The wave of corporate distress is still breaking in Europe, with insolvencies and restructurings on the rise. There is increasing uncertainty about the likely outcomes of corporate restructurings – partly as a result of economic conditions, and partly because the market is more complicated than ever before.
Previously, best practice for corporate restructurings was the London Rules, and their successor, the London Approach (as set out in the Insol principles for multi-creditor workouts). According to the views of many market participants, this approach been blown out of the water.
Debt restructurings in today’s environment give rise to numerous challenges. Many borrowers have huge debt burdens, which represent large multiples of their EBITDA. There are often many layers of debt.
At the larger end of the leveraged finance market, a borrower could have senior debt (including a second lien facility), mezzanine debt or a high yield bond, and payment-in-kind debt, as well as trade creditors.
Due to extensive syndication of debt, lenders may comprise a very diverse universe of investors, including lending banks, CLOs, institutional investors, mezzanine lenders, investment funds and distressed debt traders.
In many circumstances, lenders of record are not the ultimate decision-makers. This is due to the rise of credit default swaps, total return swaps and similar instruments, as well as the securitisation of certain debts or even whole businesses.
Many countries in Europe have significantly reformed their insolvency laws, and the EU has passed regulations relating to the location of insolvency procedures. In practical terms, there are significant differences in the procedures for insolvent companies in different countries. To add complexity, governmental bank rescue programmes have often resulted in governments having oversight or decision-making powers with respect to certain loans.
Traditional lending banks have their own liquidity restraints, so are often very unwilling to provide additional funds to borrowers that face a cash squeeze. Other non-traditional lenders are often unable or unwilling to provide extra funding to borrowers in need. And all too often, it is extremely difficult to find a cash buyer for a distressed business at anything other than fire sale prices, leading to very low valuations and no easy prospect for a quick sale as a resolution to corporate distress. Insolvency-based solutions such as pre-packs are on the rise, as are debt amendments and extensions. True consensual capital restructurings seem to be few and far between at present.
There are three possible responses to these challenges: do nothing, legislate or prepare new best practice guidelines.
Doing nothing is easy, but would not provide the guidance needed to address the complexities of the current market.
Legislation is another possible solution, and indeed, the UK Insolvency Service has recently proposed two reforms, which would address some of the perceived problems. The drawback is that any legislation will only effect change in the local country. Legislation may also seek to achieve a particular political outcome.
The other alternative is to create an updated set of best practice guidelines, developed by key industry representatives, including trade associations and professionals. They would have the advantage of being largely consensus driven, and advocated by those with the most experience and direct influence in the market. The downside would be that it would not be easy to achieve consensus between the differing participant groups, and guidelines do not by their nature have the power to bind.
A new London Approach
At its heart, the London Approach (as set out in the Insol principles) encouraged a consensual and consultative restructuring process, aiming to avoid the insolvency of the distressed business.
However, the Insol principles were published in 2000, in a world where bank lenders were still in the driving seat in any distressed corporate restructuring, able to provide expert staff to work on rescue negotiations, and banks could fund liquidity for the borrower.
The London Approach needs to be updated, or redrawn, to address current complexities with the goals of reducing uncertainty and preserving the maximum value for all creditors wherever possible.
Uncertainty may provide arbitrage opportunities for some. However, when a business is in distress, that uncertainty tends to reduce the size of the available pie rapidly and radically, even if it may possibly allow some to get a bigger slice. Accordingly, it is important to try to preserve the value of a distressed business as a whole.
A new London approach should address the likely investment considerations of non-traditional lenders, and contemplate that additional liquidity may be provided not by senior bank lenders, but by other investors, including the existing equity and/or new equity.
Guidance should address issues of valuation, including the appointment of valuers. More thought should be given to the communication of information and confidentiality issues.
Guidance on dealing with “interested creditor” entities such as credit default protection providers, and holders of bonds representing an interest in payment streams from securitised debt would be helpful.
Some elaboration on what is expected from participants in relation to insolvency-based rescue procedures would also be helpful, for example, so called “pre packaged” insolvencies and any applicable cram-down procedures.
The numerous difficulties facing distressed borrowers and their creditors in today’s market could be best addressed by an updated set of guidelines setting out best practice for participants. It is time for a fresh set of guidance, rather than more legislation and regulation, or continued uncertainty.