Architects of restructuring: Harnessing insolvency to protect value and fairness

Insolvency was once viewed as a last resort option but as the insolvency toolkit expands and is increasingly deployed in multi-territory processes, it’s becoming a valuable lever and accelerator for consensual restructuring solutions. Drawing on the discussions at our Act now: Insolvency: More than a last resort webcast, we look at how businesses, creditors and restructuring practitioners can make the most of today’s evolving insolvency techniques.

By David Kelly, Restructuring and Insolvency Partner, UK Head of Insolvency, PwC United Kingdom

Despite emerging signs of economic recovery, the number of insolvencies continues to edge up¹. Tellingly, 97% of UK insolvencies involve businesses with a turnover of less than £1 million. With lenders recognising that value is generally best preserved by restructuring solutions, the vast majority of mid- and large-size companies have still been able to renegotiate or restructure their debt facilities.

Rather than being sidelined, insolvency mechanisms such as schemes of arrangement, restructuring plans, company voluntary arrangements (CVAs) and pre-packaged (‘pre-pack’) administrations are making a significant contribution to successful recovery, restructuring and survival in the UK and across the globe.

And as insolvency legislation and case law evolve, the options continue to expand. Prominent developments include bringing the bespoke administration regime for water companies² into line with the broader and more flexible general insolvency framework. The options opened up include ‘hive-down’, which allows the most viable and valuable assets to be transferred to a wholly-owned subsidiary.

These developments highlight the broad spectrum of potential solutions that insolvency covers, of which administration is the exception rather than the rule. Creditors and regulators are also recognising the value of insolvency techniques that allow the insolvency practitioner as much flexibility as possible to realise value and that this expertise is vital in also supporting consensual restructuring and these stakeholders are becoming ever more confident in harnessing them.

Lever of agreement

What does insolvency offer that can’t be achieved through restructuring alone? The development of an insolvency process to run alongside restructuring plans can act as a fallback and contingency. Insolvency techniques can also be used as a critical lens to evaluate restructuring plans. For example, across many jurisdictions including the Netherlands, a liquidation valuation can provide a baseline to gauge the potential surplus value that could be created from the restructuring proposals and hence judge whether the process is worthwhile. Insolvency mechanisms can also provide a counterfactual yardstick against which to assess legal safeguards such as ‘no creditor worse off’ fairness and with mechanisms such as cross-class cram-down, can also help to accelerate and enforce agreement among creditors.

Multi-territory solutions

Insolvency mechanisms are also opening up new and successful routes to multi-territory debt recovery and restructuring. The options now stretch from the use of US Chapter 15 to the international adoption of schemes of arrangement following the UK model. Groundbreaking recent examples include a Singapore court’s sanctioning of a pre-pack scheme of arrangement for the Vietnamese construction group No Va Land. We are also seeing many Europea variations on this theme including the Dutch WHOA and the German StaRUG processes.

Challenges to overcome

But with opportunities come challenges. For example, both restructuring plans and schemes of arrangement need to protect fairness. A case in point was the court rejection of the initial scheme of arrangement for Amigo Loans. While the scheme had been approved by around 95% of creditors, the judge ruled that customers didn’t have the financial sophistication to understand the full implications of the proposals which had also not been adequately explained.

Similarly, multi-territory agreements can be complicated by subtle, but critical, variations in local legislation and application. If we compare the scheme of arrangement process in the UK and Netherlands, for example, the Dutch interpretation of fairness offers additional protection to small and unsecured creditors by placing considerable emphasis not only on the liquidation valuation, but also on the allocation of surplus value realised through the restructuring in substantiating the fair allocation of value.

Making the most of the potential

How can you overcome challenges, preserve value and ensure flexibility? Four closely related priorities stand out:

The law is evolving

Insolvency is a fast-changing field, both domestically and internationally. New routes are opening up all the time. It’s important to identify and compare the available options to make sure your plans and their execution maximise value for shareholders and creditors.

Don’t ignore local nuances

Variations in legislation and approach have the potential to delay or derail creditor and court approval, even when dealing with broadly comparable options such as schemes of arrangement. So when developing and pursuing multi-territory solutions, be mindful of how what you’re doing in one jurisdiction might differ and possibly even jeopardise what you’re doing in another.

Ensure fairness

Insolvency mechanisms can be a powerful lever for agreement. But fairness is a critical part of any process, especially when consumers and other less knowledgeable claimants and creditors are involved. Particular scrutiny centres on the sharing of restructuring surplus and the valuations and counterfactual assessments that underpin this. The recent Adler appeal has provided a clear guideline of how the UK Court of Appeal considers fairness.

Negotiations can be complex and costly

Solutions can be costly and time-consuming to prepare and approve. But failure to address potential challenges around fairness or legislative variation can needlessly add to potential costs and delays.

Cutting across all these priorities is the need for high-level expertise, domestically and internationally. People with the necessary experience can streamline the process and get to the right answer quicker, while anticipating and averting potential challenges.