Restructuring in the automotive sector

April 2021  |  SPOTLIGHT  |  BANKRUPTCY & RESTRUCTURING

Financier Worldwide Magazine

April 2021 Issue

The automotive industry, globally, faced significant challenges before the onset of the coronavirus (COVID-19) crisis. On the eve of the pandemic, original equipment manufacturers (OEMs) were preparing for major change and the attendant disruption, as the transition to electric vehicles began to gain pace. Online searches in the UK doubled overnight, for example, when the UK government announced the phase out of sales of petrol vehicles by 2030.

Faced with these major changes and with many OEMs carrying significant debt burdens when the pandemic began, the industry has suffered more than most through the period of the COVID-19 crisis and will find emerging from lockdown and the related governmental support packages even harder. Does this make the required reorganisation of the industry even harder or can even the most challenged participants find opportunities to accelerate the required changes?

Demand for new cars collapsed in 2020 to an extent not seen since the Second World War. Worldwide demand fell by 30 percent, varying by country and region from China, where falls of about 23 percent were seen, to Europe where declines of up to 40 percent occurred. Registrations of new cars in the UK in January 2021 were 40 percent below levels for the same month a year earlier. This collapse in sales has highlighted trends that were evident before the pandemic – the need to update products to meet changes in customer demand, the concomitant need to reorganise supply chains and the need to reduce debt burdens.

By contrast to the overall decline in sales seen in 2020, global sales of electric cars grew by 43 percent in 2020. In response, increasing numbers of OEMs are stepping up their transition to an all electric offering. In the UK, Jaguar Land Rover is the most recent to announce its transition away from the internal combustion engine, in its case, by 2025.

With showrooms closed for most of 2020 and limited success in selling online, OEMs will emerge from national lockdowns carrying significant debt burdens. As they do, recent experience with microchip shortages (which have forced several OEMs to slow their production lines) suggests that traditional just in time supply chains will take some time to regain their pre-pandemic efficiencies, if they ever do. In Europe and the UK, the effect of Brexit finally coming into effect mid-pandemic may force the just in time supply chain to be revisited. OEMs reliant on erratic microchip supplies have already indicated the need to consider stockpiling for certain key components. Overshadowing all of this, the move to electric vehicles will render significant parts of existing supply chains redundant. The investment required to remodel supply chains will add pressure to balance sheets burdened with debt incurred both before COVID-19 and during the crisis.

Financial restructuring may be an inevitable consequence of this combination of factors for many OEMs. To some extent, that may bring additional cost and complexity for management teams already facing significant challenges. However, it may also be the case that financial restructuring will offer tools that can be used to cut through operational challenges that could otherwise take years to resolve. Both the US and the UK have existing regimes that provide companies with protection from creditors while they effect a restructuring.

In the US, Chapter 11 is now a familiar, court supervised regime through which management can retain control of a business and restructure both its balance sheet and its operational structure without creditors being able to rely on contractual controls to intervene. In the UK, administration was a process originally designed to allow a similar process, albeit under the control of an insolvency practitioner.

For most of its existence, administration has largely been a process for managing insolvency rather than facilitating rehabilitation, but recent efforts to encourage a ‘light touch’ administration may indicate a move by the market toward using administration for one of its intended purposes which has not been fully explored. The new UK restructuring plan also offers opportunities to restructure businesses, with a number of recent plans addressing both financial and operational issues. In Europe, increasing numbers of jurisdictions have instituted regimes similar to the UK’s restructuring plan in response to the 2019 EU Restructuring Directive, with the Netherlands and Germany among early examples.

Whenever an industry is subjected to fundamental change, views will differ on whether evolution or revolution is the best route to success. Questions arise about whether parts of the industry are capable of being restructured for success or can realistically only be restructured to mitigate losses. Often the answers to these questions lie in balancing the barriers to entry against the future value of (among other things) the brand, the operational platform, intellectual property and technological expertise.

Current changes in automotive trends are challenging the value proposition. As a result, barriers to entry are either lower or different. Are established automotive businesses going to be able to change fast enough while contending with the traditional restructuring challenges of complicated capital structures, servicing obsolete lines, and dealing with legacy issues linked to employment and pensions?

Each of the restructuring processes referred to above could be used to remodel or exit unprofitable or redundant contractual relationships. In more extreme circumstances, they also offer opportunities to divest or close businesses or corporate entities that no longer fit within the wider group operation, while limiting the ramifications for the wider business. In short, financial restructuring, while always stressful for those who undergo it, may also offer the opportunity to drive changes that are needed for the future.

As 2021 progresses, it seems likely that many businesses in the automotive sector will face significant challenges, many of them stemming from large debt burdens. However, techniques that can be used to address these debt burdens could also be applied to structural changes needed to respond to wider shifts in customer demand and industry norms.

Trevor Borthwick, Michael Fiddy and Devi Shah are partners at Mayer Brown. Mr Borthwick can be contacted on +44 (0)20 3130 3556 or by email: tborthwick@mayerbrown.com. Mr Fiddy can be contacted on +44 (0)20 3130 3755 or by email: mfiddy@mayerbrown.com. Ms Shah can be contacted on +44 (0)20 3130 3669 or by email: dshah@mayerbrown.com.

© Financier Worldwide

BY

Trevor Borthwick, Michael Fiddy and Devi Shah

Mayer Brown