The Australian Financial Review is reporting that law firm Slater & Gordon Limited (ASX: SGH) might be close to agreeing a deal with its banking creditors Westpac Banking Corp (ASX: WBC) and National Australia Bank Ltd. (ASX: NAB).

Slater & Gordon reported a disastrous first half of FY2016 in which it posted a negative cash outflow of $83.3 million, with debt of $783 million and a debt limit of just $850 million.

Consequently the law firm has been in a race against time to negotiate a debt restructure with its creditors to save it from bankruptcy.

It seems unlikely the banks will be prepared to extend Slater & Gordon more credit, although they won’t want to see the firm go under either, so if a deal is agreed it will likely involve a debt to equity swap or issue of convertible notes to become shares for the banks at a future date.

A debt for equity swap would involve something like Slater & Gordon issuing $100 million new equity in the firm to the banks for every $50 million of outstanding debt.

This would be extremely dilutory to existing shareholders, but would allow the firm to effectively pay down some debt, close its loss-making UK businesses, and generate enough future cashflow to pay off the principal and interest on the remaining debt.

Alternatively Slater & Gordon could issue say $500 million of convertible notes to the banks that would become scrip at a future date at say 5 cents each.

Again this would be extremely dilutory for existing shareholders, but would allow the company to survive thanks to enough debt headroom and the time to restructure its loss-making businesses mainly in its Slater & Gordon Solutions UK division.

Any deal agreed will be dilutory to existing shareholders, although on the bright side Slater & Gordon might finally be in a position where it can return to consistent profitability, with the dead weight of its Quindell business effectively written off .

There is also a small possibility that UK chancellor George Osborne’s proposed reforms to personal injury laws in the UK are shot or watered down by the legal lobby who will put up a strong challenge to reforms that are not guaranteed to go through.

Slater & Gordon faces other problems however, with rival law firm Maurice Blackburn likely to be scrubbed off the Christmas card list after it announced a class action against Slaters over its disastrous recent performance.

Expect volatility in the share price.

Discover the 'new breed' of blue chips that could take your portfolio higher in 2016

Forget Slater & Gordon! These 3 "new breed" top blue chips for 2016 pay fully franked dividends and offer the very real prospect of significant capital appreciation. Click here to learn more.

The report is free! No credit card required.

HOT OFF THE PRESSES: Motley Fool’s #1 Dividend Pick for 2017!

With its shares up 155% in just the last five years, this ‘under the radar’ consumer favourite is both a hot growth stock AND our expert’s #1 dividend pick for 2017. Now we’re pulling back the curtain for you... And all you have to do to discover the name, code and a full analysis is enter your email below!

Simply enter your email now to receive your copy of our brand-new FREE report, “The Motley Fool’s Top Dividend Stock for 2017.”

By clicking this button, you agree to our Terms of Service and Privacy Policy. We will use your email address only to keep you informed about updates to our website and about other products and services we think might interest you. You can unsubscribe from Take Stock at anytime. Please refer to our https://www.fool.com.au/financial-services-guide">Financial Services Guide (FSG) for more information.

Motley Fool contributor Tom Richardson owns shares of Slater & Gordon Limited.

You can find Tom on Twitter @tommyr345

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.