Distressed debt in the United States peaked at $934 billion at the end of March, roughly equal to 2008 global financial crisis levels and quadruple levels at the end of 2019.

Elsewhere, Fitch has doubled its forecasts of European corporate default rates in 2020 and 2021 (to 5% and 7%) and the Reserve Bank of Australia has written about corporate default risk in China.

In Australia, default rates could double existing levels to reach post GFC levels of 2.1% (representing $35 billion of corporate defaults).

While businesses including Virgin Airlines; retailers Tigerlily, Sea Folly, Colette, Harris Scarfe, Jeanswest, Bardot; and camping supplier Aussie Disposals have each gone into voluntary administration since December 2019, there have been relatively few ENR appointments as capital markets and special situations funders have sponsored solutions.

An "amend and extend" proposition promises stronger future markets and seeks, in return for more time and free use of cash, higher economic returns to financiers. This may be attractive to a funder in a market of low credit valuations and tightening repayment horizons.

Recent amend and extends agreed by lithium and graphite producers provided for capitalised coupon, improved spreads on future coupon, payment of significant fees and relatively light EBITDA, debt cover service ratios or cashflow reporting. In contrast, a recent oil well producer maintained the same economic profile with its funder in consideration for providing additional information flow, cash lock up arrangements and more regular testing of DCSR.

Increasingly, Agents and majority senior debt holders are being offered observer status at board meetings, although information flow is still restricted to cash events.

Ordinary limitations preventing debt assignment (on issuer approval, absolute prohibitions on trade competitors) are often relaxed as part of waiver negotiations. This risks disclosure of confidential information, even under confidentiality arrangements.

Lynas Corporation has done this extremely well with existing financiers.

Compare another (confidential) matter in which an exiting financier has agreed amendments to the financial instrument at the request of the incoming Agent. Those amendments add credit spread, tenor and substantial fees.

The Agent requires these changes to meet the higher economic internal rates of return requirements of the incoming noteholders behind the refinancing instrument.

The strategy works best if matched to a capital raising or merger process.

With many loans trading at discount in volatile markets, an emerging trend is for a borrower's equity sponsor (eg. minority shareholder) to trade into (purchase) debt instruments on the secondary market and then to control turnaround initiatives of the company.

Purchasing paper (credit instruments) at a discount may be used to retire debt via a credit swap into equity or to cure a financial covenant default or to avoid an equity cure.

The trade also gives the equity sponsor more influence over future transaction events inside the issuer enterprise, for example to encourage a merger or a credit bid to swap newly acquired debt into equity (subject to "control transaction" restrictions under the Corporations Law, FIRB delays, ASIC issues and ASX requirements, if applicable).

The strategy takes advantage of disconformity between going concern and special situation impaired values caused by singular (and apparently curable) events such as COVID-19.

The strategy is a more sophisticated form of one successfully employed post-GFC by savvy borrowers to buy back credit instruments at discount, for reissue on lower market terms. Fortescue Metals Group provides a useful example.

The strategy makes sense if the shareholder believes near term or existing covenant breaches or equity top up obligations can be cured through longer term business transformation and value uplifts.

The option is attractive to shareholders seeking to gain influence over recapitalisation or restructuring turnarounds, especially if the alternative exit for the existing credit provider is an enforcement process via receivership or other value destroying step (including greater cash reservations or bank guarantees, which tend to constrict cash in the business).

Due diligence is critical to understand any restrictions in credit instruments (loan note security deeds and similar), intercreditor arrangements, including any existing co-operation or good faith workout deeds and any restrictions operative at the issuer level (shareholder agreements, subordinations, turnover trusts for dividends etc). Particular attention must be given to assignment, administrative approval, restricted payment rights and confidentiality clauses within credit instruments require review, as might covenant restrictions, rateable sharing, voting entitlements, information sharing (confidentiality), participation rights.

Intercreditor arrangements and, if applicable, shareholder agreements, may also contain "tag and drag" or "follow me" rights which will need to be considered, along with related party, significant transaction and "position of influence" restrictions in the Listing Rule and Corporations Act.

In a recent (confidential) assignment for a non-commissioned processed minerals plant owner, special situations funders negotiated bridging facilities to bring the plant to post commissioning and cash generative states. The plant operator and owner formed part of a larger distressed enterprise unable to, in the time frames involved, increase credit facilities with existing financiers.

Utilisation terms enabled the curing of existing liquidity events and funding of capital. The funding, undertaken after a deep technical due diligence required project finance like covenants to be met and reported against – plant performance, offtake arrangements, key supply and reagent agreements, tenure packages, key-person commitments and cash reservation and reporting within the business.

The funding package would be expected to (and in the example mentioned above, does) contain the usual utilisation and draw down conditionality expected of project financing, together with additional restrictions around achievement of projected cashflows. A key consideration for the funder was its IRR, which was met by providing for a minimum term payout fee calculated in the same manner as a break fee for a securitised fixed income package.

Key to the funding package was the inclusion of deed of priority conditionality and certain whole of enterprise restrictions to turn off enforcement rights under the senior package for a particular term. The senior lenders gained comfort by the default cures provided by the new (rescue) funding package and the value uplifts through making the plant operational (removing an operational impairment).

If there are concerns around tail or contingent liabilities, the funder may require a formal process in order to cleanse unknown exposures – some, such as Paladin Energy, involve court processes undertaken during administration, while others, such as Carnegie. Clean Energy occur as part of a full DOCA and Prospectus process. Others still, such as WICET or Quintis are achieved via a scheme of arrangement process.

Where there are substantial lenders in a club or syndicated financing or where the economic holders are represented by an Agent, steering committees and the execution of co-operation or "good faith" agreements are common.

In an existing workout arrangement led by a majority holder of notes to an oil and gas producing entity, a steering committee was formed to encourage the issuer to undertake a merger transaction. The majority creditor joined an ad hoc restructuring committee with the issuer and others.

Provisions were included in the agreement between all holders providing for "drag alongs" of minority lenders, amendments to the administrative actions of the Agent (including to direct the Security Trustee to authorise a Receiver to "dispose" of assets on covenant default by way of "non-monetary" action; ie. permitting credit bidding to swap positions into equity). There is useful UK authority to support this direction being given to an Agent.

Most debt instruments will require a structured approach to amending some voting and form of consideration receipt provisions, as well as confidentiality and trading right restrictions.

A well-formed committee will always obtain DCF valuations of the enterprise. These valuations, which can take many months to prepare so should be developed well ahead of covenant breach or testing points, should inform the creditors and issuer as to value breaks, briefing assumption differences (reserves in particular are the subject of common debate, as are the differences between bull and bear spreads in forecasting futures, whether commodity values, operating costs or value in system logistics and supply arrangements).

Valuations will assist drive decisions around resets, recapitalisations, restructuring arrangements, workouts and other forms of turnaround planning.

The workout arrangements mentioned above are informal in design. More structured formal processes – credit bids via Receivers, cram downs via scheme of arrangement or DOCA/Creditors Trust and section 444GA equity transfers are other mechanisms used to cleanse an enterprise of liabilities an assets of liens. Formal processes may be undertaken in conjunction with Prospectus style capital raisings, shareholder approved back-door listing of new assets into the enterprise, alternatively as part of a Court-approved merger process by scheme of arrangement.

The appropriate transaction structure will depend on the value-breaks, range of interest holders and perceived execution risk.

Funds typically provide corporate or asset based finance, secured against real property and personalty.

Inside a leveraged enterprise, already primed with senior, mezzanine or other junior debt and asset based (receivables) lending, funds may take repurchase positions.

In simple terms, the fund purchases a particular asset for an agreed sum (typically something valuable such as a processing plant or inventory).

The treasury or economic entity within the "vendor" enterprise will then put an irrevocable offer to the "purchaser" to repurchase the asset at a future point in time. The "purchaser" then chooses whether to retain the asset or accept into the put at the relevant time, depending on the rate of return each option offers. Quintis is one example here.

Other forms of repurchases include commodity offtake arrangements, "build and operate own" contracts and plant or key equipment purchase agreements. These can be structured as leases, hiring arrangements or involve an agreement between a financier and the grantor under a Put option.