In December 2020, Burford Senior Vice President, Elizabeth Fisher and Director, Connor Murphy directed questions concerning insolvency trends to a respected group of experts in contentious insolvency and restructuring. Their perspectives are excerpted and gathered below.
Government and world central bank stimuli have helped keep the global economy in balance following the Covid-19 crisis. As government support is withdrawn, what insolvency and restructuring trends might we expect to follow?
Geoff Carton-Kelly: Speaking to the situation in the UK, there are two broad schools of thought: (1) That we will drop off a cliff on or around March 31 (at the time of writing) when most of the forbearance and financial support mechanisms end; or (2) The government will put us on a gentle glide path to the withdrawal of those support mechanisms. Having seen how the previous financial crisis was dealt with, and having come this far in preventing a meltdown, I believe the latter strategy will be followed.
Given that we have a plethora of restructuring mechanisms available in the UK, including the new Restructuring Plan, the Moratorium, Company Voluntary Arrangements (CVAs) and Administrations we are able to preserve value in impaired companies potentially and businesses almost certainly.
If you combine the accessibility of those mechanisms with the significant amount of distressed investment capital waiting for the right moment and opportunity to be deployed, I foresee businesses that were fundamentally sound before the Covid-19 crisis but are now significantly impaired with a lack of cash being acquired. As a profession, we will get busier as we come out of the crisis and there are greater opportunities for recycling capital and a clear horizon to focus on.
Stephanie Wickouski: There are so many variables as to fiscal support—including, obviously, a change in US administration—that it is impossible to predict specific insolvency trends with any certainty right now. A year ago, no one would have predicted $4 trillion in stimulus spending in 2020. 2021 might be just as unpredictable.
James Vincequerra: This is dependent in large part on the type of recovery we see. The trends will differ depending on whether we see a gradual recovery over the course of years instead of months as the vaccine is rolled out or a more rapid recovery. Regardless, there are a couple of general things to look for in the coming year.
As a profession, we will get busier as we come out of the crisis and there are greater opportunities for recycling capital and a clear horizon to focus on. Geoff Carton-Kelly
In the real estate sector, I expect we will see commercial mortgage-backed securities (CMBS) largely outside of formal bankruptcies due to the structural impediments to filing that come with the Special Purpose Entities (SPEs) and the non carve out recourse guarantees. There will likely be an increase in special servicing situations considering the distress that we expect to see in commercial real estate, particularly office-based real estate in major markets. But I don't think we will see traditional bankruptcy filings in the CMBS space. Instead, real estate filings will increase, and these will be more single-asset real estate cases that avoided the CMBS finance round.
The hospitality industry will not surprisingly experience significant distress. Restaurants will be particularly hard-hit: The margins in that business are already so tight that there is really not much there for formal insolvency or bankruptcy proceedings. In most restaurant cases, I think owners will simply return the keys to the landlord, shut the doors and move on. If we are going to see restaurant cases, they will be more substantial chains or restaurants where there was significant financing and branding. Hotels will face the same situation: Underperforming properties that otherwise would have limped along for years will probably wind up in insolvency, work out scenarios or formal bankruptcy proceedings.
The transport industry will see similar trends, such as in the cruise line and aviation sectors. I'm involved in a number of airline cases now and we are likely to see at least one or two more airline cases in the near- to mid-term future. Cruise lines continue to suspend global sailings. We will also see a continuation and acceleration of the retail trend of distress. Mall properties will continue to see the problems that they saw before the pandemic and so will retail businesses that didn't translate well into the e-commerce world.
Lastly, and I think most interestingly, is the potential for municipality bankruptcies as local municipalities and similar entities that have Chapter 15 available to them deal with the post-pandemic environment. Cities that have large infrastructure and fixed costs are going to have to deal with some very difficult choices. For instance, although I don't think we have to be concerned with New York City filing for bankruptcy, New York is going to face a lot of headwind in the coming years as a result of a lost tax base—as are a number of their institutions, including the transit authority. Both the city and the transit authority find themselves in the red to the tune of billions of dollars. If you combine that with what is anticipated to be an increased work-from-home environment, post-pandemic tax revenues or ride revenues for the Metropolitan Transportation Authority (MTA) are not going to return to their pre-pandemic numbers anytime soon and they will continue to have to pay out fixed costs such as pension obligations and employee wages. There are going to be huge budget holes that will be very difficult to fill without federal assistance. It will be interesting to see how that plays out across the nation.
Kevin Carey: Although this came down to the last minute, US government support is continuing. It has been largely government help that has kept the economy from crashing. That does not mean certain sectors have not been affected—they have been—but the stock market continues to stay high. It is just amazing to me how quickly and routinely the government has continued to support the economy. The first answer then is: I am not sure the government, especially given the change of administration, is ever going to withdraw support.
With the vaccine in circulation, support will be less necessary over time than it is now, but so far it has put off many ill-effects that we would have otherwise experienced. So what happens as that support is withdrawn? Assuming the vaccine is effective, the parts of the economy that have been adversely affected will pick back up. Does that mean restaurants that had to close will pick back up? You can’t predict that, but I think you’ll still find problems on both the business and consumer side.
Thus far, consumer filings have been way down as a result of the government support—and that trend may continue, given the extension of government support. If the support runs out, however, consumer filings will likely increase. From a business standpoint, it depends on the industry. Oil and gas is going to continue to be an issue, companies are overleveraged. Apart from any pandemic affect, overleverage has been an issue in our economy for an extended period.
Since the 2008 financial crisis, companies have been adding debt to their balance sheets—the US high-yield market is over six times leveraged today. How will record highs in distressed debt affect insolvency and restructuring activity? Which industries will be most affected in the long-term?
Stephanie Wickouski: Bankruptcy activity is obviously cyclical, and each cycle is unique. The duration and intensity of restructuring activity varies cycle to cycle. One commonality in all cycles is that credit downgrades are the bellwether of a bankruptcy boom. Based on the volume of low credit ratings you are seeing, it’s likely that there will be significant restructuring activity during the next two years.
Most predictions point toward energy and commercial real estate continuing to be the subject of restructuring activity, as well as airlines, aircraft leasing, live entertainment, and media/broadcasting.
For some time, I’ve been emphasizing strategies for monetizing illiquid recoveries such as unregistered stock, CVRs, warrants, options, and interests in litigation trusts. This topic will be front and center in many restructurings.
James Vincequerra: Levels of distressed debt will be high, and that will keep law firms’ debt trading practices very busy. Debt is going to translate into increased bankruptcy filings in those industries where would-be debtors have high fixed costs, such as mining, oil and gas and brick and mortar retail businesses. Those industries and businesses will be driven to formal insolvency proceedings and significant out-of-court workouts.
Bankruptcy activity is obviously cyclical, and each cycle is unique. Stephanie Wickouski
Geoff Carton Kelly: It will depend on the attitude of the holders of such debt. Anyone who can afford to play a long game will do so. But there will be plenty of instances where the absence of cash to service high levels of debt in certain industries will cause some distress, unavoidable covenent breaches and possibly lead to restructuring and/or insolvency processes. We have already seen challenges in sectors that have attracted high levels of debt such as shopping centers, casual dining and retail which were already suffering long before Covid-19. We might see a rebalancing of the level of debt in those sectors as we emerge from this crisis but there will always be acquisition and recapitalization solutions particularly when confidence returns.
Kevin Carey: I think it depends in large measure on how much liquidity remains in the marketplace. Right now, there is a lot of liquidity. With respect to either an industry or business, the overleverage will become too large to bear and investors are ready to step in to buy companies and debt. I think there will be an uptick in restructuring activity when that occurs, and it will continue after the effects of the pandemic go away as a result of the vaccines.
Oil and gas, hospitality, retail and restaurants have all suffered and will take time to recover, but the canary in the mine is commercial real estate. Remote work is likely to continue well after the pandemic ends: Some companies have told their workers they can stay home indefinitely, and others will be making decisions. That empty commercial space will have to be repurposed and there will be a lot of restructuring activity coming up in the next year and beyond in commercial real estate.
The modification to wrongful trading provisions in the UK was unexpectedly reintroduced on 26 November and is expected to run through 30 April 2021. Do you see this as the death of the [s214 IA86] wrongful trading provisions, as insolvency practitioners look at bringing alternate claims?
Geoff Carton-Kelly: I was always slightly troubled by the introduction of this modification at the beginning of the pandemic (and its relaxation and reintroduction) when it did not incorporate relief from other potential misfeasance provisions elsewhere in the Insolvency and Companies Acts. Obviously, wrongful trading is a matter that will be investigated at the commencement of a formal insolvency appointment, but the loss arising remains relatively difficult to quantify. Cases covering this period are going to be more challenging now, simply because of the on-off-on-off approach to the relief.
I would not necessarily say this will cause the death of the provisions, because they are still a useful weapon in the armory. Heading down the misfeasance route regarding specific liabilities that have been created by the directors is easier to quantify and arguably easier to prove but combining these two heads of claims may often get you the result you were looking for.
The Honorable Kevin Carey (Ret.) is a partner at Hogan Lovells in Philadelphia. Judge Carey joined the firm following his time on the U.S. Bankruptcy Court, District of Delaware, where he earned a reputation as one of the nation's top bankruptcy judges. He is a fellow of the American College of Bankruptcy, sits on the Executive Committee of the Board of Directors of the American Bankruptcy Institute, and serves as Vice President of Membership.
Geoff Carton-Kelly is a partner and Licensed Insolvency Practitioner at FRP in London. He has more than 35 years’ experience, and has been taking appointments since 1998. More recently his primary focus has been on international cases, real estate, contentious insolvency and charities. He advises boards and stakeholders, claimants, and government agencies on a range of contentious insolvency and restructuring matters.
James Vincequerra is a partner at Alston & Bird's Financial Restructuring & Reorganization Group. His primary practice is representing businesses in a variety of commercial transactions and matters. He has significant experience representing debtors, lenders, and other creditors, committees, bondholders, and asset acquirers (in and out of court) in high-stakes matters across industries, including finance, retail, education, real estate, hospitality, new media, e-commerce, and telecommunications.
Stephanie Wickouski is a partner at Locke Lord LLP in New York in the Bankruptcy, Insolvency and Restructuring practice. With more than 35 years of experience handling complex reorganization cases throughout the country, Stephanie has served as lead bankruptcy counsel in multiple high-profile cases. She is the author of three books: Indenture Trustee Bankruptcy Powers & Duties, an essential guide to the legal role of bond trustee, Bankruptcy Crimes, an authoritative resource on bankruptcy fraud, and her most recent book, Mentor X – The Life-Changing Power of Extraordinary Mentors.