Debt Restructuring PDF
Preview Debt Restructuring
DEBT RESTRUCTURING 00-Olivares-FM.indd i 2/24/2011 9:30:59 AM This page intentionally left blank DEBT RESTRUCTURING Rodrigo Olivares-Caminal John Douglas Randall Guynn Alan Kornberg Sarah Paterson Dalvinder Singh Hilary Stonefrost Consultant Editors: Look Chan Ho Nick Segal 1 00-Olivares-FM.indd iii 2/24/2011 9:31:00 AM 1 Great Clarendon Street, Oxford ox2 6dp Oxford University Press is a department of the University of Oxford. It furthers the University’s objective of excellence in research, scholarship, and education by publishing worldwide in Oxford New York Auckland Cape Town Dar es Salaam Hong Kong Karachi Kuala Lumpur Madrid Melbourne Mexico City Nairobi New Delhi Shanghai Taipei Toronto With offi ces in Argentina Austria Brazil Chile Czech Republic France Greece Guatemala Hungary Italy Japan Poland Portugal Singapore South Korea Switzerland Th ailand Turkey Ukraine Vietnam Oxford is a registered trade mark of Oxford University Press in the UK and in certain other countries Published in the United States by Oxford University Press Inc., New York © Oxford University Press 2011 Th e moral rights of the authors have been asserted Database right Oxford University Press (maker) Crown copyright material is reproduced under Class Licence Number C01P000014 with the permission of OPSI and the Queen’s Printer for Scotland First published 2011 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, without the prior permission in writing of Oxford University Press, or as expressly permitted by law, or under terms agreed with the appropriate reprographics rights organization. Enquiries concerning reproduction outside the scope of the above should be sent to the Rights Department, Oxford University Press, at the address above You must not circulate this book in any other binding or cover and you must impose the same condition on any acquirer British Library Cataloguing-in-Publication Data Data available Library of Congress Cataloging in Publication Data Data available Typeset by Glyph International, Bangalore, India Printed in Great Britain on acid-free paper by CPI Antony Rowe, Chippenham, Wiltshire ISBN 978-0-19-957969-3 1 3 5 7 9 10 8 6 4 2 00-Olivares-FM.indd iv 2/24/2011 9:31:00 AM FOREWORD Over the past decade or so, virtually all developed countries and the majority of emerging countries have made major changes to their insolvency laws. One would expect that these changes would exhibit a common philosophy. Th is is not so. Th e attitudes of the mosaic of jurisdictions point in all directions of the compass as legislators wave the legal wand in the hope of, by magic, conjuring up assets out of thin air. Th ese changes greatly complicate the international legal arena. Th is arena is already intensi- fi ed in its intricacy by other potent factors. Th ese include the fact that all jurisdictions, except a handful, are now part of the world economy or seek to become a meaningful participant. Th ey include the fact that fi nancial crises exacerbate passions and hence drive the panicky search for some panacea. Th e result is that the world is immeasurably more daunting than it used to be from the legal point of view. Bankruptcy law is the most powerful impulse behind commercial and fi nancial law. Since there are not enough biscuits and brandy on the raft, it is the law which must ruthlessly decide who is to be paid, who is to be ahead of the others on the bankruptcy ladder of priori- ties to escape the swirling tide of debt, who wins and who is lost, who is the victor and who is the victim. Th ere is no question that bankruptcy is the most critical indicator of the culture of a legal system in its business law. In addition, nowadays it is not possible to sidestep the interconnectedness of the world and hence the global impact of bankruptcy. No state is an island. Th e strict black-letter rules of bankruptcy law are the backdrop against which the resolution of fi nancial diffi culties is negotiated. It is probably true that by far the majority of fi nancial problems are resolved by a private restructuring, but there is nevertheless a pronounced ten- dency to introduce judicial reorganization statutes as an alternative. Indeed, one of the most pressing questions in our times as regards bankruptcy law is whether these statutes should be substantially debtor-protective or creditor-protective. Th e jurisdictions of the world have many answers to this question and there is little harmony on the major indicators. Th e events of the fi rst decade of the twenty-fi rst century show conclusively the inter-relation- ship between bank insolvencies, corporate insolvencies, and sovereign insolvencies. Each can have a contagion eff ect on the others. Hence the three areas have to be treated as a whole. It is a great merit of this book that all three are dealt with in one volume. Th is work is a major contribution to the practice and the law on this fundamentally impor- tant topic. It is a work on the most useful aspect of law, namely applied law, the law in action, what actually happens in the real world. Th e book is produced by leading practitioners and v 00-Olivares-FM.indd v 2/24/2011 9:31:00 AM Foreword academics in this fi eld who possess an extraordinary depth of experience and knowledge. It marks a very large step forward in the state of the art. Philip R Wood, QC (Hon) Head, Allen & Overy Global Law Intelligence Unit Visiting Professor in International Financial Law, University of Oxford Yorke Distinguished Visiting Fellow, University of Cambridge Visiting Professor, Queen Mary College, University of London Visiting Professor London School of Economics & Political Science 7 November 2010 vi 00-Olivares-FM.indd vi 2/24/2011 9:31:00 AM PREFACE Upon reviewing trends in domestic insolvency law regimes around the world, one point is strikingly clear, that is, many insolvency laws have recently been amended or are currently under review. One reason is a political reaction to address—for the interests of various par- ties—the fi nancial and economic cycles which gave rise to some unforgettable crises (eg the US sub-prime mortgage crisis and the subsequent ‘credit crunch’ crisis). Th is review of insol- vency laws is also a response to a global impetus focused on avoiding liquidation of troubled companies as well as to the adoption of UNCITRAL’s cross-border insolvency Model Law. In times of fi nancial distress, dealing with debt is a complex matter due to the uncertainties of the outcome and the scarce fl ow of funds. Corporations doing business in this context are not exempt from the turmoil. As stated by Stone, corporate restructuring on a large scale is usually made necessary by a systemic fi nancial crisis, that is, a severe disruption of fi nancial markets that by impairing their ability to function, has large and adverse eff ects on the economy.1 Financial crises do occur and when they occur they can be of great magnitude. Th e corporate episodes of Enron, Parmalat, Yukos, and Worldcom were recently shadowed by the collapse of Lehman Brothers and the bailout and restructuring of several other large and complex fi nancial institutions. Not to mention the bailouts of Greece and Ireland in the sovereign arena. Time is Money: ‘Expedited’ Insolvency Laws A corporation that is experiencing liquidity problems could fi nd itself in a position where it fails to fulfi l its obligations as they fall due (liquidity test). However, an illiquid debtor might still be solvent despite the fact that it is not able to perform its obligations. However, if the amount of the obligations of the debtor exceeds the value of its assets (assets test), irrespective of whether it performs its obligations in a timely fashion, and there is no evidence that this can be reversed in the course of business, sooner or later it will become insolvent. Th e diff erences between an illiquid and an insolvent company are quite signifi cant. Th e former could resort to some type of reorganization procedure to restore its solvency while the latter will have to face liquidation. Although there are diff erent shades of grey as a result of the diff erent insolvency laws, the liquidation process is straight forward and some general guidelines can be drawn. In a liquidation, the court—with the assistance of a liquidator— will dispose of the assets of the insolvent company and will distribute the proceeds among creditors according to their ranking of priority to collect their claims. On the other hand, an illiquid company can resort to a restructuring procedure to reduce its debt burden and regain a sustainable path. Th ese restructuring procedures could be per- formed under the direction of a court or out of court. 1 Mark Stone, Corporate Sector Restructuring: Th e Role of Government in Times of Crisis, International Monetary Fund, Economic Issues No 31 June 2002. vii 00-Olivares-FM.indd vii 2/24/2011 9:31:00 AM Preface Th e court-supervised procedures are usually lengthy and demand detailed fi nancial and commercial disclosure of information about the company. Th is is in many cases a recipe for disaster since often bad publicity resulting from the disclosure requirements and the time elapsed since the beginning of the restructuring can worsen the state of aff airs. If this hap- pens, the position of the corporation can change almost instantaneously from a position of illiquidity to insolvency, from being potentially viable to a position of being unviable, from restructuring to liquidation, from a position of recovery to sudden death. Importantly, the substance of the new ‘expedited’ bankruptcy laws is that they provide a signal to creditors that they may be better off engaging in swift, voluntary, and less cumber- some restructurings than actual insolvency proceedings. Corporations, during economic stability periods, invest and try to expand. During recessive periods, corporations try to maintain their market share and develop new lines of business. In both cases, corporations resort to diff erent fi nancing techniques to raise the required capi- tal to achieve their objectives. Subject to their debt-to-equity ratio, corporations have to decide if they are going to fi nance themselves with debt or equity. All time low default rates prior to the US sub-prime mortgage crisis had pushed non-bank fi nancial institutions into new areas in order to extract value during a period of excess cash and low returns which in turn enabled arranging banks to structure ever bigger and more complicated debt packages comprising tranches of senior debt, second lien, mezzanine and sometimes junior mezzanine.2 Th is de-equitization trend based upon the lower cost of debt, excess liquidity in banks due to their tradability in the secondary debt market, and collateral- ized debt obligations repackaging (CDOs and CDOs-squared3) made debt more attractive in certain markets vis-à-vis equity. Th is resulted in an excessive accumulation of debt which due to a sudden dry-up of liquidity in the capital markets produced an abrupt halt. Many enterprises, particularly in the fi nancial sector, had to restructure their debt. Th at fallout also saw massive amounts of value wiped off the balance sheets of banks along with asset and business sales thus reducing them from global proportions to a tiny fraction of their previous size compared to a few years earlier. Th e Special Nature of Banks Banks are especially prone to crises due to the fact that they operate on a fractional reserve system. Upon the mere spread of a rumour that a bank is in distress, a bank run can occur. Th at is the reason why there is an array of tools and mechanisms to prevent it from happen- ing. However, sometimes banks fail despite the fact that an offi cial safety net is in place inter alia formally to supervise its activities through a supervisory authority or central bank. Th e supervisory system must foresee the possibility of a crisis unfolding and be prepared to manage it when it occurs. Th is is why one key function of bank regulation and supervision is the prevention and management of banking crises albeit its primary function is to protect depositors. Crisis management in banking involves an array of instruments that includes 2 See S Patel and M Fennessy, ‘Th e Changing Nature of Stakeholders in Restructurings’, 3(5) International Corporate Rescue, 2006, p 266. 3 A CDO-squared or a CDO2 is a type of CDO where the underlying portfolio includes tranches of other CDOs. viii 00-Olivares-FM.indd viii 2/24/2011 9:31:00 AM Preface emergency liquidity support through the lender-of-last-resort (LOLR) role of the central bank; deposit insurance schemes; and bank insolvency proceedings (including prompt corrective actions). According to Lastra, government policies for protection of depositors (both insured and uninsured) should also be included among this array of instruments.4 In addition, another salient feature in dealing with bank insolvencies is the ‘too-big-to-fail’ or ‘too-interconnected-to-fail’ doctrine (TBTF). As regards bank insolvency proceedings, there are four basic actions that may be taken in dealing with a fi nancially distressed bank: (1) rehabilitation; (2) sale or merger of the bank as a going concern; (3) asset sales and liabilities assumptions on a wholesale basis in the context of downsizing or liquidating the bank; and (4) liquidation, in which case the assets will be sold and depositors’ and other creditors’ claims will be resolved in winding up the bank.5 It is important to stress in regard to these insolvency proceedings that a bank that is facing actual or imminent insolvency should have its assets protected through early intervention by the supervisory authority because the longer an economically insolvent bank is allowed to continue operations, the higher the costs to the insurance fund.6 Th e demand for more (or better) regulation following a crisis is certainly a constant in the history of banking. By their very nature, mechanisms for resolving banking crises and insol- vencies are ex post.7 Th e objective is to provide: (1) certain ex ante policies to be implemented to prevent banking crises as well as measures to strengthen the fi nancial system; and (2) to explain the array of instruments available to deal with a banking institution in distress in the event that banking crises occur. Opportunities for Arbitrage Th e transnational reach of many corporations means they are able to raise fi nance from a variety of markets and so take advantage of a foreign currency with better terms and lower costs. Th is, however, leads to an additional risk: ‘currency risk’. When the economies of the countries of these indebted corporations are going through a recessive period, they are faced with low rates of return. In a crisis, it is not strange that currencies can be devalued resulting in even lower rates of return (in terms of net present value). While their income is reduced, the burden to pay the principal and/or interests of the corporation’s indebtedness in a foreign and (maybe) ‘strong/er’ currency increases. Th is mismatch, in many cases, has ended in restructuring episodes. As Rieff el stated, a sharp depreciation of the domestic currency in the course of a crisis causes companies to default on their loans from domestic banks as well as from foreign creditors, rendering a large segment of the corporate sector insolvent.8 4 See R Lastra, ‘Cross-Border Bank Insolvency: Legal Implications in the Case of Banks Operating in Diff erent Jurisdictions in Latin America’, Journal of International Economic Law (2003), p 80. Also see E Hupkes, ‘Th e Legal Aspects of Bank Insolvency: A Comparative Analysis of Western Europe, the United States and Canada (Studies in Comparative Corporate & Financial Law)’ (Kluwer, 2000). 5 H Schiff man, ‘Legal Measures to Manage Bank Insolvency in Economies in Transition’ in R Lastra and H Schiff man (eds), Bank Failures and Bank Insolvency Law in Economies in Transition (Kluwer, 1999), p 81. 6 Ibid, p 100; and G Benston, R Eisenbeis, P Horvitz, E Kane and G Kaufman, Perspectives on Safe and Sound Banking: Past, Present and Future (MIT Press, 1986), pp 37–42 and 91–3. 7 J J Norton, ‘International Co-operative Eff orts and Implications for Law Reform’, in R Lastra and H Schiff man (eds), Bank Failures and Bank Insolvency Law in Economies in Transition (Kluwer 1999), p 293. 8 Lex Rieff el, Restructuring Sovereign Debt: Th e Case for Ad-hoc Machinery (Brookings Institution Press, 2003) pp 43–4. ix 00-Olivares-FM.indd ix 2/24/2011 9:31:00 AM
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