Debt for Equity Swaps – How to Restructure Debt and Strengthen Cash Flow

What is a Debt for Equity Swap and Why Companies Use Them

A debt for equity swap is a corporate restructuring transaction in which a company’s debt is converted into equity. Instead of repaying some or all of what is owed in cash, the company issues shares to the creditor, who becomes a shareholder in the business.

Debt for equity swaps are most commonly used where a company is under financial pressure, over-leveraged, or facing covenant breaches, but still has a viable underlying business. By reducing debt and strengthening the balance sheet, the company can improve cash flow, restore lender confidence, and create a platform for recovery or growth.

These transactions are often associated with turnaround situations, refinancing exercises, or distressed restructurings, but they are also used proactively where a business wishes to rebalance its capital structure ahead of investment, sale, or further reorganisation. While powerful, debt for equity swaps are legally and commercially complex and must be carefully structured to avoid unintended consequences. Debt for equity swaps must comply with the Companies Act 2006, particularly sections 549 to 551 and 561 to 567, which govern directors’ powers to allot shares and statutory pre-emption rights.

When a Debt for Equity Swap Is the Right Option

Common scenarios where debt for equity swaps are used
Debt for equity swaps are typically considered in situations such as:

• Financial distress or cash flow pressure, where servicing existing debt is unsustainable and risks insolvency if left unchanged.
  
• Covenant breaches or near-breaches, where lenders are unwilling to extend further waivers without a fundamental change to the company’s capital structure.
  
• Refinancing negotiations, where lenders agree to convert debt to equity as part of a wider restructuring or rescue package.
  
• Turnaround and recovery plans, where creditors are prepared to take equity upside in return for supporting the business through a difficult period.
  
• Preparation for future investment or sale, where reducing debt improves the company’s attractiveness and valuation.
  

In each case, a debt for equity swap should form part of a coherent strategy rather than a short-term fix.

When a debt for equity swap may not be appropriate
Debt for equity swaps are not suitable in every situation. They may be inappropriate where:

• The underlying business is not viable.
  
• Creditors are unwilling or unable to take equity risk.
  
• Existing shareholders are unwilling to accept dilution.
  
• Regulatory, licensing, or ownership restrictions prevent creditors from becoming shareholders.
  

Early financial and legal analysis, including due diligence on creditor rights, is essential to determine feasibility and align objectives.

How Debt for Equity Swaps Work in Practice

The basic mechanics explained clearly
In a typical debt for equity swap:

• The creditor agrees to release or compromise some or all of the debt owed.
  
• In return, the company issues new shares to the creditor. Such issues must reflect a fair value for consideration under section 593 of the Companies Act 2006, ensuring compliance where shares are issued for non-cash consideration.
  
• The creditor becomes a shareholder, often with negotiated rights and protections.
  

The swap may involve ordinary shares, preference shares, or a bespoke class of equity designed to balance risk and reward. The precise structure depends on valuation, negotiating leverage, and the parties’ commercial objectives.

Valuation and dilution considerations
A key issue in any debt for equity swap is valuation. The value attributed to the company directly affects how much equity the creditor receives and how diluted existing shareholders become. Disputes often arise where stakeholders have differing views on value, particularly in distressed scenarios.

Independent valuation evidence and clear documentation are critical to managing these risks.

Legal Framework for Debt for Equity Swaps

Company law considerations
Debt for equity swaps must comply with the Companies Act 2006. Key issues include:

• Authority to issue shares under the company’s articles and shareholder resolutions.
  
• Disapplication of statutory pre-emption rights where shares are issued to creditors.
  
• Proper allotment, registration, and filing requirements at Companies House.
  
• Filing requirements include completion of Form SH01 (Return of Allotment of Shares) within one month to record the new share issue.
  

Failure to follow the correct process can invalidate the equity issue and undermine the restructuring.

Interaction with insolvency law
Debt for equity swaps are often undertaken when insolvency is a real risk. Directors must therefore consider their duties to creditors and the potential application of the Insolvency Act 1986. Directors should be mindful in particular of sections 238 and 239, which deal with transactions at an undervalue and preferences, and section 214 relating to wrongful trading.

Transactions carried out when a company is insolvent, or which prejudice creditors, may be vulnerable to challenge. Structuring the swap transparently and on proper valuation terms helps mitigate this risk.

Tax Considerations in Debt for Equity Swaps

Corporation tax treatment for the company
The release or modification of debt can have corporation tax consequences for the company, including the recognition of a credit arising from the release of a liability. In certain circumstances, exemptions or reliefs may apply, particularly where the company is in financial difficulty or subject to insolvency-related procedures. These exemptions are primarily found in Part 5 of the Corporation Tax Act 2009 under the loan relationship rules and are supplemented by HMRC guidance in the Corporate Finance Manual at CFM 33200 and following.

Careful analysis is required to determine whether the debt release gives rise to taxable income or falls within an available exemption.

Tax position of creditors and shareholders
For creditors, exchanging debt for equity may crystallise gains or losses depending on the nature of the debt and their tax position. For existing shareholders, dilution may affect future tax planning, valuation, and exit strategies. Anti-avoidance measures, including the rules on debt releases to connected parties, may also apply.

Debt for equity swaps often interact with capital gains tax, loan relationship rules, and, in some cases, employment-related securities legislation. Early tax input is essential to avoid unexpected liabilities.

Debt for Equity Swaps and Directors’ Duties

Heightened responsibilities in distressed situations
Directors overseeing a debt for equity swap must comply with their duties under sections 171 to 177 of the Companies Act 2006. Where the company is financially distressed, directors must prioritise the interests of creditors and avoid actions that could worsen their position.

Failure to do so can expose directors to personal liability, including claims for wrongful trading or misfeasance. This includes potential exposure under section 212 of the Insolvency Act 1986 for misfeasance or breach of duty.

Documenting decision-making
Given the scrutiny that debt for equity swaps can attract, particularly in insolvency scenarios, it is vital that directors properly document their decision-making process. This includes recording professional advice received, valuation evidence, and the rationale for concluding that the swap is in the best interests of creditors as a whole.

Practical Challenges and Risks

Negotiating stakeholder alignment
Debt for equity swaps often involve multiple stakeholders with competing interests, including senior lenders, junior creditors, shareholders, and management. Achieving consensus can be challenging, particularly where dilution is significant.

Clear communication and structured negotiations help manage expectations and reduce the risk of dispute.

Impact on control and governance
Creditors receiving equity will often seek governance rights, such as board representation, veto rights, or enhanced information access. These changes can materially affect how the company is run and must be carefully negotiated and documented. Changes to equity structure must also comply with sections 630 to 633 of the Companies Act 2006, ensuring that any variation of class rights is properly approved.

Regulatory and contractual constraints
Certain businesses operate in regulated sectors or have contracts that restrict changes in ownership or control. These issues must be identified early to avoid breaching regulatory conditions or triggering termination rights.

Using Debt for Equity Swaps as Part of Wider Restructuring

Integration with refinancing and reorganisations
Debt for equity swaps are often combined with refinancing, capital reductions, share buybacks, or schemes of arrangement. In more complex cases, a swap may be implemented under a Part 26 Companies Act 2006 scheme of arrangement or a Part 26A restructuring plan, allowing the arrangement to bind dissenting creditors or shareholders where statutory conditions are met.

Sequencing is critical to ensure each step is legally effective and supports the overall restructuring objective.

Preparing for future investment or exit
While debt for equity swaps can stabilise a business, they also reshape the shareholder base. Careful thought should be given to how the new equity structure will affect future funding rounds, investor appetite, or exit strategies.

Why Jonathan Lea Network Is Trusted for Debt for Equity Swaps

Restructuring and insolvency expertise
Jonathan Lea Network advises on debt for equity swaps across the full spectrum of restructuring, from early-stage financial stress to complex distressed situations. We understand the interplay between company law, insolvency risk, tax, and commercial negotiation.

Commercial, solution-focused advice
We focus on practical outcomes that preserve value and balance stakeholder interests. Our advice is grounded in commercial reality as well as legal precision.

Partner-led teamwork
Clients work directly with experienced lawyers who coordinate with tax advisers, insolvency practitioners, and other professionals to deliver cohesive and efficient solutions.

Transparency and value for money
We provide clear scoping, realistic timelines, and cost transparency, helping clients navigate complex restructurings without unnecessary expense.

Common Client Concerns We Help Address

Will existing shareholders lose control?
Control outcomes depend on valuation and negotiation. We help structure swaps that balance creditor protection with appropriate shareholder influence.

Does this mean the company is insolvent?
Not necessarily. Debt for equity swaps can be used proactively, although they are often undertaken where insolvency risk exists. We advise on positioning and risk management.

Can a swap be forced on unwilling shareholders?
In some cases, court-approved restructuring tools may be required. We advise on the available options where consensus cannot be reached.

Will this damage future investment prospects?
If structured well, a swap can improve investment appeal by reducing debt and stabilising the business.

Take the Next Step – Speak to Debt for Equity Swap Specialists

Stabilise your business and protect value
Debt for equity swaps can be a powerful way to restructure debt, strengthen cash flow, and preserve value, but they carry significant legal, tax, and governance risks if handled incorrectly. Our UK debt for equity swap lawyers work closely with lenders, investors, and directors to deliver compliant, value-preserving outcomes.

Jonathan Lea Network advises companies, lenders, and shareholders on debt for equity swaps with clarity, commercial focus, and technical rigour. We manage the process from strategic planning through to implementation and post-transaction support.

To discuss whether a debt for equity swap is appropriate for your business, call us on +44 (0)1444 708 640 , or email us to arrange a confidential discussion with one of our corporate restructuring specialists. 

This overview is for general information only and does not constitute legal or tax advice.