An increasingly legal landscape

Setting the scene with an overview of the German restructuring landscape, Max Mayer-Eming, Managing Director at Macquarie Restructuring & Special Situations explained that Germany has very few financial restructurings and if something goes into insolvency, it
had already become a very distressed operational situation. “I think from a regime perspective we are currently seeing – over the last ten years at least – that everything is going rather ‘legal’ in order to increase transaction security: we have the S6 [restructuring opinion] which is very important, although there is so much focus on that, sometimes too much in my view,” he said, while also noting the changes in insolvency law to enable a debtor-in-possession insolvency plan style restructuring. Mark Hoffmann, Portfolio Manager at Robus Capital described the process of assessing the restructuring options for a company. “The first question is can it be done out of court, or does it have to be done in court. I think in most cases, particularly for financial investors, the former is the preference, simply because as a creditor you keep more control”, he explained.

“Where it is not possible to achieve an out of court deal, eg if the unsecureds will not play along or you have a larger consortium where a single party has different views and wants to obstruct or extract value, clearly that has a negative impact on price because – as much as it has evolved for the better – the German framework, in particular for in-court restructurings, is still fraught with uncertainties in terms of outcome, particularly when it comes to keeping a grip on the process as a large creditor,” explained Hoffmann.

“If a restructuring has to be in-court then the preferred avenue for value preservation and later stage value creation would be the Chapter 11-type insolvency plan, but that still has major issues: you might be the largest creditor and own perhaps 80% of the claims but you can still be voted down because of how the groups are structured. That is something you can never fully grapple with beforehand,” added Hoffmann. “So, if you can get it done out of court that would achieve the highest price, if you have enough vantage points for the insolvency process, management and shareholders are on board and you’re all working together that is next (highest). If you have none of that clearly you would put the lowest price on the whole situation because of the uncertainty,” he concluded.

According to Hoffmann, “the willingness of banks to sell assets – particularly the willingness to potentially sell earlier when it is still 50/50 whether it is the right time and price – has shrunk; which is understandable because everybody wants to hold on to assets.” “Unfortunately, that leads to a situation where banks try to sell when it is way too late and the price would then have to be very low, which is difficult to stomach for the selling bank. Also, if they leave it too late they can come up with other ways to make good or try to be difficult or push companies into insolvency under some assumptions that don’t then necessarily hold true and ultimately the recovery for everyone is lower, so that’s definitely a negative side effect of the
current liquidity.”

Scheme supreme?

Continuing on the subject of predictability and certainty of outcome,Grell pointed to the UK scheme of arrangement. Dawn Grocock, European Legal Analyst at Debtwire, explained that “the English court – in particular Mr Justice Snowden – has been very keen to emphasise that it is not a rubber stamp and will scrutinise the facts of each case. The court has a discretion whether to sanction a scheme.” Grocock gave an example of the Indah Kiat case, which came before Snowden J last year and raised a number of concerns at the convening hearing which led to Snowden J adjourning the hearing. One concern was that it was not clear how independent the supporting creditor was. “Unfortunately for a lot of commentators,the case was settled so we never got to find out what would have happened”, explained Grocock. While the UK scheme has had a period of success, “there is a potential storm on the horizon in the shape of Brexit”, warned Grocock. “In spring 2019 the UK is going to come out of the EU and no one knows exactly what the arrangements are. I think the key hurdle for the scheme will be recognition, ie the question of whether or how other EU member states will recognise schemes”.Grocock explained that the English court will only sanction a scheme if it is satised that the scheme is likely to have ‘substantial effect’, ie be recognised and effective in any jurisdictions where the debtor is incorporated or has assets or creditors. Absent an agreement to the contrary, the EU Judgments Regulation, which is the main ground currently relied on for EU-wide recognition of schemes will no longer apply in the UK post-Brexit. While various other bases for recognition are being mooted, eg the Hague Convention on Choice of Court Agreements, and (if more countries implement it) the UNICTRAL Model Law on Cross-Border Insolvency, there is no clarity. However, Grocock remained confident that the UK’s commercially-minded judiciary and expert advisers will be able to deal with the recognition conundrum and that we have not seen the end of the UK scheme.

Bertram Schuetz, Partner and Head of Germany at Capzanine,strongly disagreed: “Why would you take the chances if there’s a hard Brexit? People will think about potential solutions in the Netherlands, which is also much closer to the continent than the UK,or elsewhere. I think it will have a very drastic effect. If I had to restructure a company in spring 2019 I would not lose too much time in thinking about whether it would be recognised and how it would work if I go to the UK. If I’ve got other options I would definitely go for the other options.”

The panel noted that the Dutch are making headway with reform, including the introduction of a scheme tool. The draft bill was published recently and, all being well, it could be in force within ayear. “Dutch lawyers I’ve spoken to seem to think it will be highly competitive with the UK scheme and will have various advantages,the main one being a US Chapter 11-style cram down – so entire classes can be crammed down – whereas perhaps one of the weaknesses of the UK scheme is that every class needs to vote in favour of it,” explained Grocock. “Having said that, the UK government is considering reforms, including introducing a new exible restructuring plan with cross-class cram down. However, the last update we heard was almost a year ago – I’m guessing the government is distracted by Brexit.”

 "The UK’s commercially-minded judiciary and expert advisers will be able to deal with the recognition conundrum."

Questioned by Grell about what makes companies go to the UK and use the scheme despite German law having been modernised,Mayer-Eming said “I think the reason why we moved to the UK and to implement something by a scheme is clearly the lack of out-of-court majority decisions we still have in Germany. I think this is potentially going to change [with the new pre-insolvency law]. The other reason is most of the schemes or bigger situations we had have been LBOs with very international creditors, and many of them have been based – especially if it got more and more distressed – in London. This is in my view going to change: if you have got to decide if a scheme is going to be recognised after Brexit or not, this is a clear game-changer.”

Grell was “cautiously optimistic” that we will have a practical regime implemented via the EU. “From a German perspective, we have the tendency to criticise our own regime, but we see that the Dutch and English are considering cross-class cram downs, which not only the US have but which Germany also has. Sometimes it’s good to be reminded of the fact that our laws are more modern and better than we think.”

Alternative funding

On the subject of alternative investors, Schuetz did not believe that Germany mirrors the American market where private debt funds provide mid-sized companies with debt. However, he noted the different types of management coming into place, with third generation management in family-owned businesses. “They have (been) trained at university, even the States, and have a very modern corporate governance style. They would expect to see more than the classic house bank offering on the table, so it opens the space and might mean that in restructuring situations people get a bit more realistic and open minded and accept different people around the table, not only bankers.”

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Dawn Grocock Legal Analyst Debtwire