Letter of licence

3 key takeaways

• A letter of licence temporarily suspends debt collection to allow a debtor to continue operating and restructure their finances.
• Creditors agree to the letter of licence to potentially recover more of the owed amount in the long term, rather than forcing immediate liquidation.
• It is a formal agreement outlining the terms, duration, and conditions under which the debtor can operate without creditor interference.

What is a letter of licence?

A letter of licence is an arrangement between a debtor and their creditors, in which the creditors agree to refrain from pursuing debt repayment for a specified period. During this time, the debtor is allowed to continue business operations in an effort to reorganize and improve their financial situation. The goal is to enable the debtor to stabilize their business and eventually repay the debts under more favorable conditions.

Example

A small business facing temporary financial difficulties may request a letter of licence from its creditors. If granted, the business can continue to operate without the immediate pressure of debt collection, using the time to improve cash flow, cut costs, and increase revenue.

Key components of a letter of licence

Identification of parties

The letter must clearly identify the debtor and the creditors involved in the agreement, including names, addresses, and contact information.

Terms and conditions

The document outlines the specific terms and conditions under which the creditors agree to suspend debt collection. This includes the duration of the suspension, the actions the debtor must take during this period, and any reporting requirements.

Duration

The letter specifies the time frame for which the debt collection suspension is effective. This period allows the debtor to reorganize their finances and improve their business operations.

Obligations of the debtor

The debtor must agree to certain obligations, such as maintaining transparency with creditors, providing regular financial updates, and taking steps to improve their financial health.

Signatures

The letter of licence must be signed by authorized representatives of both the debtor and the creditors to be legally binding.

Advantages and disadvantages

Advantages

• Time to restructure: Provides the debtor with breathing room to reorganize their finances and business operations without the immediate pressure of debt collection.
• Potential for higher recovery: Creditors may recover more of the owed amount in the long term by allowing the debtor to stabilize, compared to immediate liquidation.
• Business continuity: Helps avoid bankruptcy or liquidation, allowing the business to continue operations and preserve jobs.

Disadvantages

• Temporary relief: The letter of licence offers only temporary relief, and the debtor must effectively use this time to address underlying financial issues.
• Creditor risk: Creditors take on the risk that the debtor may not successfully reorganize, potentially leading to future financial losses.
• Strict conditions: The debtor must comply with the terms and conditions set forth in the letter, which may include regular financial reporting and specific business actions.

When is a letter of licence used?

Financial distress

A letter of licence is commonly used when a business faces financial distress but has a viable plan to recover if given time and temporary relief from debt obligations.

Creditor agreement

It is used when creditors agree that allowing the debtor to continue operations could result in a better outcome than forcing immediate repayment or liquidation.

Business reorganization

A letter of licence can be part of a broader strategy to reorganize a business, cut costs, improve cash flow, and increase revenue to eventually repay debts.

Related topics

• Debt restructuring: Learn about various strategies to reorganize and renegotiate debt terms to improve financial stability.
• Bankruptcy: Understand the legal process of bankruptcy and how it differs from temporary relief measures like a letter of licence.
• Business turnaround: Explore methods and strategies for turning around financially distressed businesses and restoring profitability.

A letter of licence is a valuable tool for businesses in financial distress, providing temporary relief from debt collection and an opportunity to reorganize and improve their financial health. By understanding its components, benefits, and challenges, businesses and creditors can effectively navigate this arrangement to achieve mutually beneficial outcomes.