The Looming Corporate Debt Crisis: A Call to Action for Directors & Policymakers
A financial crisis could be on its way – unless directors and policymakers take steps to prevent it
A mountain of corporate debt is threatening to collapse over the European Union – destabilizing Europe’s financial system and burying any potential economic recovery in its rubble. So far, EU policymakers have done little to prevent that calamity. Suspension of wrongful trading in countries like the UK and Germany, and a €500 billion bailout from the EU commission may stave off insolvencies temporarily, but they will not be sufficient to restructure Europe’s share of the world’s €13.5 trillion in corporate debt.  While the initial response is understandable given the urgency of the situation, government aid alone won’t be enough to save many otherwise viable enterprises, or their investors. “Some of the so-called ‘zombie’ companies – the ones surviving on cheap debt – will likely disappear, and perhaps rightly so,” says Patrick Corr, head of European Restructuring and Insolvency at Sidley. “But much of the remaining corporate debt will have to be restructured, in ways that don’t completely destroy a company’s value, that maximize returns to creditors and that don’t stick taxpayers with a massive bailout bill.” Unfortunately, the EU doesn’t have an efficient and harmonized way to approach such restructurings. Not yet, at least.
Patrick Corr leads Sidley’s European Restructuring and Insolvency practice. He has extensive experience in both contentious and non-contentious corporate recovery and turnaround matters, and regularly lectures on issues of European and international insolvency/restructuring law and practice to banks, note holders, in-house counsel and accountants. Patrick is based in London.
Wherever they turn, today’s business leaders face unprecedented challenges on a global scale. As the challenges mount and shift, and as the pace of change accelerates, so do the questions that keep boards and executives awake at night. They need answers – fast. Insights for Leaders delivers the perspective leaders need to understand what today’s news will mean for tomorrow’s world, and to make smart, agile decisions that will ensure their organizations not only survive, but thrive in an uncertain world.
This article has been prepared for informational purposes only and does not constitute legal advice. This information is not intended to create, and the receipt of it does not constitute, a lawyer-client relationship. Readers should not act upon this without seeking advice from professional advisers. The content therein does not reflect the views of the firm.
Directors must proceed with caution
In lieu of sustained, effective and standardized government intervention, directors overseeing debt-laden balance sheets must proceed with extreme caution. Any temporary relief from liability, like the suspension of wrongful trading laws in the UK and elsewhere, is just that – temporary – and doesn’t wholly absolve directors of their fiduciary duty to creditors.

After all, no one knows just how long lockdowns will last. Even as parts of Europe tentatively reopen, a second wave of infections could very well be on the horizon. Without the ability to accurately project what the situation will look like in six or nine months, laying plans becomes a tall order.

The best directors can do is consider all of the options.

“You have to look at whatever you can do to build and conserve liquidity and to preserve all options to protect the business and protect the interests of all stakeholders, particularly creditors,” Corr says. “Whether that’s taking government aid, extending credit-line terms, agreeing on a standstill with suppliers and customers, terminating certain contracts, checking insurance terms or all of the above.”

He may not know what the future holds, but Corr says directors must keep their eyes on preserving value and on what their companies might look like when they finally emerge – from the crisis, a restructuring or both. That means eschewing new debts the firm may not be able to service down the line. It also means negotiating deals with existing creditors, whether it’s debt-to-debt deals, issuing new secured instruments in exchange for non-secured bonds, or other agreements.

“You don’t want to come out of the crisis with new debt coming due that you can’t service,” says Corr.

“You don’t want to come out of the crisis with new debt coming due that you can’t service,” says Corr. “Everything, even government funding, is likely to come at a price. Directors can’t assume that someone will suddenly switch a light on and all will return to exactly how it was before COVID-19.”

Though projecting forward may be difficult, directors should take professional advice to help them work through all of the options. They must be proactive.
A more efficient restructuring regime?
No matter how prudent or shrewd directors may be in preventing and managing insolvencies, a massive wave of restructuring is likely headed our way.  Handling these insolvencies will be a herculean task. Unfortunately, Europe’s existing restructuring regime may not be up to it. Too often, today’s courts resort to liquidation, stripping creditors of returns and disincentivizing new investors. Without standardization across member states, the flow of sorely needed capital will be stifled. And the slow, arduous process inhibits the return of productive assets to the economy.

Handling these insolvencies will be a herculean task. Unfortunately, Europe’s existing restructuring regime may not be up to it.

Without an efficient, harmonious regime in the EU, today’s COVID-19 crisis threatens to spool out into a financial crisis of unparalleled magnitude. While last year’s so-called “second chance directive” – which directs all member states to adopt something akin to a Chapter 11-style debtor-in-possession regime – could be a step in the right direction, the new rules may not be adopted until July 2021. That may be too late.  While European governments decide how best to implement the directive, Corr suggests adopting a more immediate solution. And he sees one right under the EU’s nose, in Ireland. The Irish examinership process has proved unusually adept at restructuring insolvent businesses, protecting jobs and preserving value for creditors, he says.
“It is an excellent tool,” Corr says. “The best part is that it already exists. It’s proven to work, and it’s there for the taking.”

As in an American Chapter 11 proceeding, in Ireland an examiner formulates the restructuring proposal; meanwhile the firm’s directors remain in control of operations and a moratorium is imposed on creditor actions. Yet unlike a Chapter 11, an examinership runs only 70-100 days. And only one class of creditors must vote in the plan’s favor – by simple majority.

Some may argue that 100 days is too short a timeline to get these restructurings done. But that is likely a misnomer. The Irish process forces the parties to do the bulk of the restructuring planning before filing for examinership. And the compressed time frame keeps creditors and directors focused, holds costs down and bolsters investor confidence.

An EU-wide examinership scheme could allow member states to extend the timeline. In 2015 for example, Cyprus adopted examinership but extended the timeline to four months with possible further extensions by the examiner of 60 days and the court by up to six months.
The bottom line?
“Compared to a Chapter 11 it’s cheaper, faster and less vulnerable to hold-out creditors – which will become absolutely crucial in the coming months,” says Corr.

It may not be enough to fix all the cracks emerging in our financial system. But one thing’s for certain: moving to handle the coming onslaught of corporate debt and insolvency – via considered but swift action by directors and policymakers – may be the only way only to avoid disaster, and point our economies in the direction of recovery.