Insolvencies in a post-Brexit world
Effect on financially stressed companies and buying opportunities
While the United Kingdom has not yet implemented its withdrawal from the European Union, real-world consequences have already resulted from the June 23rd Brexit referendum. These consequences flow from the market’s anticipation of Brexit.
For UK companies facing liquidity or operational challenges, uncertainty caused by Brexit may shift the delicate balance needed for a troubled company to reorganize successfully. Brexit could also create opportunities for investors willing to tolerate a higher degree of uncertainty and risk.
In order to reorganize, a distressed company must fulfill several requirements:
- The company must have sufficient cash flow for operations. The market effects of Brexit may either assist a distressed company in reorganizing or cause additional challenges, depending on the finances of the troubled company. For example, Brexit has caused a short-term reduction in sales in some segments, requiring some companies to seek additional liquidity. The anticipation of the UK’s exit from the EU could make financing more expensive. The sharp decline in the value of the British Pound could increase borrowing costs if a company needs new multi-currency loans. There also appears to have been a slowdown of new deals as the lending market cautiously awaits the fallout from Brexit. Longer term, the devaluation of the British Pound (and market uncertainty) could result in an influx of capital by alternative lenders, who may be more likely to lend to troubled companies.
- A troubled company’s existing lenders must maintain confidence in that company’s ability to reorganize. Lending markets typically do not thrive during periods of uncertainty and volatility. Because a distressed company’s existing lenders are often the best source of new money, Brexit could dry up resources by dissuading existing lenders from extending new money during the period of uncertainty. Further, short term volatility may negatively affect operational results, which can further erode lender confidence. If a company does not maintain lender support, lenders can sell their debt on the secondary market to purchasers with a different agenda. For example, a larger purchaser may seek ownership of the company through a debt to equity conversion, rather than reorganizing it. However, secondary debt sales facilitate a restructuring, because secondary purchasers have often paid materially less than face value for the debt. Acquisitions by secondary debt purchase can be a lower cost alternative to acquiring a company, particularly at a time when sterling continues to trade low against the dollar.
- A troubled company must have a realistic business plan to address both liquidity needs and operational challenges. While the uncertainty of Brexit may exert pressure on a troubled company’s projections, lenders will likely focus on the underlying value of the business, even in an uncertain market.
US bankruptcy filing as an alternative or addition to UK administration
For companies that need court protection to reorganize, a US filing may constitute an alternative or may complement a UK administration. A company can file an insolvency proceeding in the US, even if it is not governed by US laws. For companies with assets, securities or creditors in the US, a US filing may provide needed protection. While the original debt holders may not be American, secondary debt trading may result in a significant number of US holders. Further, non-US creditors will be bound by a US filing if the creditor has assets in, or other significant contacts with, the US. Finally, the US may present a favorable venue for securities governed by US law.
In addition to the protection offered by a US filing, a US case may enable financing that is not be available in the UK. A US bankruptcy case can grant super-priority status to lenders that provide new money after the filing. In certain circumstances, the pre-petition lenders may receive priority for their existing debt.
If the troubled company is seeking administration in the UK, it may also file a case in the US under chapter 15 of the US bankruptcy code. Chapter 15 is designed to allow coordination between US and non-US insolvency proceedings. Using a chapter 15, a troubled company could reorganize its business in the UK, while protecting assets in the US. The chapter 15 would also prevent any US creditor from taking action in the US. US courts have already held that UK administrations have the requisite consistency with US public policy and with protections provided by US bankruptcy law to designate UK administrations as “foreign main” proceedings (i.e., to be the lead case).
Chapter 15 cases recognize a non-US insolvency proceeding as either (i) a foreign “main” proceeding, where the non-US insolvency proceeding is located where the company has its primary interests or (ii) a foreign “non-main” proceeding, where the non-US insolvency proceeding is not located in the location of the company’s primary interests. The principle difference between a foreign “main” and a foreign “non-main” proceeding is the level of protection the company is automatically entitled to in the chapter 15 case. In either a foreign main or foreign non-main case, US courts can provide protection for a company facing liquidity or operational challenges to facilitate its reorganization.
While the prospect of leaving the European Union will create numerous challenges for companies (including those in financial distress), it may also present opportunities for both companies and investors.
About Dorsey’s Bankruptcy and Financial Restructuring Practice. Dorsey’s Bankruptcy and Financial Restructuring group provides not only extensive experience in domestic and international bankruptcy and insolvency matters, but also expertise in mergers and acquisitions, corporate governance, tax law, securities law, finance, business litigation and other disciplines that are critical to the restructuring of viable businesses and assisting creditors and others in preserving their rights. Dorsey’s Bankruptcy and Restructuring attorneys represent a wide array of interested parties in international insolvency and bankruptcy matters, including cross-border filings and chapter 15 cases.