Waiting for Carney – hard times and hard choices for restructuring counsel

‘Restructuring types will tell you the market’s just about to take off. It’s all going to hell in a handcart – catastrophe just around the corner,’ says Peter Baldwin, partner and co-head of Ropes & Gray’s special situations practice. Baldwin’s comments, of course, carry more than a hint of irony as hardened insolvency practitioners have been confidently – and wrongly – predicting an explosion of demand for their services since the banking crisis, only to be frustrated by the New Normal of permanently low interest rates.

But while restructuring counsel have cut increasingly forlorn figures in recent years, like Beckett characters forever hoping for the arrival of their Godot – or at least a decent rate rise from Mark Carney – nearly ten years on from the global financial crisis, they wait still.

It is telling of the current lull that one of the largest ongoing matters is a hangover from the banking crisis – the Lehman Waterfall litigation, to determine how some £8bn surplus on the estate of Lehman Brothers International (Europe) should be distributed.

There are a handful of big European restructuring and insolvency situations, but the likes of the $3.8bn Premier Oil debt restructuring and the Monarch Airlines collapse remain more exception than rule. With ultra-cheap debt plentiful and the banks that would have once casually triggered an insolvency becoming less central players, companies have repeatedly kicked the can down the road.

‘The restructuring market has been pretty quiet for the last two years, mainly driven by the ease with which companies can refinance,’ notes Ben Larkin, a partner at Jones Day. ‘Restructuring lawyers tend to be busiest when there is a burning platform. Ultra-low interest rates and enormous amounts of liquidity mean that most companies have plenty of time to deal with their issues and very rarely face a cliff edge unless it is a bond maturity.’

While restructuring counsel bide their time, they face an awkward decision on how to position their practices amid a challenging environment.

A seismic shift

‘Over the past decade there has been a seismic shift in the distressed market in Europe, characterised by a retrenchment of traditional banks and a massive influx of alternative capital, private equity and hedge funds,’ notes Kon Asimacopoulos, a partner in Kirkland & Ellis’ European restructuring group.

Where once banks were the dominant players, the likes of The Royal Bank of Scotland (RBS) and Lloyds have retrenched, while a proliferating band of credit shops, hedge funds and specialist investors have occupied much of the space once held by senior lenders. Nervousness around driving a distressed transaction with its risk and political ramifications have led all of the UK clearance houses to substantially reduce their exposures.

‘There has been a seismic shift in the distressed market in Europe, characterised by a retrenchment of traditional banks and a massive influx of alternative capital.’
Kon Asimacopoulos, Kirkland & Ellis

The surge in funds handling direct lending in restructuring – like GSO (Blackstone), Bain Capital, TSSP – has created ample liquidity for banks to unload distressed assets. ‘For funds there is not the same systematic risk as for banks if things go wrong,’ notes James Roome, a restructuring veteran at Akin Gump Strauss Hauer & Feld’s London arm.

Other recent trends are more sectoral. Insolvency work often comes in mini-waves. Where the dotcom crash and financial crisis brought their own cyclical spikes in activity, the downturn du jour since 2014 has hit the energy sector thanks to the oil price plummeting below $50 a barrel, with knock-on impact across the oil, gas and offshore services space.

The complex restructurings of UK-based North Sea oil producers EnQuest and Premier Oil proved a boon for legal advisers, but in Europe at least, energy mandates have started to tail off, with companies going down the disposal route as an alternative to restructuring.

The uncertain economic outlook in the UK and structural shifts linked to the rise of online shopping mean that the high street and travel sectors are viewed as other large targets. The scene was set by the high-profile collapse of UK retail stalwart BHS in April 2016 (see box below). Corporate failures like BHS and the recent administration of Monarch Airlines hit the headlines but remain exceptional.

More companies like Carillion and Interserve, which provide support services for government-backed entities, are also predicted to struggle amid budgetary constraints across UK government departments.

The ubiquity of debt securities in restructuring can be a double-edged sword for struggling businesses, in part for the sheer complexity of some of the new capital structures. ‘When the problem comes it becomes a car crash as they don’t have the money to pay the coupon. The problem becomes acute a lot more quickly,’ says Ken Baird, head of the restructuring and insolvency practice at Freshfields Bruckhaus Deringer.

Companies’ financial structures have changed hugely over the last ten years, typically becoming more complex and leaning increasingly on securities and specialist products over long-hold debt.

‘Companies used to have mainly senior and junior bank debt. Now you have more sophisticated structures with super-senior loans and bonds, and holding company PIK [payment in kind] notes. The result is a much more process-heavy transaction with more advisers, which takes longer and is more costly,’ agrees Kirkland partner Partha Kar.

Tooling up

The rise of credit and special situations funds has meant that advisers that have been able to move with the times have fared better in today’s more fragmented market. The debate continues in the industry as to how well the City players with a heavy bank focus such as Allen & Overy, Clifford Chance and Dentons have pivoted to cultivate links with the new band of funds that define the modern restructuring sphere. Unsurprisingly, US-based advisers argue their heritage and the influence of US debt investors give them an edge. While there is an element of sales pitch here, a neutral observer would only have to glance at the inroads made in some areas by Kirkland, Akin Gump, Weil, Gotshal & Manges and Latham & Watkins to conclude that such claims are more than just marketing.

Of the City firms, Ashurst is felt by some to have made a credible job of widening its franchise beyond key lender clients like RBS and Lloyds, it has also forged business with funds such as Cerberus, Apollo, Oaktree Capital, Bybrook Capital and York Capital Management.

‘For funds there is not the same systematic risk as for banks if things go wrong.’
James Roome, Akin Gump Strauss Hauer & Feld

Team head Giles Boothman notes the contradiction of the current market that lack of volume of traditional insolvency has not changed the attraction for law firms of being able to flexibly deploy lean, high-quality restructuring counsel across a range of situations. ‘We [Ashurst] see ourselves in the top tier with one foot in the mid-market. You have to do mid-tier as if you limit yourselves to top tier you may find there’s not enough to do.’

Of the London firms, Linklaters – a firm which few can challenge for company-side roles – has moved to bolster its core restructuring team with several notable hires this year to position itself with credit funds. In May, Linklaters hired Ropes partner James Douglas, two months after recruiting Goldman Sachs managing director Sarah Mook.

But the lion’s share of the notable recruitment has been at American advisers. Last year Sidley Austin, which in the last two years has sought to expand beyond its core structured finance business into mainstream City deals, has also sought to build out a UK restructuring capability. The firm last year hired up-and-coming Linklaters restructuring specialist Yen Sum, one of the partners who had been charged with building out the Magic Circle firm’s alternative investment client base.

Kirkland has been ramping up its team with the recent hire of James Watson as a restructuring partner from Stephenson Harwood. Even more significant was Kirkland’s recruitment of Freshfields restructuring partner Sean Lacey in May this year. The well-regarded Lacey was co-head of Freshfields’ alternative capital team and had previously advised clients including The Carlyle Group, WIND Hellas, BNP Paribas, ING, Natixis and UniCredit.

The latter hires came during the same week that Kirkland landed one of the most high-profile UK insolvency mandates of the year, the administration of Monarch (see below).

Kirkland also has the advantage of one of the largest US restructuring practices, investment in the City market predating the banking crisis and – like Latham – a natural crossover with its core leveraged finance business.
Weil Gotshal, Kirkland and Latham all have established relationships with the likes of Oaktree, Apollo and TSSP.

While Slaughter and May, Linklaters and Freshfields have unsurprisingly remained dominant players for advising major plcs in restructuring situations, US advisers have been able to play off the US insolvency elements typically emerging in major cross-border workouts. Given the staggering level of fees that can be generated in the deeper and more active US bankruptcy sector, such an edge is not to be dismissed.

But while many in the insolvency sphere are expecting an upturn in cross-border work, hopes for a revival in the UK market have faded, reflecting expectations that a post-Brexit Britain could be mired in ultra-low interest rates for years. Indeed, the gulf between the kind of fees that can be generated in US and UK restructuring has never been so huge.

Earlier investments in the City saw Weil Gotshal in 2014 recruit Goldman Sachs heavyweight Andrew Wilkinson, who at Cadwalader, Wickersham & Taft previously built a pioneering UK bondholder practice, while Jones Day the same year recruited high-billing partner Ben Larkin from Berwin Leighton Paisner.

‘Firms in the US are ramping up their restructuring businesses with headline moves and wouldn’t be doing so if they weren’t confident in a boom,’ says Weil Gotshal partner Adam Plainer.

In anticipation of a downturn, funds like TSSP, which has $20bn of assets under management, have raised a vast amount of capital which needs to be deployed, with limited opportunities for investing in distressed assets.

‘The scale of the funds raised and the timeline for the return of capital to limited partners means that special-situations investors have had to move away from solely-distressed investments in order to deploy the capital,’ comments Baldwin at Ropes.

The dearth of distressed situations means clients and their advisers have had to become more open-minded about the scope of their businesses.

Firms like Ropes – which has a ‘special situations practice’ instead of a restructuring and insolvency team – have diversified their offering to keep the business flowing.

‘Firms in the US are ramping up their restructuring businesses with headline moves and wouldn’t be doing so if they weren’t confident in a boom.’
Adam Plainer, Weil, Gotshal & Manges

Similarly, Larkin at Jones Day built on his fund relationships by advising Macquarie on a refinancing and sale respectively of two assets in Macquarie European Infrastructure Fund II.

With activity in the oil, gas and offshore space tailing off, lawyers will have to look further afield for restructuring work. ‘In offshore there is a lot of M&A – it has become a big recovery story,’ says Akin Gump veteran Roome of the other alternative to restructuring.

The end of the road

But while restructuring specialists are left either hunkering down or diversifying, the iron-clad belief endures that finally, eventually the day of reckoning that has been largely postponed since the banking crisis must arrive. With the Bank of England in November putting through the UK’s first rate rise for a decade – from 0.25% to 0.5% – and Brexit expected to heap further pressure on the UK economy, there is some cause for cheer (or rather gloom).

‘There could be a rise of UK companies limping gradually towards liquidation as they have been able to service their debt but have not been able to invest in growing their business,’ concludes Larkin.

The demise of BHS is expected to foreshadow a swathe of restructuring and insolvency situations for high-street retailers, not only due to Brexit-related curbs on spending but also the growing popularity of online shopping and a rise in retail rents. Fashion chain New Look is headed for a restructure of some £1.2bn of debt brought about by plummeting profits, while the owners of Jigsaw are tabling refinancing and disposal options for the cash-strapped chain.

‘There’s going to be a lot of distress on the high street,’ predicts Plainer, who advised BHS on its insolvency (see box, below).

While the full impact of Brexit is not expected to be felt for some time, many anticipate sections of industry to be hard hit long before the true effect on the wider economy becomes apparent. ‘The next wave of restructurings is likely to be in the discretionary spending arena. The likes of bar and restaurant businesses – anywhere consumers can curtail their spending on non-essential items,’ adds Larkin.

Until the next ‘boom’ arrives, the top restructuring firms are forced to watch their team leverage and resourcing closely and be ready to flexibly deploy their skills across a range of adjacent areas, including leveraged finance, capital markets and general corporate. There is still a demand for the select band of restructuring advisers who bring that special mix of nous, experience and judgement to the table.

‘Lawyers get business if the incumbent adviser doesn’t have the skillset to do a restructuring. If the existing advisers are not up to snuff, the financial adviser will say you’ve got to hire a proper restructuring counsel,’ says Baird.

‘Where a lot of practices are increasingly commoditised, restructuring is one of the few where the lawyer is at the forefront in the boardroom,’ concludes Boothman. ‘It ranks alongside public M&A, antitrust and high-end litigation as an area where the lawyer is as important as the financial adviser.’

If only there was a bit more of it. LB

nathalie.tidman@legalease.co.uk