A workout arrangement is an out-of-court agreement between creditors and a debtor to revise the debtor's payments to the satisfaction of all parties. A loan workout can involve a variety of adjustments to the original loan agreement, such as:
- Spreading the payments over a longer period of time
- Writing off part of the loan balance
- Reducing the interest rate
- Replacing some or all of the debt with equity ownership in the debtor
A creditor has an interest in allowing these adjustments, since the alternative may be the bankruptcy of the debtor or its complete nonpayment of amounts owed, which will require the creditor to engage in expensive legal alternatives. The owners of the debtor can also find a workout to be a reasonable alternative to bankruptcy, since it may allow them to retain some or all of their existing ownership of the business, while also avoiding the costs of bankruptcy. In addition, a workout is a less public activity than a bankruptcy, so customers are less likely to be aware of it. The essential forms of a workout are as follows:
- Standstill agreement. The creditors agree to halt their collection activities for a period of time, to let the debtor straighten out its financial and operational situation.
- Restructuring agreement. The creditors agree to reduce some portion of their claims against the debtor, usually in exchange for an equity position in the debtor.
A concern with workout arrangements is that they are normally between all of the creditors and a firm, so one or more of the creditors could hold out for better terms, at the expense of the other creditors. The result may be no workout deal at all. Another concern is that a workout arrangement does not give the debtor any way to void executory contracts, such as leases, that may be imposing a substantial financial burden on the business. If these contracts are a major cause of the financial decline of a debtor, it may be necessary to enter bankruptcy protection in order to eliminate them.