The potentially significant economic downturn in 2020 triggered by the COVID-19 pandemic, and for companies in the energy sector, extremely low commodity prices, increases the likelihood that many companies may develop liquidity issues in the near term. Boards of directors should ensure that company management develops liability management strategies to prepare for and cope with these challenges. We summarize below a list of liability management strategies that companies should consider when faced with a liquidity constrained environment. As a general matter, prior to engaging in any of these strategies, directors should understand any contractual restrictions imposed on their business’s ability to raise capital, including confirming constraints under the company’s existing debt instruments.
In addition, and as a ground rule, directors need to familiarize themselves with the potential interaction of federal securities laws with any liability management strategy that they may pursue. In particular, while in possession of material, nonpublic information, companies will be limited in their ability to engage in the types of liability management strategies that are discussed here.
Debt Repurchases or Exchanges
In many cases, the fair market value of corporate debt has fallen significantly below face value. Some companies may wish to take advantage of this opportunity to repurchase their debt at a discount rather than paying back the debt at par value at maturity. Alternatively, distressed companies with limited cash can conduct debt exchanges to extend maturities by issuing longer dated debt or equity to repay fast approaching maturities and therefore avoid near-term liquidity issues. However, it is likely that the interest rate on the new debt will be higher than that of the existing corporate debt and typically have tighter covenants that can restrict other types of financing available to the issuer in the future. Even with these disadvantages, many issuers that have this option available may find it helpful in managing their liabilities as it give companies a potentially longer “run way” while awaiting for some normalcy to return to the capital markets and their businesses.
While capital markets have significantly tightened for most companies, some companies may still be able to tap into the bond market. These transactions are typically structured as refinancing transactions where debt that is maturing in the near term is refinanced with longer dated debt.
The trading value of most companies’ stock has fallen sharply across all sectors as fear of an economic recession continues to take its toll. A common strategy for companies with dramatically undervalued stock is to repurchase their shares at the current low market prices and to reissue these shares once the market recovers, thereby increasing their equity capital without issuing any additional shares. However, directors should be cautious with this strategy, especially if the company has the risk of encountering short- or mid-term liquidity issues.
Capital and Operating Expenditure Reductions
Companies facing potentially serious liquidity issues can consider reducing capital expenditures. This strategy may, however, come at a high price. Depending on the industry, cutting capital expenditures now may materially and adversely affect future revenue streams. Companies can also consider a reduction in operating expenditures through employee layoffs, furloughs or, alternatively, salary and benefit reductions or freezes.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.