Debt equity swaps - an alternative form of corporate rescue
Charles Wilson of City law firm Trowers & Hamlins LLP explains the increasingly popular form of corporate restructuring; the debt equity swap.
In the current economic climate, certain companies with substantial bank borrowings have been hit by the lethal combination of a decline in demand and a tightening of banks' lending conditions. For some companies this has meant insolvency, while others have restructured successfully.
One increasingly used type of restructuring is the debt equity swap. A number of restructurings involving debt equity swaps such as New Star Asset Management have been completed in recent months and other companies such as Four Seasons and General Motors are actively considering them.
Unpublicised debt equity swaps involving private companies have also been completed. Further, the UK Government announced on 14 January 2009, a Capital for Enterprise Fund providing £75m to be used to exchange debt for equity in qualifying small companies.
What is a debt equity swap?
Debt equity swaps are a form of corporate rescue in which a bank or group of banks (or other creditor(s)) exchange debt owed to it/them by a company for shares in the business. Therefore new shares are issued which increase the total number of shares in the company.
Why are debt equity swaps carried out?
In years gone by, where a company breached financial covenants owed to a bank or materially breached agreed payment terms with a creditor, typically the bank would appoint a receiver or the creditor would seek to wind up the company rather than consider the possibility of a debt equity swap.
However, in recent years it has become more commonplace for banks (and other creditors) to accept a debt equity swap, rather than appoint a receiver or administrator or seek to wind up the company, because they hope to receive a higher return as a result of taking equity once the company has returned to profitability or is sold.
For companies, a debt equity swap helps to make the company more attractive to potential investors, a more viable trading entity and reduces the likelihood that the directors could be personally liable for wrongful trading under section 214 of the Insolvency Act 1986. (Wrongful trading is where a company continues to trade when in the knowledge of the directors it will be unable to meet its debts when they fall due).