Debt Restructuring: Definition & An Overview

KEY TAKEAWAYS

• Debt restructuring is undertaken by countries, individuals, and companies to help reduce interest rates or extend due dates. 
• When a nation wants to restructure debt, it can move it into public sector institutions from the private sector. 
• Debt restructuring can include a debt-for-equity exchange, where a creditor cancels a portion, or all, of the outstanding debt for equity in the company.

What Is Debt Restructuring? 

The process of debt restructuring is used to limit the possibility of defaulting on existing debt. It’s commonly used by individuals, countries, and companies who are facing financial difficulties. By negotiating lower interest rates for your debt load, restructuring becomes much less expensive than having to go through bankruptcy. This can make a big difference if you have unsustainable debt, debt challenges, require debt refinancing, or simply can’t keep up with late payments.

How Debt Restructuring Works

If a company is facing the possibility of bankruptcy, they have an opportunity to go through the process of debt restructuring. The process usually includes working with lenders to have them reduce the interest rate on a loan. 

If it’s a company, for example, lenders can agree to exempt the liability due dates that it might have. Taking these steps greatly increases the chances of a company paying back its debt obligations. This leads to the ability to stay in business and continue to operate. 

Creditors recognize that without debt restructuring, they face the possibility of receiving less if the company ends up in liquidation or bankruptcy. So, in a lot of ways, debt restructuring becomes a win-win situation for lenders and borrowers. 

Types of Debt Restructuring 

The entire process of debt restructuring works similarly no matter if it’s an individual, a country, or a company. However, the debt restructuring procedure can vary a little bit based on the debt holder and some of the debt relief options. 

Here’s how the different types of debt restructuring work for an individual, a company, or a country. 

Debt Restructuring for Individuals 

If an individual is facing potential insolvency, they can potentially negotiate new terms with tax authorities and creditors. The individual can negotiate themselves or they can use the assistance of a reputable debt relief company or debt counselor. 

For example, if someone is having trouble making payments on their mortgage, they could come to an agreement with the lending institution to reduce it to 70% of the original amount. The lender could then specify that for the change, they would receive a percentage of the house sale price in return. 

Debt Restructuring for Companies 

Companies have several different ways that they can go through the debt restructuring process. One of the options is a debt-to-equity swap, which is when a creditor agrees to cancel some, or all, of the outstanding debts a company has in exchange for equity or part ownership in the business.

A debt-to-equity swap is usually one of the most preferred options for companies looking into debt restructuring. This is the case when the outstanding debt and the assets the company has are large enough to make the business stop operating, which would be counterproductive. 

Another option for debt restructuring is for a company to renegotiate with its bondholders. They could come to an agreement that some of the outstanding interest payments will get written off, or agree not to repay some of the remaining balance. 

Callable bonds can be used by a company to protect against situations where it can’t make interest payments. So, if there becomes a time when there are decreasing interest rates, a debt issuer can redeem a callable bond early. 

By redeeming the bond early, the issuer can restructure debt in the future since any existing debt becomes replaced with a new one. The new debt will also have a lower interest rate. 

Debt Restructuring for Countries 

Countries might risk defaulting on their sovereign debt, which is where debt restructuring would come in. If this happens, they have the option to move debt to public sector institutions from the private sector. 

Doing this can provide a better alternative to handle the impact of a potential default. As well, sovereign bondholders might also have to take a reduction with a reduced percentage. A bond’s maturity date can also get extended, which can provide more time for funds to be secured for the repayment plan. 

It’s worth mentioning that international oversight can be lacking when it comes to a country going through debt restructuring. 

Debt Restructuring Alternatives 

If debt restructuring might not work, there are a few alternatives that can be explored. Here is a breakdown of some of the most common debt restructuring alternatives. 

• A debt management plan — Instead of restructuring debt with your lender, a nonprofit credit counseling organization could also be utilized. They would negotiate on your behalf with creditors to create or arrange a debt management plan. This can be a common choice for unsecured debts like credit cards.
• Debt consolidation — Using debt consolidation requires taking out a line of credit or a new loan to pay off current debts. But doing this, you essentially replace your debt with new debt, but it will have better terms like lower interest rates. There’s often a longer repayment period as well, which reduces monthly payments but does this in exchange for higher interest charges overall. 
• Chapter 7 bankruptcy — Debt can be overwhelming, and sometimes filing for Chapter 7 bankruptcy can be your best option. Doing this means you could be able to remove any eligible unsecured debts that are included in the bankruptcy. Essentially, you can start fresh and free up resources to pay any other remaining debt. 

Payment forbearance — Undergoing deferment or a loan forbearance lets you skip payments temporarily, all without paying late fees or being reported to credit bureaus. It can be a good option for you to explore if you have a temporary setback or don’t want to permanently change the loan you have.

Summary

Negotiating a debt restructuring proposal can significantly help with debt relief and with problematic debts. A company, individual, or country can receive better rates on loans through loan restructuring and avoid the possibility of bankruptcy proceeding. 

Filing for bankruptcy can be a last-case scenario when there’s a possibility to renegotiate the terms of repayment. But if debt restructuring doesn’t work, alternatives include debt consolidation, a debt management plan, payment forbearance, or chapter 7 bankruptcy.