The insolvency and restructuring business remains slow-moving thanks to the improving economy and low interest rates. Lawyers note increased competition and a fight for the limited work available. But this period may soon be at an end as the global economy strengthens further and "coasting" companies are forced to take a hard look at their refinancing structures and debt plans.
Traditional work has been scarce for a number of years but there have been many new branches which have proved a fresh source of work for our expert practitioners. In the US, the rise in municipal bankruptcies has gained widespread media attention. The largest of these occurred in summer 2013, when the city of Detroit filed for protection under chapter nine of the US Bankruptcy Code. US sources are expecting more of this type of work to come.
More generally, there has been a distinct lack of new liquidations in the US, and many have been surprised at the speed with which the market went “from complete crisis to barely a whisper”. A number of US lawyers have noted the abnormally low rate of chapter 11 filings. This is due to the amount of capital in the market, meaning that companies can refinance fairly easily. With the high-profile global financial crisis cases such as the Lehman Brothers having been largely resolved, the low interest rates are allowing marginal companies to sustain themselves, thus diminishing the work available. This is defined as the “zombie company” phenomenon, as (for all intents and purposes) dead companies have just enough to pay the interest without ever reducing the original debt. However, there is the expectation of greater activity in the near future: “Recession followed by improvement brings a fresh crop of business failures.” Sources recall that historically, the number of insolvencies tends to peak 18 months after a crisis or recession ends, and so they are anticipating more work in the traditional space as these zombie companies finally give up the fight.
This belief is shared by practitioners across the world. Many of the global jurisdictions are likewise still in a period of record low interest rates and so it is probable that once those rates begin to rise again, this will lead to an influx of work. Lawyers note increasing signs that it is slowly but surely returning to a more conventional market with more typical instructions, though it is not quite there yet. Despite the tough market conditions, expert practitioners with a wealth of experience have been more than capable of riding the wave and anticipate a busier next few years “heading back to the status quo”.
Mainland European banks are taking a long time to recover, with most “still essentially bust” according to our European-based sources. This has led to challenges for practitioners in these jurisdictions who now have to work with very different finance markets. The European market has been quite substantially affected by finance creditors not wanting to crystallise losses on their own books, therefore leading to a downturn in the need for insolvency or restructuring advice, but practitioners anticipate that as the economy improves, they are more likely to push for some kind of closure.
In the UK, the banks also continue to suffer from huge capital problems. The past few years have been marked by a steady rate of deleveraging – examples cited include the Royal Bank of Scotland and Lloyds Group. With banks having been in withdrawal mode for the past few years, there has been a lot more action in the bond market. This has in turn led to a tendency on the part of banks to increasingly sell their debt to funds. UK lawyers have observed banks selling off whole portfolios of loans to hedge funds in order to raise capital. With this development, the work of the lawyer has also changed, as they attempt to navigate this new environment. Their job is rendered more difficult because of the uncertainty as to whether the funds are here to stay or whether they are going to exit the market “as rapidly as they arrived”. In order to remain active in the field, it has now become necessary for practitioners to decide not only which funds to align to but also how to attract those funds. The substantial differences between banks and these distressed debt traders, such as hedge funds and private equity houses, do not make this new role easy. Lawyers note that these new investors, as funds who have seen an opportunity to make profit by buying and selling debt, come at the business from a completely different angle and are “much more likely to take a short-term view”. Therefore, practitioners in their advisory capacity will have to adapt to this new pattern, recognise these new goals and targets, and understand more fully the different types of challenges that these potential new clients face. All of this, according to our sources, renders the job “even trickier than first anticipated”.
However, while this is the case for jurisdictions such as the UK, the US and large parts of Europe, there are certain economies where lawyers have observed more conventional activity. Countries which have seen greater growth over the past few years have conversely increased the work for insolvency and restructuring lawyers. Key jurisdictions cited to us by our sources include Brazil and the Middle East. China has also been a huge source of work for many. This is largely due to the fact that it has become a highly leveraged market, and recent times have been marked by significant borrowing without a lot of verification. Lawyers warn that this is “creating a bubble which will inevitably burst at some point soon”. Bank restructurings and claims have been notoriously difficult in China as the laws on security and recovery are “unpredictable at best”. This primarily affects US funds which form a significant proportion of the investment going into China, but with cross-border insolvency increasing in use, lawyers from around the world need to be aware of the challenges of the Chinese markets.
Asia in general is seen as a key market by law firms which will be looking to target that area of the world in the near future. A number of the region’s economies are in growth mode, which will throw up problems, and so it is likely that the area will provide a significant proportion of work in the years to come.
Despite a slump in the amount of new work, lawyers have nevertheless been kept occupied by the protracted nature of high-value insolvencies that have occurred in the last few years. A number of lawyers highlight the Madoff case as one that “just keeps on giving”, both for onshore and offshore experts who are still seeing a wave of related claims. Suntech is another extremely high-profile case which has come out of Asia. Suntech Power Holdings was the largest producer of solar panels in the world. Its main subsidiary in China became bankrupt in March 2013. This was a consequence of the fact that the Chinese solar industry was hit particularly badly by the eurozone and US crisis, which led to a huge drop in demand (lawyers cite LDK Solar as another example of this). Sources anticipate more activity generally in the solar sector because of the stark difference between supply and demand. Other cases finally drawing nearer to their end include the Nortel case (considered one of the biggest bankruptcies in Canadian history) and the Kodak case, which has also gained a large amount of media attention.
INDUSTRY SECTORS IN TROUBLE
A number of practitioners have noted that the perennial cases are still around retail. Pressure from internet sales and the general economy has led to further difficulties for the retail sector. In the UK, the Insolvency Service reported that in the 12 months to Q4 2013, the wholesale and retail sales sector recorded the second highest number of liquidations (following construction). Overall, however, the number of new liquidations remains fairly low. Retail businesses that borrowed money a few years ago are seeing those debts become due with no refinancing plans in place and there are a growing number of zombie companies in this sector. Sources note that many companies that have not yet fallen into liquidation are “barely staying above water”. It is expected that these companies will soon lose the battle, thus leading to an increase in the number of new liquidations.
This unfortunate situation is being replicated across a variety of other industries. The past 18 months have also seen a lot of strain on the global shipping industry. This is due to a confluence of factors including low charter rates and the larger number of ships available which has increased competition in this area. Companies are thus feeling significant pressure and this is expected to continue. Lawyers from multiple jurisdictions are feeling the effects of this continuing development, given the international nature of the shipping world.
The commodities sector is seeing a significant amount of activity given the volatility of prices across the natural resources sphere. In the energy space, particular tension is being felt by alternative/renewable energy clients. Sources have observed that once the subsidies started to diminish, profitability fell. This in turn has led to issues with financing and so lawyers have found themselves instructed to lead a greater number of workouts.
While the onslaught of regulation in the financial services sector has evidently led to more work for lawyers in related fields, such as banking and corporate, it is also expected to have an impact on insolvency and restructuring practitioners who will have to help clients navigate new territory. A regularly mentioned example of new EU legislation which is anticipated to have an influence is the Solvency II directive. This new legislation requires more stringent capital requirements and stricter risk assessments for insurance companies. The potential impact of the directive is starting to lead to greater demand for advisory work in the insolvency space as the requirements for ensuring that a company remains solvent will be changing. This, alongside further developments in Europe such as the Asset Quality Review for banks and in the US with the far-reaching implications of the Dodd–Frank regulations will ensure that the future looks busy for those with clients in this sector.
Choice of forum issues are also rising in prominence in Europe. Following the introduction of European legislation over a decade ago, allowing people to choose which country to initiate their bankruptcy proceedings, this has in turn led to changes in domestic legislation in multiple countries in an attempt to make theirs the most attractive jurisdiction. This enables what is known as “forum shopping”. In December 2012 the European Commission adopted a proposal to amend the EU Insolvency Regulations to address this and other problems. Sources state that they are waiting with interest to see what potential reforms could spring out of these discussions.
THE COST FACTOR
Spiralling costs have also led to a change in the style of the insolvency and restructuring process. Lawyers have been struck by the rapidity as they note a greater tendency across jurisdictions to try and do the work as quickly as possible. Sources have noted an increase in the amount of out-of-court debt resettlements, which has been attributed to an attempt to reduce costs and also to combat uncertainty, as clients feel more able to control their own fate out of court.
Speed is also a prominent factor even when a court process is involved. Pre-packaged bankruptcies are becoming increasingly popular. According to one US source, “the days when protracted bankruptcies could go on for years will become rarer, because they simply cost too much money”. In Europe practitioners have also observed a greater demand and willingness towards schemes of arrangements.
Following the global financial crisis a number of practitioners from other fields gravitated towards this area anticipating a spike in the volume of work. While this did occur, it was not to the level that many were expecting and as a result, the legal market has become “far too overpopulated”. Traditional insolvency lawyers observed large numbers of transactional lawyers in particular who, once their work had dried up, were holding themselves out as insolvency lawyers. Now with corporate activity picking up, those same lawyers are moving back to their original areas of expertise, and so long-time insolvency lawyers are hoping that the future will see the market reduced once again.
The increasingly cross-border nature of insolvency law means that the spread of practitioners is worldwide – lawyers from 42 different countries are recognised in this edition. That being said, the US is still home to the greatest proportion of insolvency practitioners, with 38 per cent of all those selected based in this jurisdiction this year. Despite an overall drop in total practitioners, the US has seen an increase of those recognised as having active insolvency practices. The chart below focuses on the spread of lawyers featured in our publication over the course of three years. With the outer ring showcasing this edition’s distribution, the changing fortunes of European and North American-based practitioners are clearly highlighted. 2012–2013 saw a rise in European lawyers alongside a drop in North American practitioners. By contrast, in 2013–2014, the opposite occurred. This trend can be aligned to the changing face of insolvency and restructuring law, with European banks creating a significant proportion of work a few years ago compared with the current rising prominence of US funds, and therefore greater opportunity for US-based lawyers.
There will still be increased competition among the specialist firms for the foreseeable future because of the limited business available. This competitive atmosphere in jurisdictions such as the US has led to what lawyers term “beauty contests”, where companies interview a range of potential counsel in order to ensure they are getting not only the best quality but the best value for money. This mounting pressure is likely to have the biggest impact on mid-market firms, which perhaps cannot afford to be as competitively priced as the specialist boutiques and do not have the same luxury as global firms that are likely to be retained for the most complex international work.
But overall there is optimism among those we interviewed, with the majority sure that major activity is just around the corner. The key driver for this will be the imminent raising of interest rates. In the words of one lawyer, once this occurs, “companies will be going to the wall in hours, not days.”