The COVID-19 pandemic has spread globally and is primarily, but not only, a health issue: many companies are experiencing sharply declining demand, disruptions to value chains, and increased sick leave. In this part of our Digitorney Special “Prepare For The Storm” we provide an overview of legal and operational solutions that help companies prepare for a possible recession. You also find suitable templates for restructuring solutions in Germany in the Digitorney Lounge.
If one talks to entrepreneurs and executives these days, crisis signals come from different countries: many Chinese companies have achieved low revenues since the beginning of the year and have sent employees in quarantine. Due to consequential production losses and declining demand there, other regions of the world (e.g. Europe) that have strong ties with China, face both interruptions in production and significantly decreasing demand. In addition, the economic slowdown in China had already led to declining sales for many European companies, especially automotive suppliers and engineering companies.
Corona crisis in China causes ripple-down effects, especially in Europe
Although production in many Chinese companies has recently increased again, the ripple-down effects and the Corona virus, which is spreading particularly in Europe, are causing considerable economic problems: investments are being put on hold and business trips are being scrapped on a broad front. Short-time working is introduced, new hires are avoided and employees are laid off. If this situation continues for longer, financial and operational restructurings and insolvencies are likely to increase.
Capital markets lose trust and receptiveness
At the same time, investor confidence in the stock market has declined, so that listed companies face falling and highly volatile share prices and are therefore unable to implement capital raisings and thus have no access to fresh equity. In addition, publicly tradeable bonds issued by large caps have also come under pressure and the receptiveness of the bond markets is severely limited. In order to prepare for the crisis, decision-makers in companies should in particular consider the following instruments:
1. Safeguard liquidity
Securing and maximizing cash flow is paramount in times of crisis. In order to be able to actively manage liquidity, transparency must first exist and the cash flow statement needs to be updated on an ongoing basis. If an illiquidity is already foreseeable, a liquidity status should also be established immediately in order to be able to determine at an early stage whether and when insolvency occurs as the most important insolvency reason on the international level, whereas over-indebtedness does not play a legal role in many countries.
In terms of illiquidity, there are different definitions depending on the country. In some jurisdictions, such as Belgium (cessé ses paiements), France (cessation des paiements) or the Netherlands (opgehouden te betalen), it is important to decide whether there is a cessation of payments. In Germany, for example, a company is already deemed insolvent if it is unable to fulfill more than 10 per cent of its due debt. Similar concepts are also known in Austria and Italy. In most countries, mere interruptions in payments are generally not sufficient for insolvency. For each country, therefore, it is necessary to examine in detail where the legal limits of insolvency are.
1.1 Short-term measures to increase liquidity (selected examples)
– Shorten payment deadlines to customers (DSOs), extend payment deadlines to suppliers (DPOs)
– Create incentives for early payments (e.g. cash discount)
– Incentivize advantageous payment methods
– Send immediate payment reminders in terms of overdue claims, check dunning (e.g. collection)
– Raise invoices for partially finished products
– Invoice orders immediately upon delivery
– Use factoring, reverse factoring, forfaiting or dynamic discounting
– Set priorities for expenses and immediately stop variable investments/expenses if possible and according to priority
– Steer incoming payments in a targeted manner
– Implement sale-and-lease-back with regard to non-current assets
– Lease necessary non-current assets instead of buying
– Reduce inventories, shift warehousing to suppliers or customers
– Make special offers for hard-to-sell products
– Buy goods mainly on commission
– Claim open deposits or loans granted to shareholders
– Request a reduction or deferral of advance tax payments
– Apply for short-time working money (if available)
– Apply for state liquidity support
1.2 Medium-term measures to increase liquidity (selected examples)
– Close down or sell loss-making operations
– Sell non-operational assets (e.g. land, machinery, vehicles)
– Rent unused real estate, machinery or vehicles
– Strengthen outsourcing
2. Strengthening equity
If possible, shareholders should contribute to the financial restructuring through equity capital. For example, the following solutions can be considered:
– Capital increases
– Payments by shareholders to the free capital reserve
– Shareholder loans including subordination
– Capital reduction to create freely available liquidity
3. Debt restructuring
If it comes to a sharp decline in the operating business, the so-called “Leverage” increases due to declining EBITDA and stable Net Financial Debt (i.e. all interest-bearing debt without pension liabilities). Leverage (Net Debt/EBITDA). In most cases, the equity ratio also decreases. If this results in a covenant breach, this is the starting point for the financial restructuring of debt capital. For example, the following measures are appropriate:
– Agree on standstill agreement with banks due to covenant breach
– Agree on bridge loan with banks
– Agree on restructuring loan with banks
– Agree on extension or deferral of maturity or interest payments (“payment in kind”) with creditors
– Reduction/cancellation of debt and/or interests
– Convert debt into new shares by capital cut and subsequent capital increase (Debt Equity Swap)
– Exchange debt for assets (Debt Asset Swap)
– Transfer liabilities to separate legal entities in other countries in order to avoid over-indebtedness (Debt Hive-up)
