In a nutshell
The essential task of bankruptcy and restructuring lawyers is to avoid a client’s bankruptcy. The term ‘bankruptcy’ itself is a technical term that refers to when financially distressed companies, unable to restructure on their own, file for Chapter 11 to undergo a court-supervised restructuring.
In order to avoid this scenario, a company must successfully “restructure its debt to keep the company together and retain its value,” chairman of Davis Polk’s restructuring group Don Bernstein explains. But the path to financial viability – through court or not – can be convoluted. The legal know-how required and the multitude and variety of actors involved make bankruptcy and restructuring a rather complex practice.
Bankruptcy and restructuring attorneys must be adept at transactional work and litigation across a range of areas like M&A, securities, banking, labor and employment, environment, tax and IP.
Troubled companies will first attempt out-of-court restructuring, or corporate reorganization, in which they try to reach an agreement with their creditors. This has become an increasingly important stage. “Traditional Chapter 11 cases can be expensive, inefficient and harmful to the business,” according to Jay Goffman, global co-head of Skadden’s corporate restructuring group. “This means it's important to advise companies on how to avoid Chapter 11 or shorten their time in Chapter 11 and similar insolvency proceedings, rather than convincing them to do it.”
“Bankruptcy is the last bastion of the generalist.”
Chapter 11 provides for a court-supervised restructuring and, crucially, protection from creditors, who are barred from seeking to retrieve their money until the company is restructured. A notable feature of Chapter 11 work is the growing prevalence of 'distressed M&A', which describes the selling of parts – or the whole – of the ailing company. Such sales are done under the provisions of Section 363 of the Bankruptcy Code and often referred to as ‘363 deals’. Deals can also take place outside of court, but it is less common; buyers often prefer the safety of court-sanctioned sales.
The number of parties involved in a restructuring can be vast. They come from all walks of a company’s life and often have competing interests. Acting for the debtor is a challenge on its own, because then “everyone’s problem is your problem. You have to deal with every creditor and ensure the pie is allocated fairly,” Bernstein explains.
Representing creditors is often simply about trying to recover as much as you can from a debtor, but there are many different types of creditors to choose from. 'Secured' creditors include commercial and investment banks, insurance companies and hedge funds, while 'unsecured' creditors include bondholders and vendors, or 'trade creditors' (eg, auto parts suppliers). In Chapter 11, there are official committees of unsecured creditors and debtor in possession (DIP) lenders, while out-of-court proceedings will have bondholder committees.
Other parties involved may include strategic buyers and private equity firms and hedge funds interested in acquiring distressed assets. They engage in the purchase, sale and trading of debt claims. This has become one of the biggest administrative components of Chapter 11 cases. A special committee set up by the board to oversee the restructuring may also be involved and, in instances of 'gross mismanagement' by the company, a trustee is appointed to handle matters.
What lawyers do
Out-of-court restructuring for debtor
- Analyze the situation in order to determine the feasibility of staying out of bankruptcy. What’s the problem? What caused it? How big is it? Will it result in a default that is uncontrollable? Who’s in the creditor body? Are they secured or unsecured? What’s the litigation status? What’s the liquidity status? Are there sufficient funds to stay in business while being restructured?
- Look for 'red flags', such as jurisdiction. “You need to know if the entity has international operations, how it operates, how it’s interconnected,” explains Miller.
- Work with financial advisers to create a model of how the crisis will be dealt with.
- Try to persuade creditors to “just stand still” and not pursue immediate payback. “You need to focus on the nature of the debt in order to determine who you approach to get a standstill or moratorium,” Miller says.
- Negotiate with creditors and try convincing them that the problem is best solved out of bankruptcy.
- If negotiations are successful, work out payment plans for each creditor.
- If not successful, file for Chapter 11.
Court-supervised restructuring for debtor
- Initiate a Chapter 11 case to pursue restructuring within the protective provisions of the Bankruptcy Code (usually known as ‘filing for Chapter 11’).
- Prevent stigmatization of employees and business operations. Create a detailed communication plan to include regulators, shareholders, employees, vendors and clients. “Entry into Chapter 11 should be made as smooth and unruffled as possible,” says Marshall Huebner, global head of Davis Polk’s restructuring group.
- Secure financing. “Without liquidity to pay the bills, all is for naught,” Huebner explains.
- Once liquidity is secured, work with the management team and financial advisers to decide what’s core and non-core to the business. Establish the company’s new vision.
- Build creditor consensus around the chosen exit strategy. This can be a lengthy process and require delicate negotiations.
- If creditors think they are being economically harmed, there could be extensive litigation.
- Document and effectuate the eventual agreement.
Realities of the job
- “You need to be psychologically ready to handle the stress and strain inherent in being involved in a practice in which, by definition, there are huge amounts of failure,” says James Sprayregen of Kirkland & Ellis
- Jonathan Henes of Kirkland & Ellis sets out the skills needed by junior associates: “In the early years the focus needs to be on strong writing skills and learning how to be a strong oral advocate whether in negotiations or in court. As you get more senior, you need to also focus on the commercial aspects of the restructuring and become a counselor to clients.”
- Henes highlights the attraction of the bankruptcy practice as being “helping companies go from a place of trauma to a place of strength – that is a powerful thing.”
- This area is renowned for being particularly suited to those keen to get involved in the client side of things. Henes explains that you need “good judgment to thrive because these are hard situations not just intellectually but emotionally. You need to be focused on the human aspect of it all.
- The extent to which transactional work and litigation cross paths during a restructuring cannot be overstated. “There is a transactional aspect even when in court. You litigate by day and negotiate by night,” Bernstein describes.
- The nature of cases can vary enormously. Sprayregen adds: “Our work involves dozens of industries and that really does give you the opportunity to learn a lot.”
- Debtors face innumerable difficulties. They have no political muscle, whereas creditors do – and flex it. Though bankruptcy laws are constantly amended, they continue to favor creditors.
- In order to lead such a diverse group of parties to a consensus, debtor attorneys must possess strategic, tactical and managerial skills.
- Steering clients clear of Chapter 11 through out-of-court restructuring often requires a creative and innovative approach.
- The current Chapter 11 was passed in 1978, but it comes from Chapter X, which was passed in the 1930s. “The Bankruptcy Code has its roots in the Great Depression,” Bernstein says.
- Chapter 15 is the provision for cross-border bankruptcies that dictates proceedings in the USA when the main proceeding is in another country. Designed to ensure that all creditors and debtors are treated fairly irrespective of jurisdiction, it may also involve Chapter 11 proceedings if the debtor’s assets are sufficiently complex.
- Restructuring is a lengthy process that requires a considerable amount of work before an outcome can be reached. “There are so many different stakeholders and other components, and you spend a lot of time on the process itself – which I didn't expect as a young associate,” Sprayregen tells us.
- Bankruptcy and restructuring is considered a countercyclical practice. When the market is healthy, bankruptcy attorneys may find themselves working on more diverse corporate matters.
- Negotiating terms for debtors in possession is a complicated balancing act. Attorneys must assess liens or security interests, prioritize creditors, determine the value of secured properties and argue for or against continued possession of secured properties in order to remain operating to better pay off creditors.
- Lenders’ needs have to be attended to carefully, Huebner explains, because “very frequently if lenders have a vested interest in a company, they’re the ones who will get wiped out; more typical than not they become Chapter 11 financiers.” As such financiers, lenders tend to impose very difficult and sometimes onerous terms on the debtor to stimulate sales and liquidations.
- Sprayregen notes that, “ultimately, the most successful cases will be the ones that are the least problematic. Those cases are less interesting from the media’s perspective, but that's when you really see success.”
- Ira Dizengoff of Akin Gump describes how Bankruptcy is a very fast-paced area of the law: “The nature of the companies that undergo reorganizations means you will see more cross-border restructuring which adds to the complexity. You are at the cutting edge and it moves quickly – there is never a dull moment."
“You need to be psychologically ready to handle the stress and strain inherent in being involved in a practice in which, by definition, there are huge amounts of failure.”
- While the recession brought about a significant rise in bankruptcy filings in the USA, this has since been decreasing. The United States Courts records business bankruptcies falling from 34,892 in 2013 to 23,109 in 2017.
- With e-commerce booming the woes of the retail industry look to continue. In 2017 more than 300 retailers filed for bankruptcy (a record) including giants like Toys R Us, and S&P Global Ratings suggests 2018 could see even more.
- According to Moody's Investor Service, a record $1 trillion of junk-rated corporate debt that will mature by 2020, putting companies in severe debt at extremely high risk.
- Oil and gas companies continue to give bankruptcy practitioners plenty of work. The industry hosted new fewer than 21% of 2017's 71 public company bankruptcies and four of the ten largest Chapter 11 filings in 2017.
- The Federal Reserve raised interest rates at both the start and end of 2017 and forecasted three additional three additional rate increases in 2018 and 2019. What does this mean? A higher interest rate environment leads of variable rates in loans and therefore to more bankruptcies and more restructuring.
- Bankruptcy can be an expensive and lengthy process and companies try to avoid it, but it's been getting steadily more costly. To give an example of what this can look like at the top end, Kirkland & Ellis' lawyers were charging Toys R Us as much as $1,745 an hour during the company's bankruptcy proceedings – though this was 25% more than the highest rate in ten of 2017's largest bankruptcies.
- In February 2018 the Trump administration announced proposals for a new 'Chapter 14' bankruptcy process. Ostensibly to prevent taxpayer-funded bailouts, the new process was suggested by the Treasury as a 'resolution method of first resort'. Details on what this would entail in practice, and whether or not it will actually be implemented, remain sketchy at the time of writing so keep an eye on how this develops.
- After nearly a decade in recession, the US territory of Puerto Rico filed for what amounted to a federal bankruptcy in May 2017. The island owed $74 billion in debts and more than $53 billion in unfunded pensions; by March 2018 law, accounting and consulting firms had charged it $75 million in fees as a result of debt reorganization proceedings.
"It’s definitely a ‘learn on the job’ type of practice. In essence, you get an MBA on the job.”
Advice from the bankruptcy/restructuring gurus
“The common assumptions one makes about bankruptcy – be they informed or uninformed – in law school are generally erroneous. I never thought I would end up in this area of law. It sounds mundane but it’s really not.”
“It’s rare to get well-informed applicants, because bankruptcy law is a one-semester class at most law schools, so I wouldn’t expect our new attorneys to be up-to-date on the most current legal issues. It’s definitely a ‘learn on the job’ type of practice. In essence, you get an MBA on the job.”
James Sprayregen, partner, Kirkland & Ellis
“When you start working on a matter, try to imagine what the vision of success will look like and then develop the strategy and tactics that will allow you to accomplish that vision – and make sure that vision is shared by everyone on your team. But even if you succeed, you have to be flexible as the matter won't always end up like what's drawn on the blackboard. You have to embrace the chaos!”
“The restructuring process can be difficult and ugly so don't become a prisoner of emotion if you want to be valuable to the client.”