Boom to bust?

The ramifications of Brexit touch on myriad issues affecting the UK economy and business, although it is difficult to predict precisely how. Yet it is fair to say that insolvency and restructuring is one area of law and practice that stands to be significantly affected by the UK’s departure from the European Union.

On the one hand, practitioners predict a significant increase in activity. ‘We are starting to see the seeds of distress in some companies in certain sectors,’ says Sullivan & Cromwell’s London-based partner Christopher Howard, who specialises in English law restructuring and finance. He singles out the construction and outbound tourism industries, reeling from the weaker pound, and businesses that rely on government funding in areas such as the private finance initiative (PFI).

‘Margins are being squeezed everywhere,’ adds Simeon Gilchrist, a restructuring and insolvency partner at Edwin Coe. Raw materials that are priced in either dollars or euros have become more expensive, he notes. The firm is assisting businesses that are blaming Brexit for increased difficulties in repaying debt, including the hospitality sector.  

Meanwhile, England and Wales risks losing its position as a jurisdiction of choice for cross-border insolvencies and post-Brexit restructuring work. The UK has one of the world’s leading insolvency regimes, according to the World Bank; it returns money to creditors more quickly and cheaply than regimes in Germany, France and the US, insolvency and restructuring trade body R3 points out.

UK insolvency practitioners give back more than £4bn a year to creditors.

Sectors and jurisdictions

Even before the EU referendum, insolvency and restructuring lawyers (especially), were pretty busy. They are still dealing with the aftermath of the financial crisis of 2007-08. A number of insolvency cases involving Lehman Brothers are still being heard before the English courts, more than eight years after the US investment bank collapsed. And the market is also dealing with the North Sea oil downturn, following the crude price drop in June 2014; and the collapse of British high-street retailers BHS and Austin Reed in April last year.

We continue to see quite a lot of property and construction-related insolvencies. Technology businesses are also a continuing theme

– Jeremy Whiteson, Fladgate

 

‘[The effect of] BHS has trickled down to smaller retail groups, so there is more activity in that field,’ Fladgate partner Jeremy Whiteson says. ‘We continue to see quite a lot of property and construction-related

insolvencies. Technology businesses are also a continuing theme, [as they] run out of money.’

Business is also coming from sectors affected by ‘long-term structural changes’, such as printing, Whiteson adds. Directories groups have been hit hard by competition from rival internet-based services – take Hibu, the debt-laden publisher of the Yellow Pages in the UK. Last year, Sullivan & Cromwell acted for the creditors of Hibu on its refinancing and restructuring.

Then there is the rising profile of overseas clients, linked to the globalisation of insolvency and restructuring practice.

Sullivan & Cromwell’s London office is advising the co-ordinating committee of bank creditors on the global restructuring of Spanish renewable energy group Abengoa. In shipping, another industry that has been struggling since the financial crisis, the firm is acting for Israel’s Zim Integrated Shipping Services on debt restructuring, involving financing agreements governed by English, New York, German and Israeli law.

Jennifer Marshall, a London-based partner in Allen & Overy’s global restructuring group, has been dealing with the global insolvency of Denmark’s OW Bunker, which was once the world’s largest ship fuel supplier. This includes advising the lenders and receivers in insolvency proceedings in 13 different jurisdictions. ‘We have got 500 sets of litigation and arbitration pending across the world, trying to collect in amounts that customers owe to the Bunker group,’ Marshall says. In mining, another industry in difficulty, the magic circle firm has advised the co-ordinating committee of creditors in the global restructuring of the $2.24bn debt of independent steel trader Stemcor, which has significant Indian assets.

Insolvency v restructuring

Stewart Perry, chair of R3’s general technical committee, observes there has nevertheless been a downward trend in formal insolvency

procedures in England and Wales. The number of company insolvencies, including compulsory liquidations, receiverships, and administrations, fell by 39% between 2009 and 2015 (from 24,011 to 14,657). ‘People are now doing restructuring rather than insolvency,’ he says.

One reason, he explains, is that in an insolvency process the IP takes control of the business, and so the outcome is difficult to predict. In restructuring, ‘there is the certainty that the large creditors want’. Furthermore, the secured creditors (banks) who get paid first in formal insolvencies are keen to avoid the ‘bad publicity’ that ensues from that.

The result has been diminished activity for IPs and their lawyers. ‘Unless you are on a job like Lehman [Brothers], actually, the insolvency part of it is not that busy at all. There are quite a few insolvency practitioners that have had to lay people off because there isn’t that much work,’ Perry says.

Inga West, expertise counsel in Ashurst’s restructuring and special situations group, says ‘one of the identifying factors’ of the last financial crisis was the ‘very low’ number of formal insolvencies. ‘That is largely [because] it was a low interest rate crisis, and there was quite a lot of liquidity in the market. There were a lot of funds with money, looking for high-risk returns.’ Many distressed companies were able to access funds to restructure their loans.

‘A number of large institutions, mainly banks, have sold portfolios of debt to hedge funds,’ Perry adds. ‘Quite a few new players have come into the market, looking to buy distressed debt in the UK and Europe.’

Marshall says her clients have changed ‘very significantly over the last ten years. Previously our major clients used to be the banks, which very much took the lead in restructurings, and the insolvency practitioners’. Typically, the big four accountants were appointed administrators or liquidators.   

Now, about 70% of the work Marshall does is for hedge funds, including Baupost Group, Taconic Capital, King Street Capital Management and Elliott Management. ‘These are funds that buy into the debt in a distressed situation and so they are effectively the creditors; they are the holders of the debt in a restructuring scenario. Across restructuring practices as a whole we are seeing much more work done for funds,’ she says.

English law is so flexible, and our judges are so good and commercial, and people are very keen to do restructurings in the UK 

– Jennifer Marshall, Allen & Overy

West says the emergence of a secondary market for debt means that ‘the creditor community has diversified massively’, hence the need for a process to pull them all together in a restructuring.

One such process is the England and Wales scheme of arrangement, whose popularity has been on the rise since the start of the decade, particularly among foreign corporations such as Italy’s Seat Pagine Gialle, Germany’s Primacom and Vietnam’s Vinashin.

This is a court-approved compromise between a company and its creditors under Part 26 of the Companies Act 2006. Creditors are divided into classes and each class votes on the proposed plan; the English court approves the class or classes of creditors, and sanctions the plan in two separate hearings.  

Schemes of arrangement are not new; they have been around for more than a 100 years. ‘What has changed, though, has been the case law and the thinking on schemes,’ Marshall says. In particular, since Briggs J’s judgment in Re Rodenstock in 2011, schemes have been used by companies or groups even if their main centre of interest (COMI) is not in the UK. This is provided there is ‘sufficient connection’ with England and Wales.

Large businesses with complex finance structures tend to use schemes, and so it is the larger law firms that have built an expertise in this area. Last year, Ashurst advised EnQuest, the UK’s largest independent oil and gas producer in the British North Sea, on a £2bn restructuring, including an English scheme of arrangement. A&O represented Metinvest BV, the largest mining and steel business in the Ukraine, in a scheme sanctioned by the English court in February.

‘English law is so flexible, and our judges are so good and commercial, and people are very keen to do restructurings in the UK,’ Marshall says.  

But English schemes are not the only pre-insolvency rescue options. ‘There are many tools in the toolbox that a company can use to restructure itself,’ Howard says. ‘Companies are starting to look at Chapter 11 [of the US Bankruptcy Code].’  

New York City-headquartered Sullivan & Cromwell has acted for Singaporean shipping company Primorsk, which last year filed for Chapter 11. ‘What you achieve with Chapter 11 is a global protection and insulation from claims by your international creditors, so obviously the attraction of that for international companies is enormous,’ Howard explains.

Chapter 11 also enables the management of the company to maintain custody and control of the business.

Whether or not this explains the rise in Chapter 11 outside the US, there has been a significant increase in New York law-governed high-yield debt issuance in Europe, because corporates have found it difficult to access credit from troubled European banks. This has, in turn, led to ‘a rapid’ growth of New York law firms in European restructuring, Howard says.

It is  not just the economic and financial environment but specific legislation that has globalised insolvency practice. As a specialised hub in this area, London has benefited greatly. ‘Cross-border insolvency has ballooned since [the early 2000s]’ West says, particularly following the introduction of the European Insolvency Regulation (EIR) in 2002, and the United Nations Commission on International Trade Law (UNCITRAL) Model Law on Cross-Border Insolvency, originally introduced in 1985 and amended in 2006.

‘We have had a number of EIR-related COMI-shifting matters [or bankruptcy tourism], so EU debtors perceive the English Insolvency Act 1986 and regime to be a more balanced environment in which to become formally insolvent,’ Gilchrist says.

Exit plans

All of this is under threat from the UK’s departure from the EU. As Howard puts it: ‘For the UK restructuring industry and the City of London, [exiting the EU] looks very much like an own goal because the ability to use schemes of arrangement and to be at the epicentre of legislative reform in Europe is significantly diminished.’ In November, the European Commission said it was considering a Chapter 11-style pre-insolvency process in its proposed directive on Insolvency, Restructuring and Second Chance.

Marshall says English schemes will not be affected by Britain’s losing the ‘benefit’ of the EIR,  because they are part of English company law. But she adds: ‘Schemes do rely on another piece of European legislation, the Judgments Regulation, and at the moment we don’t know what is going to happen to [that].’ The Recast Brussels Regulation (the Judgments Regulation) facilitates the automatic recognition and enforcement of judgments across Europe.

The City of London Law Society is ‘fighting very hard to preserve that’, says Marshall, chair of its Insolvency Subcommittee. Before sanctioning the scheme, English courts require evidence that it will be recognised and have effect in the relevant foreign jurisdiction, and parties often rely on the Judgments Regulation for that evidence.

Euan Clarke, Linklaters partner and, until earlier this month, president of the Insolvency Lawyers’ Association (ILA), says jurisdictions increasingly compete for business and the UK is no exception. ‘We have a pretty good offering, including our insolvency processes and schemes of arrangement. But if there is even a marginal diminution in the effectiveness, or perhaps even just the perceived effectiveness of some of those procedures, there will be an increasing reliance on others, so Chapter 11 is one obvious example.’

Other jurisdictions may also benefit. The Netherlands, for instance, is reforming its insolvency law and introducing the Dutch equivalent of the scheme-of-arrangement process.

Clarke adds: ‘Our scheme of arrangement has been an extraordinarily successful tool. That success hasn’t gone unnoticed by other countries, and so they are looking to put into place similar types of regime. Post-Brexit, and in the absence of these recognition issues being addressed, there is a good chance that the competitive advantage that we have spent so long developing and exploiting as a country and as a profession will be diluted.’   

Schemes are not the only concern of practitioners. As Gilchrist puts it: ‘The European Insolvency Regulation is an enormously important platform from which English insolvency practitioners ground their rights in Europe.’ The EIR provides for the automatic recognition across Europe of insolvency proceedings in EU member states, allowing IPs to trace and recover the assets of an insolvent company or individual in another EU country. ‘How much recognition will an English practitioner have in France, should the EIR no longer be law [in the UK]?’ he wonders.

Take Canada’s Nortel, which entered into insolvency proceedings in January 2009. The UK administration covered 19 companies in 18 European jurisdictions thanks to the EIR and the Judgements Regulation, according to an R3 case study.

R3 is ‘lobbying hard’ to keep the status quo post-Brexit. ‘It would be very beneficial for the UK economy if the government were able to preserve the benefits that we have from the [EIR and Recast Brussels Regulation], and to the extent that we can’t ensure that those benefits are preserved, it will mean that cross-border cases will become more expensive and will take longer,’ Perry says.  

An R3 survey of its membership published in December found 83% of respondents believe losing the EIR will have a negative impact on the speed with which cross-border insolvencies are resolved and 79% think there will be a negative impact on the cost of cross-border work.

Frances Coulson, Moon Beever Solicitors’ senior partner and R3 council member, is sanguine: ‘I think the effect on our EU work will be fairly minimal, even if we lose the EU regulation, because we worked effectively before it and will again.’ But she adds: ‘Obviously things will be a bit slower and more expensive, but lobbying is going on to try and secure as near the same to the regulation as we can. Unfortunately, insolvency rarely comes high on government agendas unless there is a high-profile case causing pressure on votes.’

There are alternative ways of maintaining what is offered to the sector by EU regulation. The UK could accede to the Lugano Convention 2007 (as a non-EU member), which has a similar regime to the Judgments Regulation as between EU member states and Switzerland, Iceland and Norway. ‘There could be a multilateral treaty, replicating the effects of the European Insolvency Regulation,’ Clarke says, but it would take 27 member states to agree to it. In December, UNCITRAL, of which the UK is a member, published a draft model law on the recognition and enforcement of insolvency-related judgments.

It is worth noting that a ‘recast EIR’ comes into force on 26 June 2017, broadening the scope of recognition and co-operation, and including pre-insolvency proceedings. But as West notes, the UK may only enjoy the fruits for a short period, ending when Britain leaves the EU.   

Adding to the mix of possible changes to the legal and regulatory environment for practitioners is an ongoing UK government review of the corporate insolvency framework. This kicked off with a consultation a year ago. The responses were published in September 2016 and the Insolvency Service has been holding informal consultations with stakeholders since. Proposed reforms include a three-month moratorium, with the possibility of an extension if needed, for businesses to protect themselves from creditors while they sort out their finances; and ‘a flexible restructuring plan,’ combining a court procedure based on the English scheme of arrangement and a Chapter 11-style ‘cram-down’ mechanism for dissenting creditors.

In the short-term, insolvency and restructuring lawyers can at least expect more work. According to R3, 72% of those surveyed believe the referendum result will cause corporate insolvency numbers to rise by the end of 2017, while 55% say business finances have already been affected.

After a downward trend, Insolvency Service statistics for the last quarter of 2016 showed an uptick in corporate insolvencies: a 54% increase on the previous quarter and a 59% rise on the same quarter the year before.

Howard says: ‘If we were to have a hard Brexit on the basis of WTO [rules] many restructuring professionals, myself included, think that would inevitably increase the volume of reorganisations and restructurings in the UK economy, and will be highly damaging.’

Pain in the neck

The regulatory and legal upheaval on the horizon comes just as the Insolvency Rules 2016 come into force (on 6 April). These repeal the Insolvency Rules 1986 and consolidate all amendments introduced since into a near 500-page tome. They are part of the government’s agenda to reduce red tape.

So what do lawyers make of it? ‘It’s a profound change for the industry. It will touch insolvency practitioners in ways they don’t yet understand,’ says Gilchrist, who is also chairman of R3’s smaller practices group committee. ‘[It’s] a wholesale rewriting of the rules. The chapters are different, the structural organisation is different and there are some content changes.’

That includes the abolition of statutory forms. ‘In theory, creditors could use whatever form they want, provided the content complies with the rules.’ But, Gilchrist argues, this would increase costs for IPs and the courts.

Perry adds: ‘The court staff are going to have to try and work out what the document is when they see it, rather than just instinctively knowing because it is in the right format.’ But some organisations such as Companies House will continue to use prescribed forms for documents to be submitted to the Registrar of Companies.

The Small Business, Enterprise and Employment Act 2015 and the Deregulation Act 2015 introduced amendments to the Insolvency Act 1986 that also came into force on 6 April. These included: enabling electronic communications with creditors and the use of websites; a new deemed consent procedure; and the removal of the automatic requirement to hold physical creditors meetings, unless creditors request them.

‘The idea of virtual meetings is good but the practical implementation of it is going to be quite testing,’ Perry says. ‘One of the goals of the government was to ensure more creditor involvement and engagement in insolvency processes. They thought that having virtual meetings, so that people wouldn’t have to travel, would make them more likely to attend.’ But Perry says virtual meetings can be confusing, and access is problematic when broadband download speeds are not uniform across the country.

‘We are overdue a modernisation,’ Clarke says. ‘The use of websites and electronic communications is obviously a welcome development. But on one view, if you are going to undertake what at least in appearance terms is a significant overhaul of the insolvency rules, there was an opportunity to get into the substance of them rather more.’

‘It is fair to say that it is a modernisation both in process and language, rather than a substantive change in any way,’ Clarke adds. For instance, there were early attempts to codify case law on administration expenses, but that did not materialise.  

That is a problem for insolvency practitioners, and it relates to the question of which claims have priority over ordinary unsecured claims in an administration. ‘Despite this going all the way up to the Supreme Court in the Nortel case in relation to pensions, there is still a huge amount of uncertainty as to what counts as an administration expense, and therefore what should have priority,’ Marshall says, adding that it was ‘disappointing’ that the Insolvency Service in the end decided to leave it for the courts to clarify the issue. There was also an opportunity to improve insolvency set-off rules, particularly in administration, says Marshall, an ILA council member.   

Even if the substance has not altered much, all the rules have changed numbering, so it will take a while for lawyers to re-navigate them. Marshall concludes: ‘It is going to be a real pain in the neck because we have to change all our precedents, and we are going to have to change all of our opinions to refer to the rules, but in terms of actual practical impact I don’t think [they] are going to have any whatsoever.’

Marialuisa Taddia is a freelance journalist