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How security trustees protect investor rights in corporate debt restructuring

12 May 2022

In the wake of the global economic downturn initiated by the Covid-19 pandemic, numerous businesses have found themselves facing financial difficulty. As a result, many companies – especially those in the emerging markets – are having to undergo corporate debt restructuring. In this article, we’ll explore the corporate debt restructuring process and the important role of the security trustee in enforcing investor rights and ensuring restructuring arrangements proceed smoothly.

According to the IMF’s Global Financial Stability Report, in October 2019 (pre-pandemic), the global corporate sector was already vulnerable due to rising debt burdens. Firms assumed larger amounts of debt and increasingly applied it toward financial risks, like funding corporate payouts to investors or mergers and acquisitions. Many of these firms were overleveraged and unprepared for the additional strain of a global pandemic and other financial stressors. In the years since, we’ve seen an increase in NPLs and declarations of bankruptcy. In this environment, corporate debt restructuring can provide financially distressed companies with a path to remaining in business.

What is corporate debt restructuring?

Corporate debt restructuring is the process that distressed companies undertake to reorganise debt obligations, restore liquidity and prevent bankruptcy. The benefits of corporate debt restructuring include access to better interest rates; reviving cash flow; and much-needed ‘breathing space’, allowing daily operations to continue.

How, exactly, do firms reorganise their outstanding obligations to creditors? Restructuring is done by reducing the total amount of debt and decreasing the interest rate charged while extending the loan period. Occasionally, some of a firm’s debt may even be forgiven in exchange for an equity holding in the company.

Specific approaches to corporate debt restructuring include:

  • Covenant waiver and reset
  • Debt rescheduling
  • Debt for equity swap
  • New debt injection
  • Refinancing by new lenders

When borrowers seek to obtain new funding at lower interest rates, senior lenders may decide to end their relationship with the distressed firm and sell their debt on the secondary markets. These types of transactions require an impartial interface between the company (or borrower) and its multiple creditors.

This is why an independent security trustee is essential in the debt restructuring process.

Role and advantages of a security trustee

The security trustee acts as an impartial interface between borrowers and creditors, tasked with protecting creditor interests in the event of default or bankruptcy. They hold the security on trust for the benefit of secured creditors or groups of creditors.

The contractual arrangement takes the form of a security trust deed, which is signed by the borrower, creditors and security trustees to outline the rights and liabilities of each party and to regulate the role of the security trustee.

The security may take different forms: a debenture over assets, undertakings and guarantees of the company, or charge over property.

The security trustee’s duties usually include:

  • Acting impartially from the borrower
  • Monitoring the borrower’s compliance
  • Protecting the creditors’ rights
  • Enforcing security upon default
  • Distributing the proceeds of enforcement

Choosing the right security trustee is essential in order to alleviate the administrative burden associated with such transactions, while giving the necessary comfort to creditors that their interests are protected.

A case in point—security trustees in action

One client of IQ-EQ, a tech-enabled asset finance company operating in East Africa, is capitalised by way of equity and debt. It has borrowed funds from a group of lenders, including investment firms and development finance institutions (DFIs). The company’s shares are pledged in favour of the primary lender, with a security sharing agreement in place between the company, the primary lender and other lenders. The loan book and security are administered by the primary lender.

When the company’s financial position required a loan restructuring arrangement, they approached additional lenders who agreed to participate in the debt of the company. They then needed to ensure that the security was extended to those incoming lenders. In addition, while the existing lenders all agreed to extend the security, the primary lender did not want to continue administering the loan book. The additional administrative burden was simply too high.

IQ-EQ Mauritius was engaged to act as security trustee to ensure that the obligations of the company towards the incoming lenders were secured and that the loan book was properly administered. Our team also assisted with drafting the security trust deed and with amending the other constitutive documents such as the share pledge and security sharing agreement.

The two most critical attributes of a security trustee are impartiality and experience. As an independent and regulated service provider with extensive global experience in managing transactions throughout the credit cycle, IQ-EQ offers both.

IQ-EQ provides a full suite of trust services to the loan and bond markets, including trust formation, drafting of the security trust deed and loan documents, and acting as security trustee, facility agent, private placement agent, calculation agent and registrar. To find out more, please don’t hesitate to contact me.

Working with IQ-EQ has been seamless – you and your team understand our business, advise us appropriately, and handle your side of our collective partnership so that we can focus on making good investment decisions. Evan Gibson SVP, Merchants Capital

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