Debt Restructuring: Key Issues

Victoria L. Kaplan, Kateryna S. Chechulina

Restructuring… In the last year and a half this word has ceased to be something frightening for both debtors and creditors. Prior to the financial crisis banks in Ukraine could only imagine what “financial insolvency” (at least, on such a scale) and “debt restructuring” meant and only some banks had previously had to face the problem of non-performing loans. Bankers and politicians trusted or sought to trust in the financial solvency of their debtors (corporations or individuals) and were sure that, although the financial crisis was spreading like wildfire around the world, it would simply pass Ukraine by leaving the country untouched by its effects. However, as we have all seen, this was not the case…

Today debt restructuring is a very topical issue as the private banking system (including Ukrainian and foreign banks, foreign financial institutions and corporate lenders) has far more insolvent debtors (or debtors who are very close to insolvency) than before the crisis. Fortunately, banks have quickly realised that a mutual agreement between the parties is always better than court proceedings. While acceleration of a loan is usually equivalent to the bankruptcy of a debtor, debt restructuring allows the parties to “keep the peace” and is advantageous for both sides. Whilst full repayment of debt is the biggest advantage for a lender, the biggest advantages for the borrower are a repayment holiday and the opportunity to avoid “legal insolvency”. Creditors have a financial interest in restructu-

ring, as practice shows that acceleration of a loan where a debtor is “financially insolvent” may prove more expensive and time-consuming for a lender than receiving later repayment through a restructuring arrangement. Therefore, appropriate restructuring of a debt transaction helps to minimise the financial pressure on a debtor and gives it an opportunity to maintain its business which, in turn, strengthens its ability to repay the debt.

The specific features of a debt restructuring will vary depending on the particular circumstances and initial terms of a transaction. However, the parties to the restructuring should start by considering and agreeing on the following key points (on which we will focus in this article)¹:

• registration requirements;
• possibility to have a grace period/payment holiday;
• interest capitalisation;
• issues related to interest payments;
• possible change of parties to the transaction;
• surety/guarantee issues;

• amendments to the security package; and
• the use of a standstill agreement.

Registration requirements

It should be remembered that in cross-border loan transactions any changes to information in the registration certificate issued with respect to the loan agreement by the National Bank of Ukraine (the NBU) such as the amount of the principal, interest and other payments under the loan and the final repayment date, should be properly registered by the NBU and the relevant amendment to the certificate made.

Furthermore, it is worth mentioning that in October 2009 the NBU reintroduced caps on the interest rate foreign lenders can charge on loans in foreign currency. As a result, when registering any amendment to the transaction with the NBU, even transactions, which were registered when there were no maximum interest rates, must comply with “maximum interest rate” requirements existing at that date of the amendment’s registration. In other words, the interest rate payable under the loan, amendments to which are being registered, should not exceed the maximum interest rate cap established by the NBU at the date of registation of such amendments. In view of this, it may be preferable for parties to choose restructuring options, which do not need to be registered with the NBU, although we admit that this is almost impossible. Almost all the restructuring options considered below are subject to registration with the NBU.

Grace period/payment holiday. Interest capitalisation

A grace period or payment holiday is a period during which the lender, subject to the terms and conditions of a restructuring scheme, does not have the right to demand that the borrower repay any of the principal and/or interest and/or any other payments under the loan agreement. Depending on the agreement reached by the parties and if the final maturity date is not postponed, it is often better for the borrower to only suspend interest payments, which will ensure that the cost of the loan for the borrower will not rise. If only payments of the principal are delayed and no extension to the term of the loan is agreed, after the end of the grace period the amount of the regular payments will be higher for the borrower compared to the regular payment amount initially agreed. However, the total amount of the loan will remain the same. Moreover, the borrower will actually pay a higher amount of interest overall, as the interest will continue to be accrued on the indebtedness during the payment holiday and this amount of indebtedness will not decrease during this period due to the absence of repayments during the grace period.

The grace period/payment holiday commonly includes an extension to the general term of the loan. The final maturity date is usually postponed, but this alone is unlikely to help the borrower to avoid default. Therefore, the entire schedule of payments is usually revised. Having a longer term enables a decrease in the amount of the regular loan payments and this, in turn, reduces the financial pressure on the borrower.

Upon agreeing an interest payment holiday, the borrower may suggest to the lender capitalisation of interest, which may be a major benefit for the lender in restructuring payments. However, in the case of cross-border loans, every time that interest capitalisation has occurred, capitalisation has only been effective from the moment of registration of the increased amount of the loan with the NBU.

Issues related to interest payments

The parties to a loan usually proceed to agreeing on the amount and type of interest at first. What the borrower would prefer is most likely a decrease in the interest rate, if not for the entire term of the loan then at least for a certain period. The lender may accept this and waive its right to charge default interest. However, using this approach may be risky for the lender.

The other option, which can be considered by the parties, is a change to the type of interest rate, i.e. replacement of a floating interest rate with a fixed one and vice versa. Although a fixed interest rate guarantees more certainty for the borrower in terms of its financial management, implementation of the fixed interest rate usually results in a hedging arrangement being put into place. Apart from the additional costs, which could adversely affect the borrower, it is doubtful whether a Ukrainian borrower itself can in fact sign a hedging agreement due to certain restrictions in Ukrainian legislation. In practice, a Ukrainian borrower is prohibited from making hedging payments abroad directly so, as a result, the hedging structures in cross-border loan transactions are usually rather complicated.²

The discussions between parties on interest may include the possibility of interest pre-funding. Loan agreements usually provide for a fixed date or period when the borrower has to pay interest.

In some cases, due to the nature of the borrower’s business (e.g. leasing), the funds intended to be used for such interest payments can become available to the borrower earlier than the interest payment date. Ukrainian currency control restrictions existing at the time this article was written (which, hopefully, will be cancelled before this article has been published), mean that borrowers are unable to prepay. This means that a borrower who has the funds available to repay the loan cannot use these funds efficiently. Placing these funds on deposit for up to three months (not more, since the interest is usually payable on a monthly or quarterly basis) is unlikely to provide the borrower with any meaningful profit, and will also mean it is unable to enjoy the benefits of foreign currency exchange rate fluctuation. In such circumstances, a good solution for the borrower can be to implement an “interest pre-funding” scheme, according to which it would be entitled to pay interest on any day within the interest period. The lender will not be required to make any changes if it is agreed that any interest prepaid by the borrower and received by the lender will only be applied by the lender on the initially agreed interest payment date.

Possible change of the parties to the transaction

Except for alterations to the terms of transaction, the restructuring can also be based on the assignment of rights and obligations by the parties. Considering this option, Ukrainian legislation provides the parties with the following possibilities:

• assignment/sale of a loan;
• repayment of a loan by a surety/guarantor; and/or
• assignment of a debt (debt transfer).

The main condition for implementation of any of the above options is the existence of a third party possessing available funds to repay the loan immediately or according to a schedule agreed with the lender.

As soon as the parties have agreed on one of the above options and the financial aspects related to implementing this option, the following steps will need to be taken:

(i) the relevant agreement between the parties (assignment agreement between the initial lender and the new lender, surety/guarantee between the lender and surety/guarantor, debt transfer agreement between the lender, initial borrower and the new borrower as applicable) will need to be executed;

(ii) the relevant payments provided for in the agreement from step (i) will need to be made;

(iii) for the cross-border loans, if the new lender/surety/guarantor is a non-resident or the new borrower is a Ukrainian entity, the lender’s/borrower’s replacement will need to be registered with the NBU; and

(iv) the security documents and records in encumbrances registers will need to be amended to reflect the changes to the parties.

Notwithstanding these common steps for each option, every single option will also have its peculiarities and specific consequences for the parties, which should be taken into account. For example, although assignment by the lender of its claims is allowed under the Civil Code of Ukraine, it may not do so if it is prohibited under the loan agreement. The same is true of the borrower’s consent to the assignment: it is not required unless directly provided for by the terms of the loan agreement. Therefore, it is advisable to review and consider the terms of all transaction documents carefully before making a decision as to which restructuring option to proceed with.

Surety/guarantee issues

When restructuring a debt with the assistance of a guarantor/surety provider, it should be remembered that there is a difference between the concept of a surety and a guarantee under Ukrainian legislation.

The discharge of the borrower’s debt by a surety leads to the lender being replaced by the surety in the loan agreement and security documents. This replacement of the lender by the surety takes place by virtue of law. Where the loan is repaid by the guarantor, this guarantor only receives a right of regress against the borrower with respect to the amount paid to the lender under a guarantee agreement. The guarantor does not replace the creditor in the principal obligation or in the security agreements.

Amendments to security package

One of the most important issues to be borne in mind in the restructuring process is that it may be necessary to amend not only the loan agreement itself but also the security documents. The need to amend security documents will be determined by the nature and substance of the alterations to the principal obligation, description of the secured obligations and other terms and provisions contained in the security documents, including the governing law. However, it is worth mentioning the following key issues related to security documents and any amendments to them which should always be considered:

• the possible need to register amendments with the respective register in Ukraine and abroad, depending on the parties to and subject of the amendments,
• impossibility by a Ukrainian company (non-financial institution) to act as a guarantor, and
• priority of ranking of the charge upon an increase of the secured obligation amount, etc.

Standstill agreement

Last but certainly not least, it is worth mentioning that irrespective of the approach chosen by the parties to the restructuring transaction, before proceeding to restructuring itself the lender should consider the need to enter into a standstill agreement with the other creditors of the borrower. If the borrower has more than one creditor, any restructuring scheme with a lender would be potentially unworkable and risky as the other lenders may have rights to claim against the borrower. So as to avoid this situation all the lenders should enter into a standstill agreement, according to which they would refrain from demanding repayment of each loan when it becomes due and waive their rights and remedies under the finance documents in respect of a default at the date of the standstill agreement or later. However, the waiver of rights and remedies in the agreement should be limited. It is advisable that a standstill agreement clearly states that, apart from the waivers specifically provided for therein, it shall not constitute a waiver of any existing or future default or the creditors’ rights arising out or in connection with such defaults or affect any security to which creditors may be entitled.

A standstill agreement is effectively a “contractual moratorium” on causing the borrower to become insolvent as agreed to by all creditors of the borrower, acting in solidarity. Although, the main goal of a standstill agreement is to create this “moratorium”, it can become a “road map” for the borrower and its creditors in saving the borrower.

And finally, it must be remembered that no-one is more interested in the financial health of the borrower and ensuring it does not become insolvent than its creditors.

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¹ In this article we will only consider restructuring schemes/options involving a “financially” and “legally” solvent corporate borrower (not a bank) and a Ukrainian or foreign lender.

We note that there are different types of hedging agreements insuring different types of risks and not only risks related to the rate of interest.