Preventative care for multinationals: six things for directors to consider before facing financial distress

December 2022 | SPOTLIGHT | BANKRUPTCY & RESTRUCTURING

Financier Worldwide Magazine

December 2022 Issue

To the surprise of their managers and directors, some multinational companies have ended up in the financial emergency room when they could have avoided the trip to the hospital altogether. The most common cause is a failure to understand the practical problems a multinational will encounter if and when it faces the preliminary stages of financial distress. Unlike a company operating in one primary jurisdiction, a multinational with an unexpected need to raise liquidity or extend a debt maturity will discover that the laws relevant to its financial restructuring, and the backdrop to any extension of credit, vary dramatically around the globe. Some legal systems provide extraordinary flexibility for managers, while others go so far as to impose criminal liability for the failure to timely commence formal insolvency proceedings. With important subsidiaries organised in different countries, a multinational faces a list of challenges that simply do not apply to companies operating in one primary jurisdiction.

Although the challenges are not obvious, they are predictable. Multinationals that wish to reinforce their ability to use liability management tools can do so in advance by taking some simple precautionary measures. Unfortunately, many multinationals fail to do so, or wait until it is too late. There are several reasons why. One reason is intrinsic to the psychology of financial distress. The unpleasant nature of the worst-case scenario discourages management and directors from openly discussing it. Another reason is the limited number of precedent cases. Unlike domestic restructurings, experience with true cross-border financial restructurings is limited to a relatively small handful of international practitioners. Corporate executives who themselves have been through a global restructuring and learned the lessons best, of course, rarely go through it again and generally wish to forget about it when it is over. So, lessons learned are not always passed on.

There is no regulator that requires a non-financial corporation to prepare a ‘living will’ in the manner of a bank resolution plan. Yet advance planning can be just as dispositive. This short article discusses six of the simplest and easiest ‘housekeeping’ items, tailored for a general audience and a typical multinational issuer. Each housekeeping item can be addressed inexpensively and confidentially, and has demonstrable value when put in place prior to the active phase of a restructuring.

Appoint senior executives to subsidiary boards

A multinational corporate group in financial difficulties is no stronger than its weakest subsidiary. The premature commencement of an insolvency proceeding by a single subsidiary can quickly lead to a fatal chain reaction around the world. Yet multinationals often fail to pay sufficient attention to who is on the boards of their subsidiaries. The typical subsidiary board for a modern multinational includes in-country business, tax and legal officers who may be several organisational levels below the C-suite. Restructuring law in many jurisdictions imposes personal civil liability (and, sometimes, criminal liability) on directors who fail to seek insolvency protection when they are required to do so. Assessing when an insolvency filing is required, and negotiating arrangements to avoid the filing, can be difficult work that requires a sophisticated understanding of the multinational’s overall business and the readiness to make risk-weighted decisions of the sort typically made only by senior leaders of the parent company. This is especially true when ‘independent’ insolvency-related advice is obtained from local insolvency professionals with a vested interest in the outcome. Accordingly, the first item on the housekeeping list is to review and change out, where appropriate, the directors of subsidiary companies to ensure that sufficiently senior executives, or new independent directors with requisite experience, will make the hard decisions in a worst-case scenario.

Simplify internal claims

During a restructuring, the ideal internal financial structure for a multinational group is to have working capital pooled at one or more subsidiaries that serve as cash pool leader or group bank. Intercompany transactions can then be cleared in the ordinary course of business, leaving each subsidiary, at any time, with a net debit or net credit position with the bank. There are many advantages to this structure: it eliminates diverse credit risks, allows safer funding of debit subsidiaries, and makes it easier to reassure the directors of creditor subsidiaries that they can reliably ‘lend’ money to the group by depositing funds at the bank. Unfortunately, most multinational groups do not conform to the ideal structure. It is common to find large intra-group liabilities among individual subsidiaries that have not been cleared through the central cash pool at the group bank, for example from the push down of acquisition debt. If these internal liabilities are not cleaned up before a restructuring, they can heighten concerns by local directors, increase liquidity requirements and prevent certain types of liability management transactions altogether. Thus, the second item on the checklist is to net settle and remove large internal claims from the corporate structure, clearing them through the central cash pool to result in a single net position for each subsidiary. Tax and other concerns will often prevent this from being done completely, but there typically are many claims that can be cleared without adverse consequences.

Establish viable fences around key risks

Multinational groups operate through networks of subsidiaries. As a regular part of its monitoring of major business risks, the board of directors of a multinational group should consider where in the corporate organisation chart the group faces material contingent liabilities or business failure in the future. Exposure often can be appropriately cabined within one or more limited liability companies, protecting the global business from local problems. This ‘ring-fencing’ review requires more than the creation of limited liability companies and the observance of legal formalities. A proper ring-fencing analysis also examines whether business activities are truly separate, or separable, from the other activities of the group at the operational and financial level. Relevant considerations include the ownership of intellectual property (IP), the nature of supplier and vendor relationships, common manufacturing, access to working capital, corporate support arrangements, financial guarantees, group liability for pension and other statutory charges, employee matters, and more. Although ring-fencing is never perfect, a few simple precautionary measures can help protect the group from the risks that concern management and the board. Doing so in advance of trouble as part of a general group risk assessment is always preferable to reacting last-minute to a suddenly exigent concern.

Review IP and group service agreements

Every multinational group has a set of contracts pursuant to which it provides subsidiaries with access to IP and corporate services. No matter what form these arrangements take or what law governs, one clause is consistently important: subsidiary access to group services and IP should terminate immediately if the subsidiary ceases to be controlled by the group parent. In other words, if creditors foreclose on the subsidiary, the subsidiary should lose its rights immediately. Although this principle is fundamental to a multinational in distress, only a small minority of multinational groups include it clearly in their material arrangements with subsidiaries. In some cases, the provision does not appear in the relevant agreements at all. In other cases, it is garbled or imprecise, or has problematic exclusions.

Update protections for subsidiary officers and directors

Corporate laws around the world have an evolving set of permissive rules about the extent to which a company can indemnify and exculpate its officers, directors and owners. Many multinational groups have paid attention to these issues for their parent corporation, but largely ignored the same questions as they relate to subsidiaries. In a restructuring, when the interests of one subsidiary may diverge from the interests of the group, the absence of protective provisions for decision makers can be troublesome. Fortunately, it is usually a very cost-effective exercise to review and amend the constitutive documents for group subsidiaries in order to ensure that the best available corporate form is being used for each subsidiary and that any permitted defensive provisions are state-of-the-art. For example, Delaware allows a limited liability company agreement to include a waiver of the fiduciary duties of officers and directors, or even to eliminate the board of directors entirely in favour of member management. Other countries have analogous laws. If a restructuring is necessary someday, having the best corporate form with state-of-the-art waivers will help make sure that subsidiaries can stay safely under the effective control of the parent board for as long as appropriate.

Create jurisdiction for pre-insolvency proceedings

Finally, multinationals thinking ahead about their capacity to withstand financial trouble should take a moment to consider whether they have access to a court-supervised liability management process. The most relevant processes are not ‘insolvency’ proceedings, but the special type of proceedings available in jurisdictions around the world to facilitate balance sheet restructurings. Such ‘pre-insolvency’ proceedings can be quick and inexpensive ways to compel hold-out creditors to accept a liability management transaction that has been negotiated with, and approved by, a substantial majority of other creditors. The proceedings typically allow the company to convert consent from 51 percent, 66.6 percent or 75 percent of creditors into consent from 100 percent by operation of law. The most common proceedings of this type are ‘prepackaged’ Chapter 11 cases under US law and the scheme of arrangement under English law. However, many other countries offer effective options as well, including tried and true pre-insolvency regimes in Canada, the Caribbean, Hong Kong and Singapore, and interesting new alternatives on the books in other jurisdictions as well. However, each has different practical eligibility requirements and many of these are best put in place in advance, rather than at the last minute. Accordingly, like the other five items, some simple advance planning is worthwhile to ensure that the group will have access to at least one viable pre-insolvency regime.

There is no need for a healthy multinational group to spend substantial time or money worrying about worst-case scenarios. However, review of these six items should be on the parent board agenda for any multinational whose business creates a risk, even a remote risk, that a financial restructuring of all or part of its business may someday be required.

Andy Dietderich is a partner and Alexa Kranzley is special counsel at Sullivan & Cromwell LLP. Mr Dietderich can be contacted on +1 (212) 558 3830 or by email: dietdericha@sullcrom.com. Ms Kranzley can be contacted on +1 (212) 558 7893 or by email: kranzleya@sullcrom.com.

Andy Dietderich and Alexa Kranzley

Sullivan & Cromwell LLP