It quickly became obvious, as countries began to enter into lockdown and many companies were forced to suspend their operations, that a tsunami of insolvencies was likely to follow in those jurisdictions which had been hardest hit by Covid-19, particularly in the event of a second wave of the disease.
Some businesses saw their cashflows dry up with a terrifying rapidity. For those that were already struggling, lockdown was the final straw, with stakeholders taking a view that it was no longer worth fighting to save the business and that the pandemic provided the perfect excuse for closure. The owners of many previously viable businesses chose to mothball all or part of their operations until lockdown ended, only to discover, on emergence, that their business model needed to be significantly adjusted to operate in a world of physical distancing – a problem that was particularly acute in the hospitality, tourism and transport sectors. In other cases, management were confronted with significant liabilities incurred during the lockdown, such as accrued rent or obligations to pay for the supply of no-longer required goods, that had to be urgently addressed.
If this was not difficult enough, pressures on liquidity had an immediate impact on discretionary spend, putting further pressure on the services sector, while consumer confidence was dented by both fear of the disease and fear of its economic consequences, including significant increases in unemployment. It is hardly surprising, in this context, that the first half of 2020 saw a record number of US Chapter 11 bankruptcy filings.
It is hardly surprising, in this context, that the first half of 2020 saw a record number of US Chapter 11 bankruptcy filings
How have legislators sought to head off what, in insolvency terms, might be viewed as a perfect storm? In summary, as illustrated by the chapters in this guide, there has been a three pronged approach, with efforts to provide economic support to hard pressed businesses, the temporary suspension of legislative provisions which could force previously viable companies into insolvency and the introduction of new insolvency legislation aimed at improving the longer-term survival prospects of such companies. Sadly, it often takes a crisis to force insolvency onto the legislative agenda.
Forming a response
Government support initiatives have largely consisted of providing short term financial support to businesses. In the UK, the government has provided loans, deferred tax payments and covered the costs, through the furlough scheme, of employees who would otherwise have been made redundant. In other jurisdictions, such as Hong Kong, companies have benefitted from a temporary moratorium on debt repayments. While such measures allowed struggling companies to survive, the concern going forward is that there will soon be a day of reckoning, as amounts that have been borrowed and payments that have been deferred will need to be repaid or restructured, raising the possibility that government loans may have to be converted into equity stakes.
The temporary suspension of legislative provisions which could force previously viable companies into insolvency can also be viewed as a short term response to the lockdown and its consequences. Examples include France and Germany suspending directors' obligations to initiate insolvency proceedings once their company becomes insolvent and restrictions in the UK on the presentation of winding-up petitions where the relevant company's financial problems are clearly Covid-19 related.
The longer-term response to the impact of Covid-19 has been the introduction, or acceleration, of insolvency legislation, the main aim of which is to give previously viable companies a better chance of survival. At the risk of generalisation, five key trends can be identified in such legislation, some of which clearly draw inspiration from Chapter 11 of the US Bankruptcy Code:
- A desire to limit the ability of shareholders and out-of-the-money creditors to block a restructuring plan which has the support of in-the-money creditors and which a supervising judge considers to be fair and equitable. The widespread introduction of cross-class cram-down procedures, such as those under the Dutch Bill on the Confirmation of Private Plans and the "super scheme" introduced in the fast-tracked UK Corporate Insolvency and Governance Act, reflect this desire.
- The need to give viable companies facing immediate or anticipated financial difficulties an opportunity to prepare a restructuring solution, free from immediate creditor pressure. A model for such protection can be found in the EU Preventative Restructuring Frameworks Directive, which requires a "breathing space" moratorium to be introduced into the legislation of each EU Member State.
- The introduction of light-touch or streamlined insolvency procedures which could be used by struggling SMEs, which may face significant liquidity issues, being heavily represented in sectors such as tourism and hospitality, but which may lack the resources to implement a full restructuring. One example is the Coronavirus Aid, Relief, and Economic Security (CARES) Act, which made important revisions to the US Bankruptcy Code aimed at allowing more struggling SMEs to reorganise their financial affairs in an efficient and cost-effective manner, using a streamlined Chapter 11 procedure.
- A recognition that, while many restructurings over the last decade have focussed on financial indebtedness, the next wave is more likely to include operational indebtedness and that struggling companies should have some legal leverage when dealing with suppliers threatening to take enforcement action or terminate critical contracts. The moratorium discussed above may assist in such cases, as may the introduction, in some jurisdictions where they did not previously exist, of statutory restrictions preventing supply agreements from being terminated by reason of the counterparty entering into an insolvency procedure.
- An acknowledgment that liquidity will continue to be a major issue going forward, and that prospective lenders should be encouraged to provide funding in appropriate cases, whether by giving new lending statutory priority or by removing deterrents to making funding available to companies facing financial difficulties. In those jurisdictions where there is currently no legislative framework for DIP financing, there have been recent examples of self-help, with existing procedures, such as UK Schemes of Arrangement, being used inventively to create platforms for de facto priority lending.
Where does this leave us, looking ahead over the next year, given that most temporary government support initiatives will cease to apply by the end of that period? It will certainly be an interesting time, with opportunities for those who are in a position to invest or provide liquidity, and challenges for those working with new legislative measures which, in some cases, have been fast-tracked and do not, therefore, answer every question. The challenge for the restructuring and insolvency community is to use the available tools inventively and constructively, limiting, as far as possible, the pain suffered by viable businesses hit by the impact of Covid-19.
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Rebecca Jarvis is Linklaters' global co-head of restructuring and insolvency. She has experience in all aspects of non-contentious reconstruction and insolvency work acting for banks, financial institutions, other creditors, corporate clients and insolvency practitioners in relation to recovery, reconstruction or distressed debt problems.
Jo Windsor has been working in the field of restructuring and insolvency for over 30 years, specialising in complex cross-border matters. He has been involved in the restructuring of companies in more than 30 different jurisdictions and is the author of many articles addressing specific issues relating to restructuring and insolvency.