Sticky ends: the City's top restructuring lawyers discuss recent developments
9 July 2012
31 October 2012
23 April 2012
24 October 2012
21 May 2012
27 February 2012
The collapse of Lehman Brothers in September 2008 has propelled insolvency law into the frontline
Insolvency and restructuring practitioners are some of the busiest lawyers in the business right now. In this week’s peer panel some of the key issues and cases are debated, including the impact on the legal profession of law firm bankruptcies.
What would you consider to be the major developments in the insolvency landscape since September 2008?
Richard Tett, partner, Freshfields Bruckhaus Deringer: The major developments, in my view, are schemes of arrangement, intercreditor releases, company voluntary arrangements (CVAs) of landlords and the lack of UK insolvency legislation development compared with other European countries.
Schemes have developed into the ‘tool of choice’ for complex restructurings. The main developments have been, first, to link them to prepack administrations. This enables out-of-the-money creditors or shareholders to be left behind.
Second, the acceptance that non-UK borrowers of English law-governed debt can restructure using an English scheme. La Seda de Barcelona led the way in 2010 and Tele Columbus, Rodenstock, Metrovacesa and PrimaCom have expanded this important European development.
Intercreditor releases is really a contractual point and the market now accepts that these work. There’s always a debate about the precise wording and protecting the agents. CVAs have become the best way of restructuring companies with multiple tenancies and have been used in retail or multi-tenancy restructurings, such as JJB Sports, Blacks Leisure, Focus DIY and most recently Fitness First.
My last development is the disappointing lack of UK legislative development. Since the downturn, most countries have improved their insolvency laws materially – most recently Germany. This is in part because of companies coming to England to restructure.
Aside from the financial institution insolvency legislation, disappointingly there have been few legislative changes here – no cram-down regime for out-of-the-money classes, no new moratorium, no contract stabilisation by an executory contract regime, no debtor in possession.
The UK remains probably the most popular restructuring regime in Europe, but the fear is that we’re resting on our laurels.
John Verrill, partner, Chadbourne & Parke: Lehman Brothers’ collapse spawned a plethora of Lehman-specific but nonetheless crucial judgments, often involving complex financial instruments, but of more general interest. Take the Supreme Court [UKSC] decision in Belmont, where the issue of the anti-deprivation rule and the pari passu principle were reviewed at the highest level. The outcome was helpful, but not conclusive; not every deprivation will be bad. My win for the reviled Football Creditor Rule was based in part on Belmont, so it’s already having an impact in other arenas.
The prickly issue of administration expenses gets worse, not better. The Goldacre decision on rent as an expense is bizarre and a trip to the Court of Appeal [CoA] is long overdue. More alarming still is the fact that even at CoA level in Lehman and Nortel, the financial support directions and contribution notices issued under the 2004 Pensions Act have super-priority: pensioners get paid before professionals. But if this prevails there’ll be no one to do the work. Happily (but slowly) the UKSC with a panel of seven judges will visit the issue in the middle of 2013.
Much noise is made by the landlord community about the increasing use of CVAs to cram down rent in (usually) retail situations. This particular pendulum ought to swing back the other way – there’s even a CoA judgment that suggests a CVA can’t deal with future rent, but it seems to be lost on most.
Adam Plainer, partner, Weil Gotshal & Manges: Among the major developments include changes in the banking sector contained in the Banking Act 2009 and the emergency legislation preceding it, and in the new special administration regime implemented through the Investment Bank Special Administration Regulations 2011 and in the related Investment Bank Special Administration Rules. These are key pieces of legislation aimed at providing financial stability and confidence in the banking system, the collapse of Lehman having provided an immediate illustration of some of the deficiencies in the existing insolvency framework for dealing with the complex issues arising in the case of investment bank collapses. In particular Lehman highlighted difficulties and delays in the return to the client assets and client monies to the bank’s clients.
The special administration regime introduced to deal with failing investment banks includes a number of key new provisions that facilitate making distributions of client monies at an earlier stage than might otherwise have been the case, including provisions enabling a bar date to be set for the submission of claims as to client assets.
Other key developments, albeit in the form of trends and market practice, include the increased use of schemes of arrangements as effective restructuring mechanisms for struggling leveraged buyouts [LBOs] and the increased use of prepackaged administration.
Partha Kar, partner, Kirkland & Ellis: The major developments have been the continued use of English legal processes to effect both domestic and cross-border restructurings. Centre of Main Interest [Comi] shifts, normally followed by prepacks, have become an established tool for restructuring lawyers. Other tools such as using schemes for international groups of companies and CVAs to deal with, among other things, various lease liabilities show that these established tools can be used in new ways to deal with even the newest and most complicated capital structures.
Richard Hodgson, partner, Linklaters: Given the sheer number and breadth of seismic events that have affected the global economy since the collapse of Lehman, and the flood of new (and proposed) insolvency legislation across Europe reacting to such events, it’s difficult to summarise the major developments in the insolvency landscape during this period.
Key trends have included the evolution of special insolvency regimes (for example for banks), a greater emphasis on cross-border cooperation between courts and legal systems in complex multijurisdictional insolvency cases, and the growing use of out-of court or prepackaged restructuring solutions, particularly when dealing with leveraged finance structures.
Recent case law, particularly in relation to administration expenses, has also posed some significant challenges to the UK’s rescue culture.
How significant would it be for the Supreme Court to uphold the Court of Appeal’s judgment in Rubin & Anor v Eurofinance & Ors?
Tett: It’s very interesting and important for insolvency lawyers, but of rather focused significance. With the EC Insolvency Regulation for Europe and the Insolvency Act 1986 s426 for Commonwealth countries, Eurofinance’s impact is limited primarily to US and UK formal insolvencies. So yes, I’m watching it carefully, but it doesn’t get onto the podium for top developments.
Verrill: It would be more significant if the appeal was successful and the CoA overturned. The important message from Rubin is that international insolvency cooperation has been developing very quickly since the Privy Council decision in Cambridge Gas, which is the genesis of Rubin. The complaint of the appellants in Rubin is that they didn’t submit to the jurisdiction of the US courts so that the New York Bankruptcy Court had no business entering judgment against them for the US equivalents of preference claims and transactions at an undervalue. It follows from that argument that enforcement of those judgments directly by the English courts isn’t possible under private international law.
But in Cambridge there was no submission either and the Privy Council in the single judgment of Lord Hoffmann found that it was perfectly acceptable to assist in the implementation of a US plan of reorganisation by forfeiting shares in an Isle of Man company.
The trend internationally is towards assistance, including enforcement – indeed, just after the Rubin appeal had been heard, the court in Manhattan found that, even in the absence of any treaty, it had jurisdiction to enforce a money judgment: the court ruled that a $33m (£21.25m) judgment entered by an English court against a Saudi Arabian company can be enforced in New York even though the New York court has no basis for personal jurisdiction (Abu Dhabi Commercial Bank v Saad Trading, Contracting & Financial Services). It would be a pity if instead of leading the world in the development of a principle of international insolvency assistance, we took a step backwards.
Plainer: The judgment is certainly eagerly awaited and the question of the recognition and enforcement of bankruptcy proceedings on a cross-border basis is one that frequently needs to be evaluated in practice so that appropriate strategies can be formulated. Put simply, if a judgment in bankruptcy proceeding can’t be enforced in the jurisdiction where there are assets to meet it, then there will need to be convincing other reasons for pursuing the judgment in the first place. Although it is sometimes possible and appropriate for parallel or other sets of proceedings to be opened in different jurisdictions, where this can be avoided it will usually mean reduced costs and this will be in creditors’ interests.
In a nutshell, the CoA decided that the ordinary rules for enforcing foreign judgments did not apply to bankruptcy proceedings and that the US claims for which enforcement was sought should be characterised as bankruptcy proceedings that should be enforced directly against individuals who hadn’t submitted themselves to the jurisdiction of the US court. The US bankruptcy judgments concerned the recovery of preferential payments made to debtors in England from a US business set up in the US by Eurofinance.
On the face of it a UKSC decision upholding the CoA decision would confirm, and potentially add by slow increment to, the developing principles of private international law championed by Lord Hoffman in Cambridge Gas and HIH Insurance. Lord Hoffman termed this the principle of “modified universalism” and he considered that this requires English courts “so far as is consistent with justice and UK public policy” to “cooperate with courts in the country of the principal liquidation to ensure all company assets are distributed to creditors under a single system of distribution”.
In summary, a UKSC decision upholding the CoA would be helpful and significant, particularly if clear guidance is given on the question of the proper characterisation of claims as bankruptcy proceedings or otherwise. If the UKSC is able to deliver this in a single judgment and with unanimity, so much the better.
Kon Asimacopolous, partner, Kirkland & Ellis: The UKSC upholding the judgment in Rubin would be significant, but not unwelcome from a cross-border insolvency/restructuring, UN Commission on International Trade Law (Uncitral) model law and European law perspective. It will undoubtedly concern some parties who need to determine on a wider level how their claims may be dealt with, but is simply one small step closer to the fantasy of a truly unified global restructuring and insolvency regime.
Hodgson: The significance of the UKSC’s decision will, of course, be most keenly felt where foreign insolvency practitioners/representatives wish to make use of the English courts to go after debtors in this jurisdiction. In Rubin the defendants elected not to appear in the foreign proceedings purportedly with the intention of relying on the rules governing the enforcement of foreign judgments in England and Wales to provide them with protection. Given the current economic climate, the increasing number of complex, cross-border insolvency cases and the present difficulties facing the eurozone and the global economy, any evolution of the English common law on the principle of modified universalism will need to be examined.
The Irish Supreme Court (in Re Flightlease) recently considered issues similar to those now before the UKSC. The Irish court took the opposite view to the CoA in Rubin and suggested that further development in this area should be a matter for legislation, not the courts. Certainly, greater clarity is needed as to why there should be a separate category of bankruptcy judgments, and what they are, to which ordinary private international law rules for enforcing foreign judgments do not apply.
There is also the important question of what checks and balances for debtors any common law principle of modified universalism should have in place to prevent creditor abuse.
As UK companies continue to struggle, what should they be doing to try to stave off going into administration?
Tett: The simple answer is twofold: first, ‘hope for the best, but plan for the worst’; and second, ‘cash is king’.
Early preparation is key and overoptimism is to be avoided. While insolvency professionals may be too cynical, hope dies last for too many directors and shareholders, so embracing situations earlier is key.
Also, companies generally fail because of a lack of liquidity, so monitoring and stress testing the cash situation is crucial.
Verrill: Cash in these times is imperial, not regal. The inability of banks to lend to the small and medium enterprises sector because of Basel III has dried up liquidity. Those to whom banks can lend don’t need the cash, so cut costs, plan conservatively, fund from equity not debt and collect your receivables aggressively.
Don’t deal with suppliers with weak balance sheets or those giving off distress signals, it could damage your business: how many of us look hard enough at the credit risk of those we deal with?
There is a number of credit-enhanced (insured) packages coming to the market in response to the liquidity crisis and they deserve a good look.
Plainer: Some sectors are clearly at more risk than others, for example retail and directories. Companies need to consider whether there are operational changes and restructurings they need to make and to make sure that they’re completely on top of the finances so they can identify quickly and act upon any pending crises.
Generally being proactive with lenders and other major creditors such as landlords is going to be key. There may be scope for agreeing changes to rental payment terms, and in the case of a multi-site retailer with a mixture of profitable and unprofitable sites, the way forward may be by means of a CVA. Of critical importance is not to adopt the ostrich approach and do nothing, as directors may then expose themselves to personal risk and claims for breach of duty or wrongful trading.
Kar: Every company’s different and will have differing commercial matters it will need to deal with if it’s struggling financially, but from a legal perspective, companies should ensure that the relevant decision makers are competent and experienced and have access to up-to-date and high-quality information about how a company is trading and its daily cash position.
Executives should also have access to adequate models to determine whether there’s any shortfall or breach of covenants coming up in the next three to 12 months. This should allow for some planning and access to specialist advisers, when needed, to try to help them turn around the situation while also managing liability and risks and, if necessary, to engage with the stakeholders of the company to try to preserve value and the going concern.
Hodgson: There really is no ‘one size fits all’ strategy for companies in financial distress, as there’s likely to be a range of issues impacting on their solvency, and any strategies that might be available to them will very much depend on the factors affecting the relevant company, including the sector it’s operating in.
The problems companies may be facing could be due to the constrained credit environment; uncertainty in global markets taking its toll on corporate spending and investment; austerity programmes causing reduced government spending and impacting on consumer spending; regulatory changes; and market/ product-specific issues.
Key to confronting these issues will be early planning and timely dialogue with key suppliers, customers and creditors to create a credible plan for weathering the storm. Keeping a close eye on cash and cutting unnecessary expenditure is also essential, as management teams try to navigate a path through these troubled times.
What can the legal profession learn from the collapse of firms such as Dewey & LeBoeuf, Howrey and Halliwells?
Tett: Two things. First, our profession’s not immune from the downturn. People sometimes say that law firms’ financial performances never reach the peaks in good times, nor the depths in bad. These three collapses show the latter is not true, even if the former is.
Second, I suspect some people would say that these show how being a great lawyer doesn’t necessarily make you a great businessperson.
Verrill: High levels of debt funding wrest control of firms from their members. Dewey had over $300m of debt from JPMorgan and bondholders that it would have to service before partners’ entitlements arose. It’s tantamount to a sale of the family silver: it can only be sold once.
To gear up on debt to fund expansion by using it to pay for expensive lateral partner hires is dangerous – in extreme cases it has the economic feel of a Ponzi scheme. The conservative debt-free model looks pretty comfortable in the current environment. Beware of the firm that boasts of a war chest if it’s debt-funded.
Partners need to assert their rights to transparency – the mutterings of Halliwells and Dewey partners on this count are a warning to us all.
Finally, proper due diligence on lateral hires at a time of increasing partner mobility is essential – not only is it a safeguard, but done properly the candidate on arrival will really know their new home.
This business has to be about trust, but borne of a careful assessment of who you are in partnership with – as some have learnt to their cost.
Plainer: The key lesson must undoubtedly be the danger of overleveraging if a law firm commits itself to too high overheads by expanding too fast or taking on too large a real estate commitment. The prudent approach is to self-fund and not to rely on outside borrowings.
Another key lesson is the need to build a balanced practice so fees can be generated in a recessionary climate as well as at times when the general business climate’s more buoyant.
Hodgson: As with all businesses, law firms need to be vigilant in the careful management of cash and their financial commitments. No business is entirely insulated from the financial shocks impacting global markets, and the same can be said for law firms and other firms of professional advisers: what affects our clients inevitably affects us too.
One of the central themes is that in recent years the courts have shown a refreshingly commercial approach to the inherently flexible scheme of arrangement. Even in the proposed Lehman Brothers client assets’ scheme, the judges were sympathetic to the debtors’ aspirations, while the legislative response to its failure was the introduction of new processes in the Investment Bank Special Administration Regulations and its accompanying rules. Driven in part by the prevalence of English law finance documents, schemes continue to play a central if sometimes controversial role in the restructuring of many foreign and cross-border businesses, both with and without the use of Centre of Main Interests (Comi) shifts and the much-maligned prepack.
Several of the panelists also comment on how company voluntary arrangements (CVAs) are now quite often used to rearrange landlords’ rights, usually where unprofitable retail outlets risk collapsing what might be an essentially profitable business. This has also been controversial, but has the capacity to benefit all, so long as the CVA is structured properly and the landlords are in no worse a position than they would be on a formal insolvency. Doubtless, any attempt to stretch the jurisdiction beyond what is acceptable in the relevant market will be faced with sustained landlord challenges on unfair prejudice grounds.
The law relating to administration expenses continues to raise numerous issues. The Supreme Court in the Nortel and Lehman pensions appeals is to consider the whole area in May next year. It is to be hoped that clear, wide-ranging guidance is given. In this, as in other areas, parties often rely on the rescue culture. Judges may be sympathetic to the general principle, but do not give it overriding significance. That itself may reflect an appreciation that there are many cases where rescue is inappropriate and traditional insolvency remedies are what is really required.
The other insolvency issues with which the Supreme Court is faced go to the very heart of the most basic insolvency principles – Eurosail on the meaning of inability to pay debts and Rubin on enforcement aspects of cross-border cooperation. Belmont was an important decision on the anti-deprivation principle, while the recent attack on the football creditor rule is but one example of how attempts to engage that principle have occupied the judges in recent years.
Imaginative use of the courts will continue to be a mainstay in the world of restructuring and insolvency, but there will also be occasions on which legislative reform is the only way forward.
William Trower QC and other senior members of ‘South Square
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