When Companies Face Financial Trouble: A Practical Guide to Distressed Analysis

In this week’s webinar, founder of Fox Legal Training, Sabrina Fox, and distressed debt specialist, Glenn Zahn, looked at practical tips to navigate covenant analysis in stressed and distressed scenarios with confidence. This article summarises some of those key insights.

1.      The Basics of Distressed Investing

• ‍What does “distress” mean?

Glenn Zahn opened the session by clarifying that, in restructuring, “distress” typically refers to situations where a balance sheet restructuring is expected within the next 18–24 months. It’s not just about short-term financial difficulties—it signals the need for deep structural changes rather than quick fixes or deadline extensions.

• Why do Companies Fall Into Distress?

There are four main paths that lead companies into serious financial problems:

(1)   Markets close their doors:

• Banks stop lending
• Bond markets become too expensive
• No one wants to refinance existing debt

(2)   Business performance crashes:

• Sales drop
• Costs rise
• Market changes hurt profits

(3)   Debt becomes unmanageable:

• Interest payments eat up cash
• Principal payments loom
• No room for business investment

(4)   Unexpected events, retrenching lenders:

• Lawsuits, warrantees
• Loss of reverse factoring
• Tightening of credit lines by suppliers

2.      The Zone of Insolvency: Where Everything Changes

Once a company enters the zone of insolvency, its obligations shift. As Sabrina Fox explained, "The responsibilities they have to their shareholders... flip to being to their lenders."

At this stage, companies typically seek to stabilize their situation by:

• Asking lenders to accept delayed payments
• Converting cash payments to PIK (payment-in-kind)
• Requesting maturity extensions
• Negotiating with specific lender groups

3.      Analyzing Distressed Covenants: Following the Money

Covenant analysis forms the foundation of understanding your position when companies struggle. As Sabrina Fox emphasized, "Lenders' rights are contractual rights" - making these documents your primary source of protection.

When analyzing covenants here are some core questions your analysis must answer:

• What options does the company have for new money?
• Can deals happen without creditor approval?
• Will other lenders gain priority over your position?
• Can sponsors extract remaining value?
• What voting power protects your position?

4.      Asset Movement and Control

Importantly, your collateral protection depends on specific provisions. For the purpose of this analysis, assets typically fall into three crucial “buckets”:

(1)   Your direct collateral

(2)   Collateral securing other lenders

(3)   Unencumbered assets

Sabrina warned "Collateral will be released automatically if transfers are done in compliance with applicable provisions". This includes transfers to unrestricted subsidiaries —a lesson J.Crew lenders learned painfully.

5.      Priming and Dilution Risks

There are two major threats that lenders should look out for:

(1)   Priming: new lenders gaining priority

(2)   Dilution: sharing collateral with additional lenders

The Ardagh case demonstrated how complex these situations can become. Their documentation required extensive analysis to understand available options.

6.      Restricted Payments and Value Extraction

Modern covenants often provide multiple avenues for value movement. A notable example is Altice France, which extracted billions through provisions related to unrestricted subsidiaries.

Key mechanisms include:

• Builder baskets
• Permitted Payment and Permitted Investment capacity
• Unrestricted subsidiary rules
• Asset transfer permissions

7.      Amendment and Consent Requirements

Contractual changes are subject to varying consent thresholds:

• Sacred rights requiring all lender or 90% consent
• Super majority provisions (66 2/3% - 75%)
• Simple majority matters

Glenn noted, “Restructurings are becoming more and more costly,” citing Thames Water, where the legal process involved “thousands upon thousands of witness statements.” This underlines the importance of fully understanding your contractual position when companies seek creative ways to stay afloat.

Critical questions to consider:

• Does the company need new money?
• Who holds different parts of the debt?
• What assets remain unencumbered?
• Which lenders stand first in line?

8.      Understanding Valuation Methods

With restructuring becoming increasingly expensive, accurate valuations are more critical than ever. Two main methods can help determine a company's worth:

(1) Multiple Approach

• Compare similar companies
• Look at market values
• Factor in industry conditions

(2) DCF (Discounted Cash Flow)

• Project future cash flows
• Account for risk
• Calculate present value

9.      European vs US Approaches

Valuation and restructuring approaches vary significantly between regions. While the US relies on Chapter 11, many European jurisdictions—including the UK—follow different processes.

The UK’s Part 26a Restructuring Plan combines key strengths of Chapter 11 with a streamlined 4–6 weeks process. As Glenn noted, it “takes good things from Chapter 11 but leaves unwanted things behind.”

10.  Final Checklist

Before making any investment or restructuring decisions, ensure you’ve thoroughly reviewed:

• Covenant package details
• Amendment rules
• Asset values
• Lender positions
• Available options

As Sabrina highlighted understanding lenders contractual rights makes all the difference when companies face financial trouble. This sector keeps changing. Thames Water showed how restructurings grow more expensive. Markets shift faster. But the fundamentals of analyzing troubled companies remain essential for making smart financial decisions.

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