Dentons’ Global Restructuring, Insolvency and Bankruptcy Group discusses below some of the key legal, commercial, and practical issues related to defaulted loans, loan enforcement, and treatment of loans in insolvency proceedings. These considerations can differ from jurisdiction to jurisdiction, so seeking specific input for the applicable jurisdictions where assets, borrowers, or court proceedings are pending is important.

Spot the early warning signs

Early warning signs of trouble include the borrower:

• breaching or imminently breaching its financial covenants or overdraft limits;
• suddenly requesting new facilities;
• extending the repayment timetable; or
• drawing down on a line of credit.

The borrower may be under increased creditor pressure (including statutory demands, trade suppliers changing payment terms, or other debt collection or winding up procedures) or subject to litigation, insurance claims, or rent reviews. Borrower’s sector may be particularly susceptible to tariffs and trade disputes, creating additional financial pressures.

If management becomes unresponsive to the lender’s questions or reluctant to share information with its lender, then it may be a sign the borrower is experiencing financial trouble because management is focused on triaging the financial issues.

Other warning signs include the borrower:

• losing a key customer, supplier, or tenant;
• suddenly losing or changing its management team, in particular the finance director;
• having a sudden change of auditors or trouble signing off its accounts;
• late or incomplete financial information;
• supply chain disruptions;
• asking its bankers to send cheques for round amounts or postpone/push forward certain payments; or
• deferring any planned or regular capital expenditure.

In the current banking climate, if a borrower with a previously good working relationship and without warning makes a spurious or unmeritorious complaint about an interest rate hedging product, that could be an attempt to draw attention away from more fundamental problems with its financial position.

Be prepared: Information is key!

If a lender spots any early warning signs, the lender (or the borrower proactively) should consider:

• meeting with the borrower at regular intervals to open a dialogue and discuss strategies;
• retaining independent accountants to review the borrower's business and prepare accurate financials;
• carrying out regular lien, insolvency, litigation, and other company searches against the borrower or its affiliates, including in trade journals or newspapers;
• retaining an expert to appraise important assets and determining whether the lender has key current information about assets, such as accounts receivables and customer contact information, detailed inventory, rent rolls, or other key financial information, etc.
• exercising audit or other demand rights under loan documents; or
• assessing the borrower's out of jurisdiction presence, assets, and creditors as this may impact the choice and jurisdiction of any enforcement options later.

Talk to other stakeholders

Lenders may consider contacting other lenders and investors, and opening a dialogue with them to discuss a common strategy and information sharing. Consult legal advisors on any confidentiality restrictions or potential lender liability before undertaking discussions with other stakeholders and third parties. Also review any existing intercreditor or subordination agreements including required notices and/or standstill periods or other provisions impacting remedies.

Attempt to stop others taking unilateral action

Once a lender has identified and contacted other stakeholders, its advisers can help the lender put a standstill or other forbearance agreement in place to prevent others from taking action which would frustrate the overall strategy for the borrower. Depending on the number of other financial stakeholders and other important creditor groups, the lender may need to establish an ad hoc or other committee amongst the key creditors to simplify the day to day decision making process.

Decide on initial strategy

Whether alone or part of a group of stakeholders, is the lender going to support the borrower or consider taking action to minimize the lender’s exposure through enforcement mechanisms? Is the lender planning to sell the debt to another financier or distressed fund (either as a one off strategy or part of the lender's current strategy or risk policy)? Lenders can only make these decisions if the lender is armed with the right information.

A supportive strategy might include:

• providing new money (combined with taking new security) subject to pricing risk vs. reward;
• restructuring existing lending arrangements, giving time to pay, emergency short-term funding;
• considering new credit enhancement, for example, additional collateral pledges or taking guarantees from directors, shareholders or group companies;
• standstill/forbearance agreements in conjunction with other lenders/investors; or
• other financial, operational or capital restructuring (see below).

A risk mitigation/enforcement strategy might include:

• identifying and calling events of default;
• accelerating loans or putting them on demand;
• cancelling existing commitments;
• enforcing remedies, including foreclosure or asset sales; or

appointing an insolvency office-holder, receiver, chief restructuring officer or similar person

Is some form of restructuring necessary?

A financial, operational or capital restructuring of the borrower and its business may be required. A financial restructuring could include writing off debt, swapping debt for equity, or a loan restructuring. Operational changes could include giving the borrower time to implement its business turnaround plan, a change in business direction, or facilitating a change in management (including a chief restructuring officer or lender appointed director specializing in restructuring). The borrower may also look to restore distributable profits or balance sheet solvency by issuing new shares or reclassifying existing share capital.

Whatever the plan, consider the lender enforcement options and potential future insolvency proceedings

A lender’s legal advisers will typically review security and credit documentation to establish defaults and enforcement methods available to the lender, including a review of any intercreditor terms to see if these restrict the lender’s options or affect priority of payment on enforcement. These restrictions need to be factored in and advice sought if there is any uncertainty. The lender’s legal advisers can also help consider any cross-default issues and investigate the pros and cons of the various enforcement mechanisms.

The lender and borrower will typically consider whether any alternative lending or funding for cash flow shortfalls and any insolvency proceeding is needed, either from existing lenders or investors or from new distressed funding sources, including potential priming or rescue loans. Having current appraisals of key assets/collateral of value and the priority structure is vital for pursuing or objecting to any potential priming financing.