Bankruptcy in the Americas
September 2015 | ROUNDTABLE | BANKRUPTCY & RESTRUCTURING
Financier Worldwide Magazine
September 2015 Issue
The corporate bankruptcy landscape in the Americas over the past 12 months has been shaped by a maelstrom of restructuring activity, insolvencies, technical recession, currency devaluations, tentative markets, fluctuating filing levels, rising litigation costs, and intermittent institutional and economic crises. Numerous regulatory and legislative developments have impacted on the bankruptcy space, region by region. For now, the story of bankruptcy in the Americas is very much an unsettling mixture of expectation and uncertainty.
Shea: Could you provide an overview of the corporate bankruptcy landscape in your region over the last 12 months? Have you seen any particular trends developing?
Feldsher: The corporate bankruptcy landscape in the US over the last 12 months has seen an uptick in restructuring activity. After relatively few filings in 2014, we are now seeing a more steady number of Chapter 11 filings and out-of-court restructurings concentrated in industries heavily impacted by market-driven events, such as the deep drop in cargo shipping prices and lower fuel and electricity prices. In addition, companies are being forced into bankruptcy because of product obsolescence, overcapacity and debt-laden balance sheets. Noteworthy in terms of trends has been the large number of pre-negotiated or pre-packaged Chapter 11 cases being filed. In these cases, creditors have often emerged as the new owners of the reorganised company.
Durrer: Over the last 12 months, we have seen increased polarisation among major constituencies, with positions becoming entrenched relatively early in a complex reorganisation case. The cost of this increasing contention can be measured both in litigation costs and in opportunity costs, as third parties may be reluctant to engage in what appears to be a litigious environment as an acquirer, financing source or sponsor.
Golubow: There has been a decrease in corporate bankruptcies filed in the US over the past 12 months. Nationwide, corporate bankruptcies continued a downward trend in the first six months of 2015 with approximately 19 percent fewer corporate bankruptcy filings than the first six months of 2014. Not only are corporate bankruptcy filings down, but small businesses continue to dominate the bankruptcy count, with nearly 76 percent of corporate bankruptcies filed in Q1 and Q2 2015 by companies with $2.5m or less in gross sales. Bucking the downward trend are publicly traded corporate bankruptcies. The number of Chapter 11 filings by public companies hit its highest midyear level since 2011.
Hernández: Argentina is again facing a deep institutional and economic crisis, which, in recent months, has also been affected by the deepening of Brazil’s own crisis and acceleration of the devaluation of the Brazilian currency. However, the future of the Argentine economy is still subject to a great amount of uncertainty. After 12 years of a government marked by the same ideology, strategy and policies, in October Argentina has presidential elections and, to the extent that the current president cannot be re-elected, there will be a necessary change. The future direction of the Argentine economy depends on the new president. Therefore, businessmen, investors and other economic actors have been staying any actions. In this regard, there has been a slight increase in insolvency cases but, most importantly, many debtors are prepared to file for reorganisation proceedings depending on the policies and measures adopted by the new president, and the development of the economic conditions after the election.
MacParland: There has been a significant increase in activity over the past year in all tiers of the Canadian insolvency and restructuring field. The number of CCAA proceedings commenced over the period has almost doubled. The price of oil, the decline in value of the Canadian dollar, slow job growth and weakening in the resource sector have all contributed to a tentative market.
“Bucking the downward trend are publicly traded corporate bankruptcies. The number of Chapter 11 filings by public companies hit its highest midyear level since 2011.”
Shea: In your opinion, which industries and sectors are experiencing fundamental structural weaknesses at present?
Hernández: Argentina has structural economic problems due to several factors, including, among others, a lack of access to international financial markets, high inflation, artificially fixed foreign exchange rates, foreign exchange controls and restrictions, reduction of exports of goods and commodities, reduction of international foreign federal reserves, record taxation, high interest rates, restrictions on the import of goods and supplies, and the limitation of energy resources, logistics and transportation. All these factors are combining to cause a general recession affecting all industries and production in general, particularly among those companies which require foreign supplies, due to the restrictions on imports and reductions of internal consumption and exports. Among the more affected industries are private utility service companies, car production and spare parts, agribusiness production, importers and regional economies. Today, these conditions are aggravated by the crisis in Brazil and the deepening of the Brazilian currency devaluation.
Durrer: The oil & gas industry has been experiencing significant weakness in recent months due to a significant dip in commodity prices, with a number of high-profile bankruptcy filings during 2015 so far, including Milagro Oil & Gas, Endeavour International Corp and Quicksilver Resources Inc. In addition, international shipping companies are facing an industry-wide downturn which has been noted by some as the worst since the 1980s, leading to a number of bankruptcy filings in the US in 2014 and 2015 – for example, Excel Maritime Carriers, Nautilus Holdings Ltd and Winland Ocean Shipping Corp – and divestiture of non-core assets in the shipping space by other conglomerate entities, as Hyundai Group did in 2014. Finally, specialty apparel manufacturers and retailers continue to face challenges, with mall retailers in particular – The Wet Seal, Inc, Deb Stores Holding LLC, dELiA*s, Inc and Cache Inc – suffering from increased competition in brick-and-mortar locations and consumer shifts to online retailers.
MacParland: Retail, mining and oil & gas have all experienced significant instability. These industries account for over half of the large filings in Canada over the past 12 months.
Golubow: Declining oil prices have already led to a number of bankruptcy filings for energy and natural resource companies. Brick-and-mortar retailers continue to struggle and are vulnerable and losing the battle against online retailers as consumers realise that the items they seek are less expensive and more easily accessible online. Some cash-strapped municipalities such as Atlantic City, New Jersey, have retained emergency managers to pursue out-of-court restructuring efforts and failing that may initiate a Chapter 9 municipal bankruptcy.
Feldsher: There is fundamental weakness in the shipping, coal, manufacturing, defence and retail sectors. Healthcare is another industry that should remain on watch lists as the full impact of regulatory changes is still uncertain. And, of course, everyone is watching energy closely, where continued volatility in oil prices has begun to hamper the ability of companies to proactively raise new capital to address liquidity issues. While we have seen several successful out-of-court restructurings in the energy sector this year, many others are still in the pipeline to be restructured and may become vulnerable if there is continued volatility in oil prices. Businesses in energy producing communities are also at risk as there is the potential for a ripple effect.
Shea: To what extent are troubled companies able to refinance and renegotiate existing debt structures in the current market? Are banks relatively supportive or have they reduced their appetite to extend a distressed situation?
Golubow: Generally speaking, distressed companies have been able to take advantage of an historically low interest rate environment to refinance, renegotiate their existing debt structures and amend covenants and extend maturities. In instances where traditional banks are fatigued with smaller distressed credit, investors in distressed credit facilities or specialty finance companies are willing to service these smaller credit facilities by either stepping in to acquire debt at an appropriate discount or provide refinancing capital.
Feldsher: For companies with proven track records, out-of court restructurings have been possible. These restructurings have included amendments to covenants and extensions of maturities, albeit with less frequency. Where cash is available, some companies with debt securities trading publicly at a discount to par have even tried to capture some of that discount by engaging in targeted buyback programs. Overall, this year so far has been characterised by bond restructurings rather than loan restructurings, and the incurrence principally of second lien debt to refinance existing bank debt and add liquidity. This is particularly true in the energy sector where ‘covenant-lite’ paper often does not restrict taking on such additional debt. The new notes, however, can carry higher costs of capital.
Durrer: Troubled companies are still generally able to take advantage of the liquidity available in the current market to refinance or renegotiate their debt structures. However, market participants continue to anticipate a possible rate increase from the Federal Reserve later this year or early next year.
MacParland: In this low interest rate environment, there is still an appetite for financing. This hasn’t changed significantly over the last 12 months. We have seen many extensions and refinancings. With confidence in management and the business, Canadian banks are generally prone to work with distressed entities. There is a notable exception: traditional lenders are not interested in providing interim financing, particularly in the oil & gas or resources sectors. We have also seen a rise in streaming and offtake type arrangements in the mining sector as an alternative to traditional financing.
Hernández: Creditors’ expectations for recovery in liquidation proceedings in Argentina are extremely low. Therefore, except in particular situations where creditors perceive that the debtor may make a better offer or have intentions of hostile takeover, creditors are relatively more supportive and cooperative in helping to achieve a successful reorganisation. Many creditors prefer to restructure through private restructuring agreements or out-of-court, pre-pack restructuring agreements, trying to avoid the expenditures of costs and time of full plenary insolvency cases, such as reorganisation proceedings or the losses of liquidation procedures. In addition, due to the uncertainty and expectations for the development of the economy in the near future, many creditors are more willing to agree on temporary refinancing or extensions until the economic conditions are clearer.
“Troubled companies are still generally able to take advantage of the liquidity available in the current market to refinance or renegotiate their debt structures.”
Shea: Have any recent legislative or regulatory developments, including high-profile cases, had a particularly big impact? What effect do you feel these will have on bankruptcy and restructuring activity in your region going forward?
Durrer: In June, a federal judge in the Southern District of New York issued a final ruling on the merits in favour of bondholders who had alleged that certain proposed out-of-court restructurings that involved changes to non-payment terms of governing bond indentures violated the TIA, affirming the bondholders’ theory that these changes affected the practical ability of a bondholder to recover payment on its bonds. Shortly thereafter, the bankruptcy court in Illinois overseeing the ongoing Caesars Entertainment Operating Co (CEOC) bankruptcy refused to stay similar bondholder litigation against CEOC’s parent company, Caesars Entertainment Corporation (CEC), during the pendency of CEOC’s bankruptcy case. As a result, bondholders who are dissatisfied with the proposed CEOC restructuring remain free to pursue litigation theories against CEC to reinstate a parent guarantee of certain CEOC debt and, in light of the favourable Marblegate opinion, the potential exposure to both CEOC and CEC may be substantial. Going forward, these two opinions make out-of-court restructurings more difficult to achieve, absent near unanimous support from bondholders, and underscore the importance of engaging with creditor constituencies early in order to mitigate the potential impact of disruptive litigation during a bankruptcy process.
MacParland: There have been no significant legislative changes in Canada over the past 12 months. We have had a number of significant decisions in the Nortel proceeding, as well as a decision of the Supreme Court of Canada on the general organising principle of good faith in Bhasin v. Hrynew. In Nortel, the issue of entitlement to post filing interest is under appeal. Likewise, the decisions of the US and Canada courts on the allocations of the proceeds of the assets sale was groundbreaking and subject to further motions and possible appeals.
Hernández: The most important recent developments in Argentina took place during the beginning of the last decade in response to the 2001 crisis, including the method for computing the holders of notes and debt securities issued in series for the purposes of calculating the principal majority for endorsing a reorganisation plan or out-of-court restructuring agreement. A more recent legislative development consists of the granting of additional rights to workers’ cooperatives in liquidations, including the right to request the stay of enforcement of mortgages and pledges for up to two years upon approval by the court of the debtor’s continuance of business activities after bankruptcy adjudication. They also include the right to set-off cooperative member workers’ claims against the purchase or bidding price for the purchase of the debtor’s equity upon failure of the debtor to obtain the approval of the reorganisation plan under certain circumstances.
Feldsher: Late last year, the American Bankruptcy Institute (ABI) released its long-awaited and much-anticipated report on proposed amendments and modifications to the Bankruptcy Code. The report contained recommendations to Congress for improving the bankruptcy process including certain changes designed to shift some of the leverage from secured lenders back to debtors and junior stakeholders. While the recommendations in the report are not law, the issues raised are being closely watched by bankruptcy restructuring professionals and are being cited in court filings. In addition, the Supreme Court recently addressed uncertainty in the industry over the constitutional authority of bankruptcy courts created by the Court’s controversial Stern v. Marshall decision. In Wellness International Network, Ltd. v. Sharif, the Supreme Court strengthened the scope of bankruptcy court authority by ruling that bankruptcy courts have the right to enter final judgments, even on Stern claims, if the parties consent to the bankruptcy court’s jurisdiction. While the decision leaves open the more interesting question on the contours of what is a Stern claim, the decision should spare the federal district courts from a large influx of bankruptcy litigations.
Golubow: The ABI’s study on reforming Chapter 11 was established approximately three years ago in recognition of the ‘general consensus among restructuring professionals’ that it was necessary to evaluate US business reorganisation laws as a result of numerous changes that have occurred since the Bankruptcy Code was enacted in 1978. In December 2014, the ABI Commission, comprised of several prominent insolvency and restructuring professionals in the United States, released a 400-page report with proposed reforms to Chapter 11 and related statutory provisions. The recommendations in the report are intended to modernise Chapter 11 business reorganisation by providing a more balanced approach to reorganisation of business debtors with the attendant preservation and expansion of jobs and realising maximised asset values for all creditors and stakeholders. Much of the report is focused on the role and impact of secured creditors in large Chapter 11 cases. While some of the ABI Commission’s recommendations may be beneficial to secured creditors, many would constrain the rights of secured creditors as compared to existing law. Unlike Congress, the ABI Commission has no legislative or regulatory authority. Thus, the report itself does not effect any specific legislative or regulatory changes to the Bankruptcy Code. Only time will tell what, if any, action will be taken by Congress in response to the report.
Shea: How would you characterise the current market for distressed M&A activity? What strategies are distressed investors using to get deals done?
Hernández: There has not been much appetite for distressed assets in recent years, even though the Argentine economy is facing structural problems that create the conditions for distressed M&A activity. This is primarily due to the uncertainty surrounding the outcome of the presidential elections. Depending on the results of the elections and the policies and measures adopted to address the current economic structural problems, the number of available distressed assets may increase and their price may drop far below their current prices. Accordingly, investors are waiting for more certainty on the economy’s future in order to make a more accurate assessment of their potential investments, risks, losses and gains and distressed M&A activity may increase in the near future.
Feldsher: Distressed M&A has remained highly competitive. Supply continues to lag demand and prolonged low interest rates allow banks and other investors to continue weathering the economic storm. With demand outstripping supply, valuations often are still too rich to generate the returns typically sought by distressed investors. Indeed, private equity buyouts have declined, reaching their lowest levels in years during the first half of 2015. To maximise returns, distressed investors have resorted to creative structuring and capital structure arbitrage. In certain instances, valuable non-core assets are also being separated from other operating assets and used as collateral for additional debt or equity raises.
Golubow: Distressed M&A activity has been sluggish over the past year or so, due to a variety of factors including continued historically low interest rates, an abundance of liquidity sources, a lack of restructuring activity, a lack of near-term maturities, and the willingness of lenders to “amend and extend” credit facilities. The natural consequence of these factors has resulted in a highly competitive distressed M&A market with a significant amount of money chasing a very small number of opportunities leading to a substantial increase in the prices paid for distressed assets. These market conditions have distressed investors consistently reporting a dearth of acquisition opportunities at valuation levels with projected financial returns that are not commensurate with the associated high risk. The predominant distressed M&A strategy continues to be ‘loan to own’ by purchasing senior secured debt, often at a discount. The complexity of the company’s capital structure will typically dictate whether the loan to own strategy will be accomplished in bankruptcy, pursuant to a Section 363 asset sale, which is typically followed by a structured dismissal of the bankruptcy case or without commencing a bankruptcy case, through an Article 9 foreclosure, general assignment for the benefit of creditors, or receivership proceeding.
MacParland: I would describe the current market as unpredictable. There are many deals being done but we have seen a number of situations in which a going concern sale could not be successfully completed, particularly in the resource sector. The tools haven’t changed dramatically over the past 12 months.
Durrer: We have seen a pickup in the market for distressed M&A activity in approximately the last nine months. Interested investors continue to seek out proprietary deals in the market. Proprietary deals are opportunities in which the investor has an existing relationship or position in the target’s capital stack. This makes the investor a natural partner for the target and enables both parties to engage in a potential transaction with less exposure to the market and therefore less competition. This creates at least three advantages. First, because the players have an existing relationship, they can transact earlier in the life cycle of distress, allowing for more flexibility. Second, although such transactions must ultimately be exposed to a market test or competition, the investor will likely enjoy some advantage relative to others in the market. Lastly, it is sometimes possible to avoid a competitive process altogether.
“Investors are waiting for more certainty on the economy’s future in order to make a more accurate assessment of their potential investments, risks, losses and gains.”
Shea: What themes are you currently observing in terms of disputes and litigation in connection with the bankruptcy process? To what extent are bankruptcy-related disputes growing in complexity and, as a consequence, lengthening the process?
Golubow: In the wake of Stern v. Marshall and its progeny, there have been substantial challenges to a bankruptcy court’s jurisdiction to enter final orders in matters routinely handled by bankruptcy courts including preferential and fraudulent transfer litigation. These challenges to bankruptcy court jurisdiction present threshold issues that allow litigation targets the ability to delay litigation, increase cost for the estate and leverage settlement. In the area of ‘loan to own’ bankruptcy acquisitions through Section 363 sales, there continues to be substantial litigation over the right to credit bid, the appropriate credit bid amount, and related issues as unsecured creditor committees attempt to create or preserve a return for their constituents. Efforts to create a return for unsecured creditors where assets are of nominal value relative to outstanding claims or assets are fully encumbered has resulted in increased litigation against officers and directors based on alleged wrongdoing that precipitated the company’s demise and bankruptcy filing. Creditors have increased incentives to pursue these types of claims which may be the only unencumbered asset with any potential substantial value in a liquidating case. These types of claims tend to involve numerous parties, are factually intensive and legally complex, the natural consequence being a substantial lengthening of the bankruptcy proceeding.
MacParland: Most of the large filings over the past 12 months have involved the liquidation of a Canadian subsidiary led by the US parent. Examples would include Target, US Steel and Bloom Lake.
Feldsher: Two current themes have dominated bankruptcy litigation of late. The first is centred on creditor rights and recovery matters, such as cram-up interest rates under Till and make-whole premiums. Although confirmation of Momentive’s plan added additional clarity on cram-ups and make-whole premiums, open issues remain and litigation is sure to continue. The second theme has been the apportionment of assets and value among creditor classes in multinational corporations, where different countries have concurrent legal jurisdiction. Cases such as Nortel and Lehman have dominated the headlines in this area, but there have been a number of noteworthy Chapter 15 litigations as well that have reminded us about the real complexities that can arise in cross-border matters. The issues raised and the corporate structures involved in recent filings have undoubtedly been complex and the parties are significantly more litigious these days, however the routine appointment of mediators and examiners, as well as the tight timetables demanded by bankruptcy judges, have helped mitigate the length of the litigation process.
Durrer: Bankruptcy litigation, just like non-bankruptcy litigation, can be an extremely costly and time-consuming process for a company. However, bankruptcy litigation is unique in two respects. First, a company which is going through a formal bankruptcy process demands tremendous focus and attention from its management team to undertake a financial or operational restructuring at a time when that same team is typically already operating in a stressed environment merely to continue operations. Second, bankruptcy litigation enhances speculation regarding whether the company will survive, and this speculation may further impede the overall progress of the restructuring. Therefore, even though bankruptcy litigation proceeds on an accelerated timetable relative to non-bankruptcy litigation, it is often more damaging and distracting for company management due to the contextual pressures imposed by the ongoing restructuring itself.
Hernández: In liquidation cases, we are seeing a trend to preserve the debtor as a going concern, mainly due to the social impact of closing a business. For this purpose, in some cases the bankruptcy court authorised a workers’ cooperative to continue the debtor’s activities with the financial aid of national or provincial governments, and in other cases the national or provincial government directly assumed the financing of the continuity of the bankrupt debtor’s activities. These continuations delay the liquidation procedure and the recovery by creditors. Bankruptcy related disputes grew in complexity during the last decade where, due to the 2001 crisis, for the first time in Argentina many companies’ restructurings involved large amounts of internationally issued, foreign law governed and worldwide traded debt securities. All new issues arising in connection with those restructurings were successfully addressed in recent years, including the method for computing the holders of those securities for the purposes of calculating the majorities for endorsing a reorganisation plan or an out-of-court restructuring agreement, the way to obtain those security-holders’ consent, the challenge of filing Chapter 7 involuntary petitions in New York, and filing former Section 304 petitions in New York.
Shea: What are some of the common types of disputes dominating today’s bankruptcy proceedings? How can companies address these issues to achieve a successful restructuring?
Durrer: Bankruptcy litigation is certainly on the rise as capital structures, and therefore reorganisations, become more complex, which has led to more contentious and adversarial cases. Issues of valuation are sometimes contested among constituents, particularly by constituents who may be at risks of great financial loss but whose advisers are required to be paid by the debtor. In addition, recent Trust Indenture Act opinions from the Southern District of New York may lead to increased litigation and incentivising minority bondholders to challenge out-of-court restructurings, making it more difficult for debtors to engage in out-of-court restructurings.
Feldsher: Common disputes have centred on jurisdiction matters and bondholder rights and recoveries. A tremendous amount of time has been expended and ink has been spilled recently analysing the terms of indentures and intercreditor agreements to determine the rights of secured lenders and bondholders vis-à-vis each other and the estate. The impact of the Trust Indenture Act on a company’s ability to consummate an out-of-court restructuring has also been disputed. To try to address these issues, companies need to interact with stakeholders early, before there is a crisis and when the company still maintains leverage in order to generate support for a restructuring plan. The plan itself must be clearly defined and must be deep enough to provide sufficient liquidity to overcome the original causes of the bankruptcy. Management and communications skills in these negotiations are essential. Transparency does not hurt either.
Golubow: Chapter 11 bankruptcy proceedings are frequently consumed by disputes over asset valuation and competing claims to the limited assets available for creditor recovery or distribution. Such disputes typically involve competing expert testimony, which usually results in increased professional fees and significant delay in resolution of the bankruptcy proceeding. To avoid this, many troubled companies attempt to negotiate with creditors prior to entering Chapter 11 in order to ensure a streamlined and fast-tracked restructuring process. Failing that, a post-petition negotiated or mediated settlement as to value and often a comprehensive case resolution is the norm.
Hernández: Some of the most common types of disputes dominating today’s bankruptcy proceedings are those relating to the calculation of the required majorities for endorsing a reorganisation plan or out-of-court restructuring agreement, fraud in the determination of the assets and liabilities of the debtor, and abuse of the terms and conditions of the reorganisation plan vis-à-vis the unsecured creditors or certain secured creditors. Except for issues involving fraud, companies can only address the negotiation of the terms and conditions of the reorganisation plan or out-of-court restructuring agreement with the main unsecured creditors, representing the highest possible majority, and then seek additional consents to reach the requisite majorities for endorsing the reorganisation
MacParland: We have seen an increase in the use of construction liens and litigation in the insolvency regime. This can be somewhat of an awkward fit as evidenced by the Comstock proceedings. However, if successfully asserted, a claimant can recover in priority to other secured creditors. Former employees and current pensioners are emboldened and taking a more active role in insolvency proceedings.
“The routine appointment of mediators and examiners, as well as the tight timetables demanded by bankruptcy judges, have helped mitigate the length of the litigation process.”
Shea: What tactics are creditors regularly employing against insolvent debtors as they look to recover as much value as possible?
MacParland: Creditors are trying to import the US concepts of equitable subordination into Canadian insolvencies. Traditionally, this issue has not had a meaningful impact in Canada, however there are a number of ongoing cases in which creditors are forcefully asserting rights.
Feldsher: Creditors are organising earlier in the restructuring process to grab a seat at the table. Oftentimes, ad hoc groups of creditors are formed well before a bankruptcy is filed to negotiate with the debtor-company over the terms of a restructuring plan. During these negotiations, creditors often try to better their position in the capital structure by rolling-up prepetition debt or exchanging it for secured debt in return for additional capital. Once a bankruptcy case is commenced, creditors employ a variety of weapons to try to enhance their leverage and thereby increase their recoveries, including serving on creditor committees, investigating prepetition actions by management or third parties, and pursuing avoidance actions to recover funds or assets transferred to third parties. Creditors can also challenge confirmation of a debtor-sponsored Chapter 11 plan and in certain circumstances obtain the right to propose and solicit their own plans concurrently with or in lieu of the debtor.
Durrer: As creditors utilise broader and more aggressive strategies in attempts to recover value, it is likely that the focus will be on pre-petition transactions, particularly transactions involving alleged insiders or affiliates. Preference and avoidance action will likely remain a focus in bankruptcy litigation. Furthermore, an increase in Trust Indenture Act litigation is likely to occur following the recent decisions in the Southern District of New York.
Hernández: The main tactic regularly employed in Argentina consists of the acquisition of unsecured debt – in the case of companies holding debt securities trading in stock exchanges or other securities markets – or the syndication with other unsecured creditors for purposes of blocking the approval of any reorganisation plan or out-of-court restructuring agreement for the purposes of gaining bargaining power in the negotiation of the terms and conditions of the restructuring. Another tactic consists of litigating challenges to the reorganisation plan or the out-of-court restructuring agreement or other bankruptcy related issues in order to also obtain a better bargaining position to negotiate the best possible restructuring proposal.
Golubow: Secured creditors continue to explore selling their claims to distressed debt purchasers or private equity groups wishing to employ a ‘loan to own’ strategy. Unsecured creditors often have a limited ability to recover from the sale of assets, and are likely to seek recovery through the pursuit of avoidance action claims. A common method unsecured creditors use to assert claims against insolvent debtors is to challenge the actions of a debtor’s board of directors and its officers in an attempt to recover from any directors’ and officers’ liability insurance policy that may exist. Indeed, the proceeds from a D&O insurance policy may be the only avenue of recovery available to general unsecured creditors. Alternatively, if there are no obvious sources of recovery including a D&O insurance policy available to unsecured creditors in a bankruptcy estate, creditors will often seek to pursue the next ‘deep pocket’ such as a company’s financial adviser, from which creditors may otherwise seek a recovery.
Shea: To what extent are dissatisfied creditors more likely to target D&Os in post-bankruptcy litigation? What are the typical claims being brought against D&Os?
Feldsher: Directors and officers of financially distressed companies do face a heightened risk of personal liability suits as their actions leading up to a bankruptcy filing are frequently scrutinised by creditors or trustees. That being said, there has not been a marked increase in the number of litigations being brought against directors and officers in US Chapter 11 cases. Typically, claims are brought to recover value from a significant D&O insurance policy as a source of funding for Chapter 11 plan recoveries. Claims against directors and officers vary from case to case but may include breaches of fiduciary duties or fraud.
Hernández: In recent months we have seen an increase in the filing of post-bankruptcy claims against D&Os. In addition to general corporate liability actions for breach of fiduciary duties and criminal actions, the Argentine Bankruptcy Law provides for a specific cause of action, which can only be filed by the receiver, for D&O liability in insolvency cases when the D&Os have wilfully provoked, facilitated, permitted or aggravated the insolvency. This specific course of action extends to all such acts carried out by the D&Os up to one year prior to the payments cessation date. This date may not extend beyond the two years immediately prior to the date a petition for reorganisation is filed or the adjudication of bankruptcy. Scholars and recent case law agree that the liability of D&Os requires wilful misconduct. In a recent precedent, the Court of Appeals imposed a temporary restraining order on the managers of the insolvent debtor to secure potential liability claims. In addition, labour courts are generally extending social security and labour liability claims against D&Os.
Durrer: D&Os face increasing scrutiny with respect to their independence and exercise of business judgment in decision-making with respect to major transactions. The timely formation of independent or special committees is a powerful technique to address such claims and allegations responsibly and efficiently. The use of this strategy also enables the company to evaluate proposed transactions involving arguably interested or affiliated parties while preserving, in most cases, business judgment reviews of director decision-making.
Golubow: While the aggregate number of claims and suits against D&Os has declined from peak figures seen after the financial crisis, there continues to be D&O suits initiated by the Federal Deposit Insurance Corp. against directors and officers of failed financial institutions. In the private sector, D&Os still remain the target of post-bankruptcy litigation, particularly on the grounds that the management – or mismanagement – of the D&Os directly resulted in the bankruptcy filing or ultimate failure of the company. In such instances, creditors’ committees or trustees assert claims, on behalf of the larger body of creditors of a debtor’s bankruptcy estate, against D&Os for breach of their fiduciary duties, to the company and its shareholders. Also, although a breach of fiduciary duty claim might exist, but not provide any meaningful recovery to creditors, the conduct of professionals in aiding and abetting or assisting that breach may provide an avenue for recovery.
MacParland: Bankruptcy-related claims against D&Os are not very prevalent in Canada. There has been really no significant change in this regard over the past 12 months. Creditors continue to assert claims against directors and officers for typical D&O liabilities such as accrued wages and unremitted source deductions. There have also been a number of cases in which creditors have threatened to assert claims against directors for continuing to trade while the company was insolvent but prior to any formal insolvency filing.
“Former employees and current pensioners are emboldened and taking a more active role in insolvency proceedings.”
Shea: What advice would you offer to bankrupt debtors in terms of dealing with post-bankruptcy issues? How can companies in this position re-establish their reputation and revitalise their performance?
MacParland: We think that the Canadian restructuring regime gives companies the ultimate platform to relaunch and re-establish their business without the burden of suffocating debt and claims. If the fundamentals and management are right, the post-bankruptcy issues should be minimal. The goodwill in a business can be preserved with effective communication to key stakeholders, ensuring continuity of supply and fair dealing during the restructuring process.
Golubow: The obvious advantages of Chapter 11 reorganisation includes allowing a business to continue to operate, preservation of jobs and protection of other stakeholders while management re-evaluates the economics of its operations and financial condition and develops a plan to restructure the company’s debt. Re-establishing reputation and revitalising performance post-bankruptcy is difficult but not impossible. Strong leadership is key to all successful corporate comebacks. A company’s leadership must develop and implement comprehensive plans to retain or hire trustworthy managers, rebuild employee morale, reconstruct customer and vendor trust, and revive profitability.
Durrer: Bankruptcy administration is a costly and time-consuming distraction to any management team. Depending on the formulation of the reorganisation plan, this administrative effort often does not conclude at ‘emergence’ from bankruptcy. In order to minimise the impact on the day to day activities of the go-forward business, many practitioners recommend a liquidating trustee to address claims reconciliation, prosecution of avoidance actions and distributions so that company management can focus on running the business. The key challenge to using a liquidating trustee is to ensure – and convince creditors constituents – that the trustee will have sufficient funds to complete the post-bankruptcy administrative tasks. That said, this tool is highly effective as it allows the company to exit bankruptcy cleanly and efficiently.
Hernández: Post bankruptcy reputation re-establishment and performance revitalisation depends on different factors, like, for example, general reasons for the insolvency – whether it has been caused by general structural economic problems, mismanagement or fraud, or the behaviour of the debtor during the insolvency process – whether it has negotiated a reorganisation plan in good faith and has made the best possible offer with the highest possible recovery given the post-reorganisation estimated recovered financial situation, the manner of conducting the insolvency litigation, the treatment of creditors, and preparation of a viable post-reorganisation business plan. Good faith and cooperation with creditors and court officers will help to keep or re-establish the debtor’s reputation for improving its performance after bankruptcy, mainly when the causes of the insolvency were external.
Feldsher: There remains a debate about whether Chapter 11 still carries a stigma for corporations. For US companies, there is a belief that the asserted stigma is overblown. But many management teams continue to avoid bankruptcy unless it is absolutely necessary for fear of public perception or a tarnished image. To manage any adverse impact, management should be proactive in anticipating problems. In certain instances, for example, the US Bankruptcy Code permits a company to pay critical vendors and international creditors that may not be familiar with the US bankruptcy process. Prior to emergence, the company should develop a targeted marketing plan for assuring employees, customers and creditors that it is emerging from Chapter 11 stronger and more financially sound than ever. To the extent necessary, management should go out of their way to meet with contract counterparties and explain the exit process and the company’s plans going forward. Exit financing can also help alleviate concerns about the financial health of the reorganised company. Distancing the reorganised company from the bankruptcy estate by restricting use of a known trade name can also be beneficial. Most importantly, however, management must be patient. Memories are thankfully usually very short in business.
Shea: What do you consider to be the most important issues facing corporate bankruptcies in your region over the next 12 months? In today’s economic climate, are banks more or less likely to support struggling debtors?
Golubow: Future restructuring and bankruptcy activity depends upon a combination of credit availability, interest rates and secured creditors’ willingness to modify existing loans. Despite stagnant US macroeconomic growth, strong credit markets, low interest rates, and secured creditors’ willingness to amend and extend loans for healthy and viable businesses should lead to more refinancings, out-of-court restructurings, and distressed merger and acquisition activity and less bankruptcy filings. If credit markets tighten or seize-up, and companies cannot refinance their maturing debt obligations, the flood of bankruptcies that have so far been delayed will be unleashed.
Hernández: As anticipated, Argentina is currently facing a structural and economic crisis and uncertainty on future institutional and economic prospects. The most important issues for business and investments in the region are the result of the presidential elections in October and the measures to be adopted by the new president in December, when the new president assumes office. Today’s economic climate is one of expectation and uncertainty and, therefore, creditors and banks are more willing to support struggling creditors, even with temporary agreements until those uncertainties are cleared. If the new president adequately addresses the structural and economic problems and the economic climate improves, then debtors will be in a better position to have a clearer view of their future business and financial situation and creditors will be in a better position to negotiate greater returns in restructurings.
Feldsher: One of the most important issues facing corporate bankruptcy in the US is regulatory changes for banks and leveraged lending guidelines. More regulatory oversight will force banks to scrutinise portfolios and be more aggressive in exiting highly levered loans. In addition, the interest rate environment can have a big impact on the number of bankruptcy filings as well as the ability of entities to continue to restructure out-of-court. Although it is tough to say how much of an interest rate increase it will take to cause a surge in bankruptcy filings, any increase in rates will have a negative impact on companies trying to restructure out-of-court.
MacParland: I think that economic factors, both domestic and foreign, will be the biggest issue in the upcoming year in corporate insolvency. If Canada tips into a technical recession, weaknesses will be amplified and stakeholder patience will fray, which may lead to a flood of filings.
Durrer: Sufficient liquidity will remain the primary issue for corporate bankruptcies over the next year. Distressed companies need to continue to focus on sufficient advance planning to position financing and, ideally, a plan of action to carry the company through a Chapter 11 process. Engaging major constituencies in advance remains a key requirement for potential debtors in order to maximise the potential for consensual resolutions, and to preserve value for all interested parties.
James Patrick Shea is a partner with Armstrong Teasdale LLP in Las Vegas, where he focuses on advising financial institutions, landlords, vendors and other creditors in business bankruptcy proceedings. He has represented numerous hotel casino properties, guides creditors in all aspects of litigation relating to the debtor-creditor relationship, and assists in protecting and enforcing their rights, interests and remedies, both inside and outside of insolvency proceedings. An ABI member since 1988, he is ABI’s current president. He can be contacted on +1 (702) 415 2933 or by email: jshea@armstrongteasdale.com.
Jennifer Feldsher represents interested parties in bankruptcy proceedings and complex corporate debt restructurings, and is one of the leaders of the firm’s private investment funds group that advises special situations investment firms on their investments and acquisitions. Ms Feldsher has experience representing troubled corporate debtors, acquirers of troubled companies, creditors’ committees, and special creditors in a variety of in-court and out-of-court reorganisations, asset sales, loan restructurings and commercial loan transactions. She can be contacted on +1 (212) 508 6137 or by email: jennifer.feldsher@bgllp.com.
Natasha MacParland is a partner in the Corporate/Commercial and Financial Restructuring & Insolvency practices of Davies Ward. She has experience in corporate and commercial law, with an emphasis on debt restructuring, bankruptcy and insolvency, corporate debtor/creditor rights enforcement, turnarounds, work-outs, and proposals and bankruptcies under the Bankruptcy and Insolvency Act. Ms MacParland provides strategic advice and risk analysis on deal structuring and lending. She can be contacted on +1 (416) 863 5567 or by email: nmacparland@dwpv.com.
Fernando Hernández joined Marval, O’Farrell & Mairal in 2002 and became partner in 2011. Mr Hernández specialises in debt restructuring and insolvency and has over 12 years of experience in cross-border debt restructurings, corporate finance, banking and capital markets. Since 2002 he has been involved in some of the major corporate debt restructurings in Argentina and acquired extensive experience in cross-border private restructurings and insolvency proceedings, including structuring of ‘pre-packaged’ reorganisation processes. He can be contacted on +54 11 4310 0100 ext. 1659 or by email: fh@marval.com.
Van C. Durrer II leads Skadden, Arps’ corporate restructuring practice in the western United States and advises clients in restructuring matters around the Pacific Rim. He regularly represents public and private companies, major secured creditors, official and unofficial committees of unsecured creditors, investors and asset-purchasers in troubled company M&A and financing and restructuring transactions, including out-of-court workouts and formal insolvency proceedings. He can be contacted on +1 (213) 687 5200 or by email: van.durrer@skadden.com.
Richard H. Golubow is a founding member and the managing shareholder of Winthrop Couchot PC. Devoting his practice to the areas of financial restructuring, insolvency law, complex bankruptcy and business reorganisations, litigation, liquidations and acquisitions of distressed assets, Mr Golubow’s clients include debtors, creditors, creditor committees, bankruptcy trustees, assignees for the benefit of creditors, asset purchasers and receivers. He holds an ‘AV’ Preeminent Peer Rating, Martindale-Hubbell’s highest peer recognition for legal ability and ethical standards. He can be contacted on +1 (949) 720 4135 or by email: rgolubow@winthropcouchot.com.
© Financier Worldwide
MODERATOR
American Bankruptcy Institute (ABI)
THE PANELLISTS
Bracewell & Giuliani
Davies Ward Phillips & Vineberg LLP
Marval, O’Farrell & Mairal
Skadden, Arps, Slate, Meagher & Flom LLP and Affiliates
Winthrop Couchot PC