This article considers how an Iraqi borrower and its banks can negotiate a debt workout that reprofiles payments, adjusts security and resets financial covenants. A workout is a negotiated arrangement outside court in which lenders agree to change the terms of existing facilities to give the borrower a realistic chance of repaying. It can preserve value for both sides, avoiding the cost and uncertainty of enforcement while giving the borrower time to recover.
Banks approach workouts within constraints. They must comply with Central Bank of Iraq instructions on credit classification and provisioning, their own internal credit policies and, often, the requirements of their own shareholders and auditors. A borrower that understands these constraints and presents a proposal that fits them is more likely to reach agreement than one that simply asks for relief.
The Banking Law No. 94 of 2004 and the Central Bank of Iraq Law No. 56 of 2004 provide the framework for bank lending, supervision and instructions on credit risk, classification and provisioning. Islamic banks are also subject to the Islamic Banks Law No. 43 of 2015. The Iraqi Civil Code No. 40 of 1951 governs facility agreements, guarantees, mortgages and possessory pledges. The Real Estate Registration Law No. 43 of 1971 governs mortgages over real property. The Execution Law No. 45 of 1980 governs enforcement if the workout fails.
Preparing the borrower’s proposal
A credible proposal is the starting point for a successful workout. It should include:
- A clear explanation of the difficulty. What caused the borrower’s problems and why they are temporary or manageable.
- Realistic financial projections. Cash flow forecasts showing what the borrower can pay and when, based on reasonable assumptions.
- A business plan. Operational changes the borrower will make to improve performance.
- The requested changes. Specific proposals on repayment, interest, security and covenants.
- Contributions from others. What shareholders, guarantors or other creditors will contribute.
Banks are more receptive when they see that the borrower has thought carefully about its situation and that the burden of recovery is shared.
Reprofiling repayments
Repayment reprofiling is the core of most workouts. Options include extending the maturity, introducing a grace period on principal, moving from fixed instalments to a schedule linked to cash flow, or creating a bullet payment at the end of the term. Interest may be reduced, capitalised or deferred.
Each option has implications for the bank’s classification and provisioning of the loan under Central Bank of Iraq instructions. A restructured loan may remain classified as non-performing for a period, and the bank may need to hold provisions against it. Understanding how the proposed reprofiling will be treated helps the borrower frame a proposal that the bank can approve. For Islamic facilities, restructuring must also be consistent with the applicable Sharia principles, which may affect whether additional profit can be charged on rescheduled amounts.
Adjusting the security package
Banks will usually require additional or improved security in exchange for relief. This may include:
- New mortgages. Mortgages over real estate not previously encumbered, registered under the Real Estate Registration Law.
- Pledges. Possessory pledges over equipment, inventory or shares, where these can be perfected.
- Assignment of receivables. Arrangements under which customer payments are directed to an account controlled by the bank.
- Personal and corporate guarantees. Guarantees from shareholders, affiliates or parent companies.
The borrower should consider whether granting additional security is consistent with its other financing obligations, including negative pledge clauses in other facilities. Granting security to one bank may breach covenants owed to another. Real estate advice in Iraq can help with the registration of new mortgages and the review of existing encumbrances.
Resetting financial covenants
Facility agreements often contain financial covenants, such as debt service coverage, leverage ratios and minimum net worth. A borrower in difficulty may already be in breach. The workout should reset covenants at levels the borrower can realistically meet under the new business plan, while giving the bank early warning of further deterioration.
Covenants should be clearly defined, including the accounting principles applied and the timing of testing. Ambiguous definitions create disputes about whether a breach has occurred. The workout agreement should also waive existing breaches, so that the borrower starts the new arrangement in compliance.
Coordinating multiple banks
Where several banks have facilities, coordination is essential. Each bank will want equal treatment and will be reluctant to grant relief if another bank is being repaid faster or receiving better security. A common term sheet, an agreed sharing of security and a coordinating bank or adviser can help. Intercreditor arrangements may be needed to govern the ranking of security and the sharing of recoveries.
Documenting the workout
The workout should be documented in an amendment agreement or new facility agreement, with security documents and any intercreditor agreement. Documents should address conditions precedent, events of default, information obligations and the consequences of failure. Security should be registered where required. Commercial contract advice in Iraq can help prepare and review workout documentation.
Managing tax and accounting effects
Changes to debt terms, particularly write-offs or interest waivers, may have tax consequences for the borrower. Capitalised interest may affect deductibility. Tax advisory services in Iraq can identify the tax treatment of the proposed changes before the workout is agreed.
Anticipating the bank’s internal approval process
Bank officers who negotiate a workout rarely have authority to approve it themselves. Proposals usually pass through credit committees, risk functions and sometimes the board, each of which will review the borrower’s projections, the security offered and the regulatory treatment of the restructured loan. A proposal that the relationship manager supports may still be rejected or modified at these levels.
Borrowers can improve their prospects by providing information in a form that supports internal approval: a concise summary of the proposal, supporting financial analysis, valuations of new security and evidence of contributions from shareholders. Allowing sufficient time for internal approval, and maintaining payments where possible during that period, demonstrates good faith. Where several banks are involved, the borrower should expect each to follow its own process and should plan the timetable accordingly.
Illustrative example. An Iraqi hotel company borrowed from two banks to build a new property. Occupancy falls well short of projections and the company cannot meet its quarterly instalments. It prepares a revised business plan, and its shareholders agree to inject additional capital. The banks agree to a two-year principal holiday, extended maturity and reset covenants. In exchange, the company grants a second mortgage over another property, assigns its booking receipts to a collection account and the main shareholder provides a personal guarantee. The banks agree an intercreditor arrangement allocating the new security between them.
Conclusion & how Etihad Law Firm can help
A debt workout with Iraqi banks is most likely to succeed when the borrower presents a credible proposal, understands the banks’ regulatory constraints and offers appropriate security and covenants in exchange for relief. Careful documentation and coordination among lenders are essential to an arrangement that lasts.
Etihad Law Firm advises borrowers, shareholders and banks on debt workouts and restructuring of facilities in Iraq. Our corporate team can support the negotiation and implementation of workout arrangements.