Before sunset – City restructuring partners on what businesses need to know in tough times

Inflation has been soaring and interest rates are at their highest level in years – throw geopolitical uncertainty, an energy crisis and strike activity into the mix and it’s clear why UK businesses are facing a challenging time.

Against this backdrop, it’s little wonder that between April and June this year corporate insolvencies reached the highest quarterly level since Q2 2009, according to data from the Insolvency Service.

But while the outlook may be challenging, with well-known retail and hospitality brands including Hunter Boots and Le Pain Quotidien among casualties in recent months and homeware store Wilko on the verge of collapse as this article went to press, there are options available to companies that don’t end in administration.

Here, private practice partners talk through some of the considerations that in-house legal teams and businesses need to think about as they navigate difficult markets and try to shore up their future.

Macro influences

While some industries may be feeling the pinch more than others, the macro factors affect everyone. Recent years have seen a number of strong US firms build up London practices that can advise companies – including those destabilised by more recent market disruption – on both restructuring and refinancing matters.

During the pandemic, a lot of firms geared up for a tsunami – or wave of restructurings – but it just didn’t transpire.
Howard Morris, Morrison Foerster

Adam Gallagher, who heads the London restructuring practice at Simpson Thacher after leaving Freshfields in 2021 to launch the team, sets out the state of play in the UK: ‘Everyone has the same macro impacts; high interest rates, inflation, labour shortages etc. The refinancing market is also shallower – private credit is now a huge part of the market rather than just banks, but it isn’t the case that people with lots of dry powder are always willing to deploy it. SMEs are being hit hard – whereas the bigger institutions have generally had some insulation.’

To date though, while the markets have been tough, large collapses have remained relatively rare. Borrowing has been cheap and even when traditional banks have tightened terms, credit funds have been playing an increasingly large role in lending.

As James Watson – who joined Simpson Thacher alongside Gallagher in 2021 – points out: ‘Hedge funds, debt funds, distressed debt funds – there are not that many out there who want to own businesses. Many lenders have been built to buy and sell out of loans, not run businesses and it would be disadvantageous to their businesses to do so.’

Howard Morris, who leads the London business restructuring and insolvency team at Morrison Foerster, comments: ‘During the pandemic, a lot of firms geared up for a tsunami – or wave of restructurings – but it just didn’t transpire because governments around the world moved to give support to their corporate and enterprise sectors. The ability of the economy to withstand all these pressures is extraordinary.’

Like others, Morris believes this may now change, with higher interest rates pushing businesses closer to the brink and even larger corporates set to lose some of that insulation they’ve enjoyed.

He says: ‘We’ve seen historically low numbers of restructurings and insolvencies, particularly when one looks at the level of activity in the corporate sector. That’s for all the reasons everybody’s familiar with – lots of cheap money, few alternatives and greater sophistication among lenders and financial creditors about the prospects of what they could get out of an aggressive restructuring and willingness to show patience and extend terms. The view is that this is coming to an end.’

Dechert London practice head Adam Plainer adds: ‘Things have been flat for a couple of years, but with inflation and interest rates and a fair amount of debt that needs to be refinanced, activity is picking up. What we haven’t yet seen is an uptick in big business insolvencies – a lot of stuff has been in the mid-market.’

Under pressure

Some industries are of course expected to fare worse than others in times of high inflation. In particular, those dependent on discretionary spend are likely to feel the pain given the cost of living crisis squeezing spending. Companies whose business relates to the real estate sector are also predicted to struggle for obvious reasons, while holiday companies are also on the watch-list for next year in the eyes of many partners.

Greenberg London restructuring chair John Houghton, who joined from fellow US firm Latham in late 2021, says: ‘I think anything that involves discretionary spending [may find it harder]. Cineworld went into Chapter 11 bankruptcy protection, for example, and the cost of living crisis is going to intensify this trend. Casual dining is another example of a sector being squeezed by the slowdown in discretionary spending, along with gyms and fitness centres – anything where you can cancel to save money, because with mortgage rates going up, further belt tightening is inevitable.’

Morris adds that anything consumer facing will be under pressure. ‘We will also see that everything associated with house building and residential property will be impacted. It’s going to be very difficult in that whole ecosystem around residential property. There’s also a whole bunch of companies in hospitality that are going to be struggling – if they aren’t already.’

Feeling the squeeze

Irrespective of industry sector, any business with high debt levels will be likely to struggle, as demonstrated in recent months by the well-publicised troubles at Thames Water. The utility giant is struggling under the weight of some £14bn in debt, triggering talks of government intervention and special administration in the event that it cannot resolve its debt crisis.

In a rising interest rate environment, people aren’t swimming naked, but they are having millstones hung around their neck and are slowly drowning.
Adam Gallagher, Simpson Thacher

And it isn’t alone. As Gallagher comments, paraphrasing Warren Buffett’s famous quote: ‘In a rising interest rate environment, people aren’t swimming naked, but they are having millstones hung around their neck and are slowly drowning. It’s becoming so hard for some of them to maintain their debt.’

When trying to refinance, many corporates will find traditional banks less willing to lend than they used to be, meaning that they will be turning to credit funds instead of relationship banks.

According to partners, whoever your lender is, corporates need to accept that debt is more expensive than it used to be. Turning down a refinancing package with a higher interest rate now in the hope that better alternatives come to market in the future could lead to far bigger problems.

‘It’s easy to be wise with hindsight’, says Gallagher, pointing out that ‘restructurings happen when refinancings can’t.’ He adds: ‘Arguably those low interest rate years were never a “normal” – this higher interest rate environment may not be going away. We are likely to be in a more expensive debt market for a while, so refinancing options should probably be seen in that
light’.

When a plan comes together

What Prezzo was really about was the trend of using Restructuring Plans (rather than CVAs) to right-size large leasehold estates.
John Houghton, Greenberg Traurig

One option that companies in difficulty need to consider is the new UK Restructuring Plan. Ushered into effect in 2020, the procedure allows companies an alternative to a Scheme of Arrangement and has already been used by well-known businesses including Virgin Atlantic. The process is intended to protect businesses from collapse by allowing them to restructure and come out stronger. It enables courts to push through the restructuring order even in the event of dissent from some creditors via the ‘cross-class cram down’.

Greenberg has been involved in the restructuring plan for restaurant chain Prezzo. Houghton says: ‘What Prezzo was really about was the trend of using Restructuring Plans (rather than CVAs) to right-size large leasehold estates where the non-profitable sites were closed down and the liabilities due to the landlords written off. That was the original objective of it. So Prezzo should be read alongside the Restructuring Plans for Lifeways, Fitness First, and Virgin Active.’

While it would be impossible to save all companies – in some instances a business model may have been so badly disrupted that the business is no longer viable – like Chapter 11 in the US, the UK restructuring plan is seen as a helpful tool to let viable companies recover and rebuild.

‘The relative absence of stigma’ is a key factor behind their popularity, says Gallagher. ‘You think about liquidation/insolvency with fear, but then you look at the calibre of companies that have been through a plan – the very first was Virgin Atlantic. It’s a bit like the airlines that went through Chapter 11 – customers still trust them. These tools are seen as rehabilitative and accessible and not stigmatised. They actually fix problems and deliver a business back in a much improved state. And in most cases it’s much cheaper than Chapter 11.’

Managing through the fear

Whether a company is looking at a refinancing or a restructuring plan, or Scheme of Arrangement, it’s important to put the preparations in place early.

Burying your head in the sand will limit options and companies need to bear in mind that restructuring plans take time to put into place – and that will be time when costs continue to rack up. The formal restructuring plan process may take around six weeks, but getting to that point via negotiations with creditors and booking in a court session can take three months or so on top of that.

‘Law firms are there to help in managing through the fear,’ says Gallagher. ‘We’ve done this work before and it will be fine if you act quickly and carefully, including where the debt is held by credit funds and not relationship banks. The best thing you can do is involve people early.

‘Denial tends to be the first stage, but not talking to people early wastes time and erodes options. Restructuring plans/schemes take time and you need to allow for that. You don’t need all creditors to agree to get a restructuring plan that’s binding on everyone, but you need to build that consensus early. It can be very costly to waste time.”

In the meantime, in order to avoid problems in the longer term, all companies should be doing a healthcheck on their debt documents to make sure they are fully aware of how they are capitalised.

Legal 500 London restructuring rankings 2023

Tier 1
  • Akin
  • Allen & Overy
  • Clifford Chance
  • Kirkland & Ellis
  • Latham & Watkins
  • Linklaters
Tier 2
  • Freshfields Bruckhaus Deringer
  • Milbank
  • Weil, Gotshal & Manges
  • White & Case
Tier 3
  • Ashurst
  • Hogan Lovells
  • Mayer Brown
  • Slaughter and May