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Company rescue via a bridge loan and/or a reorganisation loan

The distinction between a bridge loan and a reorganisation loan plays a fundamental role in business financing. In the following section we first define both types of loan in order to gain better insights into the financing options of companies that have entered a state of crisis. In doing so, the specific features and purposes of the loans will be examined in order to understand their respective roles in the business reorganisation process.

The purpose of a bridge loan ...

Bridge loans play an important role as a financing option for companies that are faced with temporary liquidity shortages. This financial instrument makes it possible to bridge the period until there is a decision on the company’s ability to reorganise. 

Please note: It should be stressed that bridge loans are not primarily intended for a radical reorganisation. Instead, they can be used as short-term financial support while the review of the company’s ability to reorganise is carried out and before the option of an actual reorganisation loan can be considered.

The term of a bridge loan is normally, at most, four weeks. During this period, a great deal of work is carried out on the reorganisation. Bridge loans are generally unsecured and the lenders can call them back at any time, especially if the planned reorganisation fails.

... is not the same as that of a reorganisation loan

Banks or other lenders will grant reorganisation loans to companies that are undergoing a reorganisation or restructuring process. The principal aim of such a loan consists in averting an impending insolvency or eliminating the causes of insolvency proceedings that have already been initiated in order to restore a company’s business capability.

A reorganisation loan would be granted with the explicit focus on the upcoming reorganisation, especially if there is a situation of imminent illiquidity. Here, the company would be classified as being in need of reorganisation if, without support measures, the substance of the company that is required for continuing business operations and the fulfilment of existing obligations cannot be maintained. Linking the reorganisation loan to the purpose of the reorganisation can be agreed explicitly or implicitly. 

The term of the loan would normally be oriented towards the purpose of the reorganisation; during this period, the aim would be to achieve the defined objective of the reorganisation as per the reorganisation plan.

Accounting treatment of bridge loans and ...

Short-term bridge loans are temporary financing measures and do not constitute any long-term components of business financing. Consequently, bridge loans are not considered to be a substitute for equity. This opinion is based on various court rulings and administrative principles where it has been noted that such loans are not automatically considered to be equity equivalents.

Reporting bridge loans as debt on the balance sheet hinges on the short-term repayment of the loan having to be seriously intended and determined on the basis of objective criteria. If that is the case then the legal rules on equity substitution would not apply. The reason for this is that, under these conditions – irrespective of a company’s creditworthiness -, even a neutral lender would be willing to grant a loan.

However, if there are no objective points of reference for ‘short-term bridging’ (normally four weeks at most) then the equity substitution rules under German company law would have to be applied. 

... reorganisation loans

Reorganisation loans are granted when a company clearly needs to be reorganised and has difficulty in raising loans – potentially an indicator that the company is unworthy of credit. Frequently, reorganisation loans serve as a substitute for equity notably if, in view of the crisis situation at the company, external lenders would not have granted a loan without such security.

The accounting treatment will change in the event of a positive forecast for a company’s ability to continue as a going concern and a reorganisation through debt. However, if a reorganisation loan is taken out only after an insolvency administrator has filed an insolvency petition on behalf of the company, then, under the Insolvency Code (Insolvenzordnung, InsO), this would be considered to be a claim against the insolvency assets. On the balance sheet, such InsO claims against the insolvency assets have the status of preferential debts and would be paid in preference to the ordinary unsecured debts. 

Please note: Such preferential treatment aims to ensure that the claims of creditors that are closely linked with the insolvent company are satisfied before those of others and prior to the insolvency assets being divided among the other creditors.

Conclusion: In practice, it is necessary to clearly differentiate between the two financing instruments. Bridge loans are used for short-term financial support while the review of the company’s ability to reorganise is carried out; the aim of reorganisation loans is to avert insolvency and to actively restructure the company. Purposely choosing between these types of loan – frequently also used one after another – can enable companies to ensure their financial stability even under difficult circumstances and, ultimately, to achieve sustainable growth once again.

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