. For private equity firms holding distressed portfolio entities, explore whether:
- additional equity will be made available,
- operational cost reductions can be implemented,
- government or industry support may be available,
- an M&A transaction is available, and
- the company’s other key stakeholders may be able to provide any other form of assistance/relief.
For private credit lenders, there are a number of informal restructuring tools that can be used. Debt can be forgiven, rescheduled, converted to interest only, converted to PIK-ed/capitalised interest only, and/or converted into equity. Lenders should also review their security position and, where formal corporate rescue and insolvency processes are unavoidable, consider an enforcement option which will maximise their recovery.
Options available to lenders include security enforcement, appointing a receiver, supporting a voluntary administration, appointing liquidators and/or participating in a creditors’ compromise or scheme of arrangement.
Scrutinise up-to-date information and forecasts
It is essential that accurate and up-to-date financial information is available from the company for its key stakeholders.
A low case, medium case and high case scenario, together with a business plan for short and long-term forecasts should be prepared by the distressed entity and delivered to key stakeholders.
This enables stakeholders carefully to monitor a company’s trading performance against each forecast and to determine if or when a company will run out of money in each scenario and how significantly operating cost reductions will affect that liquidity analysis.
Other stakeholder risk
Stakeholders in a company should also understand whether the company is dependent on any key supplier, customer, joint venture partner, creditor or business partner and whether there are alternative options available should that supplier, customer, joint venture, creditor or business partner fail.
The company should also be encouraged to engage with its stakeholders so that it can understand and respond to any risk of failure.
Be mindful of directors’ duties
It is important to engage with a financially challenged company’s directors to understand what steps the company’s board might take in connection with its distressed position. Well advised directors will take appropriate steps to reduce their risk of personal liability claims (in particular, regarding reckless and/or insolvent trading). This may mean appointing an insolvency practitioner to the company if the directors determine that there’s no reasonable prospect of finding a solution to meet the company’s liquidity needs. This step can occur without shareholder and/or creditor support.
‘Hands-on’ managers of portfolio companies – together with highly involved lenders – should also be mindful that directors’ duties could apply to them (as deemed, de facto or shadow directors).
The definition of ‘director’ is broad under the New Zealand Companies Act and is designed to ensure that persons who are, in fact, responsible for the governance decisions of a company can be held accountable for the obligations of directors under the Companies Act (and other legislation).
Shadow directors can be liable for breaches of directors’ duties in the same way appointed directors are (e.g. and have duties to avoid reckless and/or insolvent trading (section 135 and section 136 under the Companies Act)).
Key takeaways
For private equity firms and private credit lenders encountering portfolio companies and borrowers facing financial distress:
- early engagement, supported by experienced legal and financial advice, increases the range of options available to restructure and/or rescue the company,
- obtaining up-to-date information is essential for making informed decisions,
- understanding a company’s key stakeholders allows better risk planning and management,
- directors of a distressed company may take enforcement action to protect against the risk of personal liability claims, and
- finally, the consequences of company failure can have significant legal, reputational and financial consequences. Early intervention, clear communication and direct action can avoid years of painful investigation and litigation.
Interested in knowing more?
Chapman Tripp is publishing a series on private credit from various stakeholder perspectives and across different aspects of a transaction. Please contact our experts to be a part of the discussion or with any queries you may have.
