The Science and Art of International Restructurings

01 August 2007

Evan D Flaschen, Bracewell & Giuliani LLP

Since then, the permitted methods for enforcing debts owed by a defaulted borrower have evolved, from those in the Code of Hammurabi, to those in the Twelve Tables of the Roman Law, to the Mayan sacrificial altars, to Church excommunications, to the English gallows, to the Pennsylvania prisons. Each of these methods involved the science of restructurings, because they were all based on codified or common law principles intended to be universally known and uniformly (and often mercilessly) enforced. 

There is still much science involved in restructurings today and, for the most part, the legal principles are rather less draconian than in days of yore. The legal principles are also relatively straightforward, and while one often hears about the complications of international restructurings, it is not the laws that make them complicated. Generally speaking, the laws of various countries provide for: liquidation, reorganisation, or both; leaving management to run the business or superseding management with an office holder; a stay or no stay against secured creditor actions; an active creditors’ committee or an inactive (or non-existent) committee; and so forth. 

Put in other words, albeit simplistically, the science of restructurings can be determined via a checklist of important issues, where for each country and each issue, one simply ticks off Column A, B or C. Indeed, a phrase you will often hear is, ‘Country X’s system is their version of Country Y’s system,’ such as, ‘Administration in England is their version of chapter 11 in the US.’ Admittedly, both administration and chapter 11 permit the reorganisation of the business, permit post-commencement borrowings, have committees of creditors, permit the sale of the business, etc.

In fact, you will often seen inexperienced counsel alight on foreign shores and assume that they know how restructurings generally work in the local jurisdiction because the insolvency laws look pretty similar to the laws of their own jurisdiction. But that is only the science of restructuring, and as experienced counsel know, the science is not the determining factor at the end of the day. 

The Art of Restructuring

Restructurings are only nominally about the law. In truth, restructurings are really about attitudes, customs, political considerations and historical underpinnings and a dozen other factors that appear nowhere in the written law. In short, international restructurings are creatures of culture, not of law. It is the culture that created the law, not vice versa, and it is the culture that still dominates the art of restructuring. 

Using the United States as an example, chapter 11 appears to be a relatively balanced insolvency framework. It leaves management in charge but creates a strong creditors’ committee as a counter-balance. It provides for the ability to seek court resolution of material (and not so material) disputes. It provides a limited time for the debtor to propose a plan, then opens up the process to others. It contains a stay against enforcement actions by secured creditors but provides a mechanism to enable secured creditors to terminate the moratorium. It even has a concept called ‘adequate protection’. 

As balanced as chapter 11 appears on paper, however, it is quite unbalanced in practice, with the power tilting decidedly in favour of the debtor. The creditors’ committee may be strong, but the unofficial ‘business judgment’ rule makes the debtor much stronger. The court may be a forum for resolving disputes, but the overwhelming majority of courts have a pro-reorganisation mindset that, in practice, often results in supporting the debtor’s point of view when there is doubt. The debtor may have a limited period within which to propose a plan, but that period can be extended to as long as 18 months with court approval, which is typically granted. Secured creditors could have the statutory right to seek termination of the stay, but it is a right seldom enforced by the courts. And any secured creditor will argue vehemently that ‘adequate protection’ is neither adequate nor protection. 

US bankruptcy judges did not suddenly and collectively wake up one morning to decide to tilt the playing field in favour of debtors. To the contrary, the concepts of a ‘fresh start’ and a ‘second chance’ have been ingrained in American culture since the first pilgrims landed at Plymouth Rock to start life anew. The United States is a society more influenced by waves of immigration than virtually any other in the world, with each new wave bringing a new, hypomanic populace with the bravery to cross the world to unknown territory, looking for a fresh start and a second chance in life. In many cultures, the worst one can do is fail; in the US, the worst one can do is not try to succeed. To encapsulate all of this into a single pop culture reference, a number of Donald Trump’s business ventures have failed, yet Donald Trump is known the world over as a financial success (among other things). To switch gears to a single business reference, Texaco is one of the largest, most profitable corporations in the world today. Does anyone remember that Texaco filed for chapter 11 relief in the 1980s? 

The US culture also embraces the classic rags-to-riches story or, to mix analogies, the US is a country ‘where anybody can grow up to be president’ (why anyone would want to be president is a whole other question). It is not accurate, as some have said, that America is a society without classes. But it certainly is accurate to say that, generally speaking, American classes are defined by financial strata, not by social levels or who one’s father is or which schools one went to. Thus, with so many cultural influences that push Americans to seek greater success, it is inevitable that there will be greater failures. But it is also culturally inevitable that those failures will be better tolerated, because ‘’tis better to have tried and failed than never to have tried at all.’ 

No wonder, then, that the inexperienced American lawyer reads the German insolvency laws, notes that they have many similarities with the US insolvency laws, and reaches the conclusion that insolvencies in Germany must be pretty similar to insolvencies in the US. Of course, however similar the science of restructuring in Germany may appear to that in the US, the art of restructuring is profoundly different owing to the social attitudes and historical foundations that shape the culture in which German insolvencies are conducted. Fundamentally, failure is unacceptable in Germany and, therefore, the German restructuring culture does not presume that an insolvent business should automatically be given the opportunity to reorganise. To the contrary, it is assumed that the business will be liquidated, often by a very quick sale for low value of the operating assets. The initial focus, instead, is on preserving jobs where possible by transferring them with the assets and, when jobs cannot be preserved, providing a substantial social safety net for redundant employees. 

Perhaps the best illustration of the difference in German and American societal attitudes towards business failure would be the results of a hypothetical poll that asked Germans and Americans to list the top five reasons why businesses fail. Though I have not seen such a poll, I feel pretty comfortable (being, as my surname suggests, of German heritage) predicting that the number one reason cited by Germans for the failure of a business would be ‘poor management’, whereas the number one reason cited by Americans would be ‘inability to compete’. In other words, in Germany it would be a personal failure – the failure of the people who were responsible for managing the business – whereas in the US it is an impersonal failure, as though the business itself had an intrinsic fault beyond the management’s control. 

Given the profound differences between those two mindsets, it is unsurprising that an insolvent business in Germany is often quickly sold to new managers, while an insolvent business in the US is given a breathing spell to correct the fault with the business (these days, the ‘fault’ is typically overleverage, although it can also be collective bargaining agreements, as has been the focus in US airline restructurings). Fix the fault, return the business to management, and the future will be rosy. 

A real-life example of this recently occurred in Australia. A major mining company was operating in administration. The cultural mindset in Australian insolvencies is to seek to sell the business, hopefully as a going concern, but a sale nevertheless, with creditors receiving the net cash proceeds and moving on to the next investment. The view is that it is better to salvage what you can rather than risk losing even more. In this situation, the Australian administrators for the mining company and the major banks favoured a sale of the assets for cash, even though it would inevitably be at a lower price in the circumstances. The US creditors, on the other hand, favoured a debt-to-equity conversion, even though the risk of taking equity would be higher and the value will be less certain, at least for a while. There is no right or wrong in this debate, only strongly differing opinions as to the best way to achieve value from an insolvent business. A sale for cash is certain, fast, quantifiable and risk averse, but leads to a relatively low recovery. A debt-toequity conversion is riskier, slower and less quantifiable, but can lead to a much higher recovery if the business performs well (or a zero recovery if the business fails again). Incidentally, this being Australia, the cash sale prevailed, even though the majority in amount but not in number of the claims had been voted in favour of the debt-for-equity swap. 

A third example is the Parmalat restructuring that was recently concluded in Italy. From the Italian perspective, it was a major success. The laws were ‘adjusted’ by the socalled ‘Christmas Eve Decree’ to change the process and enable a faster, less court-focused and more reorganisation-oriented process to play out. The core Italian business was saved and there was a massive debt-for-equity swap for the benefit of creditors. It was all new and different by Italian standards and was locally lauded. 

The international community had a very different perspective. In Italy, the culture is for the office holder to run the insolvency and for the creditors to stay out of the way. However, the international investors, who were owed more than €10 billion, did not appreciate that they were effectively shut out of the process. Parmalat’s ‘extraordinary commissioner’ had all the power and, subject to oversight by the industry minister, called all the shots, and rarely even met with creditors to hear their views. The process was viewed as opaque, and with the laws being revised several times during the administration, there was little international assurance in its fairness or predictability. This was confounded by a barrage of minutely technical objections to claims that, if pursued to conclusion, would take years of litigation in Italy before a creditor could finally receive its just distribution. 

The different culture can best be exemplified by the different attitudes of the Italian banks compared to the international investors. The Italian banks strongly believed that it was the extraordinary commissioner’s job to deal with the business and the creditors should just stay out of the way, waiting for the results. Not only did they not expect to provide input, they actively opposed providing it, for fear that they could be seen as part of the decision-making process and, therefore, potentially liable for poor decisions. The international investors believed the opposite – it was their money they were trying to recover, so how could they not be actively involved in the process? As noted, the Italian culture won out. 

Another example of the irreconcilable perceptions of the process involved the creditors’ vote. The Christmas Eve Decree introduced an actual creditors’ vote for the first time, albeit a vote that the court could override on its own. This was a major advancement by local standards. Internationally, however, the vote was viewed as largely meaningless, for two reasons. First, with the extraordinary commissioner so firmly in control, there was never going to be any solution put to a vote except the one that the commissioner was insisting on, so given the choice of an unsatisfactory solution or no solution at all, creditors did not really have much choice in the matter. Second, creditors that did not vote were deemed to have voted yes. Given that the overwhelming amount of debt was in the form of public debt securities, this virtually assured creditor assent due to the difficulties inherent in identifying public debt holders and in registering their votes properly through the Euroclear and DTC systems. 

Again, from an internationalist perspective, it is hard to say whether there was a right and wrong concerning the Parmalat restructuring, because the results may well have been right from an Italian legal and societal perspective but wrong in the international view. 

* * * 

Where this all leads is the conclusion that is often stated but seldom truly appreciated or honoured. To achieve the best results in an international restructuring, an attorney must truly understand the art of restructuring in the local jurisdiction, not just the science, and the attorney must find a way to work within the realm of the possible, not seek to implement the culturally impossible. Put aside judgmental notions of right and wrong and of ‘how we do it in our country’ and ‘how things should work’. Restructurings have been occurring since credit has been offered, and a unique restructuring culture has developed in each particular country based on societal attitudes, customs and expectations developed over hundreds of years. Mayans might no longer sacrifice their debtors on the altar of the Sun God (nor do the Incas still throw their defaulters off cliffs), but the modern restructuring cultures around the world are every bit as embedded in the local art and they are often far more important than the local science.

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