Conversion of Debt to Equity: Dealing with currency challenges in Zimbabwe
Zimbabwe is home to a basket of currencies which include the Zimbabwe Dollar (ZWL), United States of America Dollar (USD), the South African Rand (ZAR) and the Chinese Yen (CNY).
Settlement of domestic obligations can be done in any of the approved currencies in line with Exchange Control Circular No. 3/2020 and Statutory Instrument (SI) 85 of 2020 on the multicurrency usage in Zimbabwe.
This development was in response to negative effects of the COVID 19 Global pandemic.
The multi-currency system was a welcome relief to prior regulations such as the Exclusive Use of the Zimbabwe Dollar for Domestic Transactions through SI 185 of 2020 and Exchange Control Directive RU 102/2019.
Exchange Control Directive RU 128/2019 issued on 22nd of February 2019 removed parity between the then RTGS Dollar and USD upon introduction of the exchange rate of 1USD:2.5 RTGS Dollars.
The currency reforms journey’s significant milestones started in October 2018 when the bank accounts were separated into FCA Nostro and FCA RTGS, followed by the introduction of the RTGS Dollar on 22nd February 2020 (SI 33/2019).
The currency reform process had far reaching implications to both lenders and borrowers as they had to deal with instant losses and gains coupled with huge unrealised exchange losses in certain circumstances.
Preserving value of debt
Financiers, both local and foreign expect repayment of principal together with interest within the agreed timeframe.
The currency reform process either wiped out value and/or reduced the asset base of most business organisations in Zimbabwe depending on the income earning structure of the business.
Assets in form of local debtors suddenly became worthless whilst foreign debt became unsustainable given a weaker local currency.
Such developments called for ingenuity from both lenders and borrowers to safeguard the values for both parties.
Conversion of debt to equity
Debt conversion is a capital restructuring exercise which transforms debt to equity resulting in dilution of ownership to accommodate new shareholders who used to be lenders to the firm.
A creditors meeting should be done to propose issuance of a shares in the business in consideration for debt at a point in time.
The resultant position is that interest burden is removed whilst debt holders assume rights to ownership of the business.
The win-win arrangement for lenders and borrowers improves the business’ bottom line and enhance its potential to continue as a going concern.
Procedures for debt conversion
- Addendum to loan agreements
The various loan agreements signed with funders should be consolidated through an addendum identifying the agreements and amounts to be converted to equity. The addendum effectively amends terms of loan agreements from the effective date.
- Suspensive conditions
Identified milestones which are mandatory for the achievement of the debt conversion such as changes to constitutive documents such as the Memo and Articles of Association and other regulatory requirements such as Exchange Control registrations in case of foreign debt would constitute suspensive conditions.
These are conditions which invalidates the process if not fulfilled by specific dates.
- Amendments and Waiver
Amendments are required to re-denominate debt from various currencies to a common currency as agreed to by the parties.
The re-denomination makes it easy to allocate shares based on valuation of the business and/or agreed modalities.
It is also critical to waive interests on debts identified for conversion to equity until such time the conversion process is finalised.
- Share Subscription Agreements
The addendum to loan agreements should be supported by a share subscription agreement which provides for former lenders and business owners to subscribe to a new shareholding structure.
Share certificates are then issued ascribing new rights to shareholders upon cancellation of old share certificates.
Fungai Chimwamurombe is a registered legal practitioner and Senior Partner at Zenas Legal Practice and can be contacted for feedback at fungai@ zenaslegalpractice.com and WhatsApp 0772 997 889. Bhekimpilo Mangena is a Business Consultant at Zenas Consulting (Pvt) Ltd and can be contacted on 0712500490.
