Workout –
what does it mean?

Key facts at a glance:

• A workout agreement enables a debtor in default and their lender to renegotiate the terms of a loan.

• The aim is to accommodate the debtor in the event of payment default so that the lender has a greater chance of recovering the capital and interest on the loan without foreclosure, which is beneficial for both parties.

• Not all lenders are willing to enter into a workout agreement, and the terms vary from case to case.

What Is a Workout?

A workout is an agreement between creditors and a debtor to review the debtor's payments to the satisfaction of all parties.

A loan workout can include a range of adjustments to the original loan agreement, such as spreading payments over a longer term or writing off part of the loan balance. Other options include reducing the loan interest rate or replacing part or all of the debt with an equity stake in the debtor.

The main forms of a workout are as follows:

• Standstill agreement: The creditors agree to suspend their collection activities for a specified period so that the debtor can resolve their financial and operational situation.

• Restructuring agreement: The creditors agree to reduce a portion of their claims against the debtor, usually in exchange for an equity stake in the debtor.

Advantages of a Workout Agreement

A creditor has an interest in allowing these adjustments because there is a risk that the debtor may go bankrupt or fail to pay the amounts owed, which would result in costly legal proceedings for the creditor.

Furthermore, for the owners of the debtor, a workout can be a sensible alternative to bankruptcy, as it may allow them to retain some or all of their existing ownership rights in the company while avoiding the costs of bankruptcy.

Additionally, a workout is a process that takes place less in the public eye than bankruptcy, so customers are likely to be less aware of it.

Potential Problems with Workout Agreements

One problem with workout agreements is that they are usually concluded between all creditors and a company, so one or more creditors could push through better terms at the expense of other creditors. This can result in no workout agreement being reached at all.

Another problem is that a workout does not give the debtor the ability to terminate ongoing contracts, such as lease agreements, which can represent a significant financial burden for the company. If these contracts are a primary cause of the debtor's financial arrears, it may be necessary to file for bankruptcy protection to eliminate them.

What Special Considerations Apply to Workout Agreements?

Early notification: Informing the lender in advance that you will not be able to meet your obligations is a good gesture of courtesy. Most lenders are more accommodating when pursuing a workout agreement if they know that a default could be an issue. Early notification builds confidence that the borrower has their credit management under control and is interested in being a reliable business partner whom the lender can trust.

Be honest and flexible: A lender is not obligated to adjust the terms of a loan, so it is up to the borrower to be honest, direct, and flexible. However, the lender will likely want to limit their losses and optimise the repayment of the loan, which is why it is probably in the lender's best interest to help the borrower as much as possible.