When Crisis Crosses Borders
As business activity has globalized, troubled companies are more likely to involve assets, operations and financial complications for creditors and other stakeholders that are international in scope. It’s not surprising, therefore, that there is increasing interest in developing global strategies for resolving cross-border corporate crises. But evolving a global approach to corporate distress is a difficult challenge, in part because the bankruptcy codes vary internationally, reflecting fundamental differences in approaches to bankruptcy and attitudes about financial recovery. To those who are not attorneys, accountants or turnaround managers, these differences may not be readily apparent because bankruptcy codes tend to share the same basic priority: to protect creditors’ interests and find ways to keep them “whole.” Jurisdictions tend to differ, however, in their assumptions about the best ways to achieve these goals within acceptable parameters of risk.
The U.S. system, for example, has long been predicated on the notion that rehabilitation, when possible, offers the best prospects for companies that are in distress, unable to pay their debts and forced to seek refuge in bankruptcy protection. There’s a commitment in the United States to explore options for a second chance, in the expectation that creditors’ and other parties’ financial interests will, in the long run, be best protected if a company can be restructured to restore and rebuild its enterprise value and, in so doing, preserve jobs.
Alternatively, the European approach has historically not been oriented toward saving either corporations or jobs, because Europeans have traditionally feared that the U.S. approach went so far in the direction of trying to save companies as to be “anticreditor” in its impact. Europeans, for example, have so far rejected one of the great strengths of the U.S. bankruptcy code: the notion that a bankrupt company can explore various restructuring options while continuing to operate as an ongoing concern. U.S. companies may even raise capital while under bankruptcy protection in order to strengthen their ongoing operations and restructuring prospects. This valuable technique, known as debtor in possession (DIP) financing, has no counterpart in Europe yet. There it’s extremely difficult for companies to pursue or raise working capital successfully after they enter bankruptcy because they cease to operate as independent entities and are typically prepared for sale or liquidation by a court-appointed administrator, making it difficult to demonstrate a need for ongoing capital. Also, as there are no established mechanisms to allow DIP lenders priority claims on assets, it’s impossible to attract new creditor involvement. As a result, until very recently most companies that filed for bankruptcy in Europe wound up being liquidated or sold off, in pieces or as a whole. The certainty of a short-term solution, even one that only partially reimburses creditors, has been preferable to the uncertainties and added expenses that often accompany a rehabilitative approach.
A Trend Toward Rehabilitation
To be sure, both the European and U.S. systems are prone to excesses. In Europe, potentially viable companies often are liquidated, while in the United States, some flawed enterprises can be repeatedly propped up — the retailing industry and airline industry are notorious in this regard. Nevertheless, it is clear that the U.S. system offers more potential to protect creditors’ long-term interests as well as to save jobs.
In that regard, recent movement in Europe, especially by regulators in Germany and the United Kingdom to try to facilitate at least the possibility of rehabilitation, can be taken as a positive sign. Several factors are encouraging this development, including the large number of U.S. creditors involved in European deals and a growing sense, even among the Europeans, that liquidations don’t necessarily maximize creditor recovery. They may even reduce potential paybacks to creditors. The recent out-of-court restructuring of London-based Marconi Plc, the struggling telecommunications giant, is a prime example of the new approach. Marconi reached an agreement with creditors to convert most of its debt into equity as part of a successful effort to avoid bankruptcy and court-supervised administration. In addition, most of the existing management team will stay on with the company, newly christened Marconi Corp.
Will this regulatory evolution eventually result in the full-scale adoption of the U.S. model by European jurisdictions? Not likely. The differences between the two models are simply too fundamental. Yet at a time when international bankruptcies have been growing exponentially in number and scale and when the fairly rigid regulations and requirements of different jurisdictions hamper the orchestration of desired outcomes, new integrated approaches are clearly in order.
One promising concept that has attracted attention abroad is referred to as the “light touch” approach. Under the light touch, the court-appointed administrator agrees with incumbent management on operating protocols and delegates certain authorities to it under his or her supervision. (That is closer to the U.S. approach than to Europe’s, where the tendency has been to remove existing management immediately after a bankruptcy filing.) This apparent desire on the part of European regulators and practitioners to evolve a more flexible, pragmatic approach to corporate distress could represent a breakthrough for the global business community.
Another favorable and seemingly sensible trend developing in Europe establishes bankruptcy guidelines on the basis of a company’s so-called center of main influence, essentially the geographic location of its main commercial and financial interests. In distressed situations with cross-border complications, the center of main influence assumes responsibility for administering the case, while other jurisdictions assume subordinated roles, thereby reducing complications and speeding up the bankruptcy process. Although this notion is still being developed, there is a growing consensus that the U.K. system may be best suited to fulfilling the lead role whenever possible. Since court-appointed administrators in the United Kingdom have generally been interested in employing turnaround-management techniques and restructuring efforts, that will further encourage rehabilitation as a bankruptcy option.
Common-Ground Strategies
To capitalize on these trends, there are two additional strategies that, if adopted, will go a long way toward establishing common ground between the European and U.S. systems.
The first is early intervention. In the United States, the most effective corporate restructurings are frequently those that involve what might be considered a preemptive strike, with intervention ideally taking place before a troubled company runs out of cash and options and well before bankruptcy is inevitable. The earlier that action is taken, usually upon prompting from a company’s creditors or its board of directors, the greater the prospects for a successful rehabilitation. In Europe, outside intervention tends to happen too late in the distress cycle to achieve anything other than a court-supervised liquidation.
It is possible that early interventionist techniques could make a difference in Europe, perhaps through the evolution of a “fork in the road” process, which might work something like this: When signs of corporate distress first appear (perhaps a significant bank-covenant failure or a major financial downturn), there would be a quick but thorough independent assessment of liquidity conditions, marketplace prospects, financing options, management capacity and other key factors. This assessment could lead to an informed decision by interested parties to make only minor adjustments in business operations or the company’s capital structure; to pursue more substantive, out-of-court restructurings of operations and/or finances; or to enter the formal process of bankruptcy.
In relatively simple cases of corporate distress, early intervention may be sufficient to set a company on the path to recovery. But in more complex situations, especially those that involve a bankruptcy filing in one or more national jurisdictions, it might be useful also to incorporate a second technique, increasingly popular in the United States: the retention of a so-called chief restructuring officer. CROs are turnaround experts who are brought into distressed situations not as consultants or advisers but as temporary officers or quasi-officers of the company. They report to the board of directors rather than to a company’s existing management team. The CRO focuses on assessing the current crisis (more comprehensively than might occur at an early interventionist stage). He or she is charged with developing and executing a plan to restructure the company’s finances and/or operations, raising outside capital when necessary and restoring the corporation’s credibility with its creditors, employees and other key constituents.
CROs might effectively be incorporated into the evolving European light-touch approach, with a crisis manager reporting either to the court-appointed administrator (in a bankruptcy) or to the company’s board of directors (in an out-of-court restructuring). Their involvement might well increase the likelihood of successful outcomes where rehabilitation is attempted with European-based companies, in part because many European practitioners lack experience in these attempts.
A Case in Point
I was recently engaged as a CRO by a troubled U.S.-based financial services firm that owned an also troubled U.K. subsidiary. The founding CEO had stepped aside, with the board’s encouragement, and the executive vice president had been promoted to run the company. Realizing he had no experience dealing with corporate crises, he encouraged the board to bring in someone who would work with him, handling the crisis while he retained responsibility for day-to-day operations.
This company had severe cash-flow problems, some of which were tied to a downturn in its industry niche. I was retained just as a major financing line had been pulled with only 10 days’ notice, thereby exacerbating the cash-flow crisis. In situations of corporate distress, the ability to assess liquidity and raise capital rapidly, if necessary, can make the difference between a company’s life and death. The first objective, then, was to shrink operations aggressively to cut costs, and to raise outside working capital quickly, in part by selling the U.K. affiliate before its value deteriorated.
There was a lot to sort out. Financial reports, though accurate, were confusing because of an idiosyncratic accounting technique used in the industry. Allegations were made in the United Kingdom about predatory lending practices and improper accounting methods, and solvency was in doubt. These international complications raised the risk that the crisis might quickly escalate beyond our ability to resolve it in a rehabilitation.
After nearly a year of communication and negotiation with new lenders, old secured and unsecured lenders, equity holders, two classes of bondholders, U.K. corporate counsel, U.K. bankruptcy counsel (just in case), two different accounting firms (in the United States and the United Kingdom), U.S. corporate counsel, regulators in both countries and many states, and various Wall Street firms, a satisfying resolution was reached. In the United States a prepack-aged bankruptcy filing paved the way for the company’s rehabilitation; the U.K. affiliate was sold; and creditors’ interests were protected.
As complicated as these problems were, those confronting distressed global companies can be infinitely more so, especially for non-U.S.-based companies. If this company had been based in Europe in the days before the current regulatory shift, it would likely have been forced quickly into bankruptcy and then sold off, probably in pieces, at a small fraction of its potential value. But with the various regulatory and attitudinal changes taking place across Europe, a viable common-ground approach that seeks to maximize enterprise value is evolving — to the benefit of companies, creditors and economies overall.