Research Trends and Conclusions: Insolvency & Restructuring 2010
Richard Woolley -
Many of the lawyers we interviewed for this book were keen not to sound too upbeat when recounting their experiences in 2009. While corporate transaction levels remained low worldwide and the hardships caused by the financial crisis continued the majority of insolvency and restructuring lawyers we spoke to were managing levels of work “far beyond anything we’ve ever seen before”.
The Lehman Brothers bankruptcy is still in a class of its own in terms of figures, but the steady increase in smaller insolvencies throughout 2009 in most jurisdictions, coupled with sweeping regulatory changes aimed at strengthening financial systems and making insolvency proceedings more efficient and cost-effective, have kept lawyers busy and seen many law firms expand their corporate recovery capabilities.
Regulatory Changes
In the wake of the financial crisis, governments in several jurisdictions have reformed their insolvency regulations and the lawyers in this book are being called on to ensure their clients remain compliant. Regulators are taking a harder line with insolvent companies by limiting the availability of public money and opening directors up to increased liability, at the same time as trying to speed up the process by which a distressed entity can be closed down or restructured.
On 2 May this year, the European Union and International Monetary Fund committed to invest €110 billion to bail out Greece, whose heavy borrowing and spending drove the country’s economy into the doldrums and saw rating agencies downgrade its sovereign debt to “junk” status. Later in the month, the EU accepted proposals from the European Commission to establish a network of bank resolution funds to prevent future banking failures from destabilising financial systems in the eurozone, ensuring that “robust mechanisms backed by private money” are in place to deal with them. In the US, the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act takes a similar stance on public bailouts by prohibiting the Federal Reserve from emergency lending to insolvent firms. With the withdrawal of public money from rescue operations, lawyers in both jurisdictions are expecting an increase in demand for advice and services from distressed financial entities trying to stay afloat without a government safety net.
In June, the European Parliamentary Committee on Economic and Monetary Affairs requested a resolution allowing the EC to draft legislation on cross-border crisis management in the financial sector, specifically on the possibility of harmonising national insolvency laws. This would provide “legal certainty” to restructuring specialists when deciding whether a transaction serves a client’s corporate interest. Harmonisation would also provide consistent guidelines on director liability so as to avoid “insolvency tourism” by directors of distressed companies. Lawyers throughout the EU mentioned the difficulties inherent in conducting cross-border insolvency matters when faced with inconsistent national regimes, particularly with multi-jurisdictional restructurings like Lehman Brothers still ongoing.
The majority of the lawyers we consulted said that the first thing distressed clients wanted in the current climate was assurance of low-cost solutions. Companies are seeking cheaper alternatives to formal bankruptcy proceedings, either through refinancings or quick asset sales in the form of “pre-packs”, which allow a company to ensure the sale of all or part of its business or assets before appointing an administrator or going to court. The model saw a spike in popularity in the UK after the financial crisis hit; however figures published by the government’s insolvency service in July 2009 showed that accountants had breached professional conduct guidelines in 35 per cent of all pre-packs filed in the first two quarters of that year. As such the insolvency service tightened its regulations by allowing courts to disqualify the directors of insolvent companies for up to 15 years if their conduct is considered unfit, and the demand on lawyers to prevent such liability is high.
July also saw the first use of a pre-pack by a listed company in Mexico since the country reformed its insolvency laws in 2007, when supermarket operator Comercial Mexicana submitted a pre-pack debt restructuring before a local court. The following day, Reuters reported a 2 per cent rise in the value of the company’s shares and forecasts for strong store growth. If the restructuring continues to be a success, local lawyers expect an increase in the use of the model going forward.
In January, the Australian minister for financial services, superannuation and corporate law unveiled proposals to reform the country’s insolvency laws. The reform package includes numerous measures aimed at reducing the cost and complexity of the Australian insolvency proceedings, which have increased steadily in number over the past two years. Under the reforms, the Australian High Court’s 2006 decision on the Sons of Gwalia insolvency was reversed in June. Under the court’s original decision, shareholders of the mining company were awarded the same status as non-shareholding creditors because the company breached disclosure obligations or misled them about its financial circumstances. The reversal restores priority to creditors ahead of shareholders to an insolvent company’s equity. It is hoped that such reforms will streamline the external administration process, which a high volume of shareholder damage claims had made costly and inefficient under the Sons of Gwalia ruling. Lawyers in Australia welcome such reductions in administrative hurdles and expenses.
Lawyers in several jurisdictions noted an expansion to their national insolvency bars since the beginning of the financial crisis. The most obvious driver for this trend is a dramatic increase in the volume of filings in recent years; however, the ease with which a business can be closed in a certain jurisdiction also plays a hand. A recent survey by Doing Business listing the countries where conducting insolvency proceedings is cheapest, quickest and most effective in terms of recovery rate, squares well with the testimonies of the lawyers we consulted in expanding jurisdictions. According to the report, the average recovery rate of an insolvency in Norway is 89 per cent, where the average cost of the proceeding is 1 per cent of the company’s estate and the average duration is less than a year. Similarly our sources in that jurisdiction reported the expansion of their insolvency teams at the associate level and predicted no drop off in the number of filings. Japan, Ireland and Canada are also identified as leading jurisdictions for quick, cost-efficient insolvencies, and sources in these countries also noted the expansion of their national insolvency bars.
Lehman and After
The unprecedented scale of the Lehman collapse means a large number of the lawyers listed in this book have worked on some aspect of it. In July, Legalweek ran an article breaking down the former investment bank’s almost $400 million in legal fees since 2008, with nearly half going to Weil Gotshal & Manges and the rest spread among firms and individuals throughout the US, Europe and Asia. Yet the knock-on effect on companies who had previously relied in part on Lehman’s issuance of short-term credit have led to a lot of work for lawyers who were not directly engaged on a Lehman file. A prominent example of this is the commercial paper market, which suffered seriously when Lehman filed for chapter 11 protection. Even in Canada, where banks remained relatively strong and the overall number of insolvencies was relatively low despite the financial crisis, failures in the country’s asset-backed commercial paper market have necessitated market-wide restructuring worth $32 billion.
Despite being involved in international, multi-billion dollar restructurings like Lehman and General Motors, a number of the full-service firms posted flat revenue figures for 2009. The insolvency, regulatory and litigation departments of top firms have been the busiest over the past year according to Bloomberg, but in many cases this has not been enough to offset the drop-off in corporate transactions and banking work.
In this climate, small and mid-sized firms that do not have large corporate departments to sustain have fared well. “It has been the best year in the firm’s history” says Ray Shapiro of Blank Rome LLP in Philadelphia “we haven’t been hit the same way as the firms that have huge numbers dedicated to M&A”. Sources in the UK and Ireland noted that a closer working relationship between the corporate recovery and financial services teams is ensuring profitability at mid-market firms despite lower hourly rates.
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M&A activity is staging a modest comeback in 2010 and insolvency figures for the first two quarters present a much more varied picture than the ubiquitous high numbers of 2009. The number of bankruptcy filings in some jurisdictions, notably the US, has risen substantially over the past year, while in the UK and other countries the volume of businesses in distress has fallen. In June PricewaterhouseCoopers reported a disappointing first quarter in terms of deal value in Europe, but noted the potential of banking sector restructurings in Germany and Spain to drive an increase in deal flow. In the US, M&A activity in the first quarter of 2010 rose by almost 60 per cent on the same period in 2009.
Companies and financial institutions the world over are still suffering from the hangover of their lending and as they attempt to clean up their over-leveraged balance sheets and the lawyers in this book should expect no shortage of appointments in the near future.