Financial distress in general refers to difficulty in honouring
financial obligations to creditors or other stakeholders. There can
be several reasons for financial distress including lack of
liquidity, unforeseen economic adversities, unsustainable profits
etc. Dealing with financial distress typically includes the
following-
- Debt Restructuring- This is an informal process of negotiating
the term of debts to the advantage of distressed entity. This
includes reduction of debt, reduced interest rate, extended tenure
of repayment etc.
Another way of renegotiation includes
issue of equity to the creditors in exchange of partial or complete
waiver of debt. This happens when company has large debts and its
liquidation shall bring loss to creditors. The restructuring in
this form leads to take over of entity by creditors as they end up
holding substantial share of the entity.
- Debt Settlement- This is an approach where debtor and creditor
agree to an amount (usually reduced) as full and final settlement
of outstanding debt. The negotiation is made via Debt Settlement
Company. The debtor pays amount to settlement in company in lump
sum or parts. However, the settlement company withholds payments to
the creditors and tries to persuade creditors to accept a lesser
amount thus profiting on the difference. This method is a lose-lose
situation for both debtors and creditors. In case of debtors, the
credit rating gets adversely affected as although they have made
the payment, they still stand as defaulters in the books of
creditors. Creditors, on the other hand, may have to settle for
less. Despite this, it is a method chosen over bankruptcy in
various cases.
- Debt Management- This is a formal process where debtors and
creditors renegotiate terms of outstanding debt. Terms typically
renegotiated are tenure of debt (which is increased thus providing
flexibility of repayment), instalment size, interest rate or
overall reduction of debt. This might be followed by additional
securitization of debt or guarantee given by a third party.