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,” chair 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, former 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' (e.g. 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.”
- The obvious story here is the economic crisis created by coronavirus. Vulnerable companies will be seeking out lawyers to manage their liquidity and solvency, and handle their bankruptcies. Already we've seen significant growth in bankruptcy staffing, reallocating from transactional areas.
- With e-commerce booming, the woes of the retail industry look to continue. In 2018, the retail industry accounted for five of the ten largest Chapter 11 filings. The trend continued in 2019 as a number of big retail brands filed for bankruptcy including Shopko, Gymboree, Diesel, Barneys New York, Forever 21, and Charlotte Russe.
- In a report published by Moody's in January 2020, VP-Senior Analyst Anastasija Johnson stated that “US speculative-grade companies have $1.186 trillion of debt maturing over the 2020-24 period, up from $1.044 trillion last year, for 2019-23 maturities.”
- That concern is echoed by additional research which suggests that large companies in the US owe approximately $10 trillion in corporate debt, representing 47% of the country’s GDP – the largest in its history. Even more worryingly, $5 trillion of this will become due in the next five years.
- According to a report by PwC, the number of bankruptcy filings in the US increased by 2.4% in 2019. That doesn't sound like much, but the aggregate liabilities addressed in those filings increased by a substantial 55.9%.
- Cumulatively, research by the American Banking Institute shows that California had the most filings in 2019 at 67,150. That’s followed by Illinois with 47,860 and Florida with 45,526 filings.
- 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's 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.
- 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.