We all know how to find a good service provider - personal recommendation. But what if you want help now and don't know who to ask?

One piece of good advice is to be wary of paying someone up front to find an investor for you - see Corporate Insolvency - Ecademy for an independent consultant's view. Any good professional will discuss your business with you first without charge and look to establish whether a business angel is likely to invest. I certainly would, and I would be delighted to help you find an investor if that's the best thing to do in all the circumstances. Of course, the right solution may be corporate or operational restructuring, or even the use of an insolvency process, and you may be advised to spend money with the professional to implement that optimum solution.

By the way, adding to the Ecademy post, if you want to find an insolvency practitioner (not that you need to look any further if you're reading this),  the most user-friendly search tool is at the website  of R3, the insolvency practitioners' trade body,  here.

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The European High Yield Association has announced refinements to its proposals to the Treasury on insolvency law reform.

Its original submission in April 2007 identified perceived shortcomings of the Enterprise Act reforms:

". . . the administration procedure has not been widely used in distressed situations and, more generally, statutory processes have been avoided.

We believe this occurs for the following reasons:

• despite the best efforts of those in government and elsewhere, administrations and Company Voluntary Arrangements (CVAs) are still perceived in the UK as reflecting corporate failure rather than rescue, which depresses confidence in the business and enterprise value;
• the ability of suppliers and customers to abandon their contracts with the distressed company if it makes a formal insolvency filing discourages filing, and where filing does ultimately occur, the ability to cancel contracts destroys the value of the business; and
• difficulties in obtaining funding in administration impair the company's ability to trade through the proceeding."

The first point above is uncontroversial; a direct remedy to the second by a simple extension of the administration and small CVA moratoria enjoys the support of the City of London Law Society (here), amongst others; and the third point refers to DIP funding (although some might argue that administration is inimical to the concept of debtor in posession).

Under a heading "Facilitating 'out-of-court' restructurings in the UK" then come three suggestions leading to "a call for a court supervised restructuring process":

• An all-encompassing stay on actions should be available to prevent value destruction as this is currently seen as an inevitable consequence of filing for insolvency in the UK. In other jurisdictions, notably the US and France, contractual termination provisions are not enforceable. The current stay deployed by English law does not go far enough in protecting failing businesses and allows customers and suppliers to terminate contractual relations just when their continued commitment is most crucial to the rescue.
• A framework should be created for fast judicial resolution of valuation disputes in restructurings, short of administration proceedings. This will enable practise and precedent to develop in restructuring valuations, thus providing stakeholders with relative certainty of outcome, whilst avoiding the value loss that arises through administration.
• Creditors or shareholders with no economic interest in the revalued enterprise should not be able to block restructurings or force full insolvency proceedings. A mechanism is needed to deal fully with 'out of the money' claims in restructurings.

It is these lightly sketched but far-reaching proposals that are now refined and extended - and will be considered in a subsequent post.

 

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Here's a view on the UK's economic outlook from Howard Reed, Chief Economist at the Institute for Public Policy Research, published in the New Statesman: Was Northern Rock the worst of it?

Despite huge stock market falls in the last two days, the balance of comment still appears to be that the underlying UK economy is in reasonable shape and whilst we can expect further tightening a recession is not on the cards.

Reports following analysis of January's Monetary Policy Committee minutes at Bloomberg and Channel 4 News illustrate current thinking (although the latter notes that George Soros, billionaire investor, disagrees. . . ).

No recession, I agree, but we certainly haven't seen the worst of the turbulence. In the business world I think there are many who have not yet come to terms with either the dramatic change in lenders' appetites or the effect the turbulence has had on consumer sentiment.

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More food for thought in a post by John Armour on the Credit Slips blog.

I agree with the conclusion that:

"we're going to see a number of the highly leveraged buyouts that run into difficulty winding up in formal bankruptcy proceedings, after a workout has been attempted and failed".

And this may well lead to attempts to reform some European bankruptcy codes.

It will also promote and no doubt extend the migration concept (previously discussed here).

Moving a COMI (centre of main interests) to a jurisdiction where the insolvency regime is more suited to concluding a successful restructuring not only can be done, but can add huge value to the restructuring.

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The credit crunch of August-September 2007 has disturbed the economic equilibrium - and may continue for a while yet. Debates about illiquidity or insolvency abound, but are we really facing a swing from boom to bust?

The underlying UK economy is strong, but we now have corporate transactions stalling through lack of funding, hedge fund failures, a sub-prime lender in administration and the Northern Rock bailout. What many considered a strange US phenomenon (had many people heard of sub-prime before this summer?) has become a real domestic issue. No wonder business and consumer sentiment is waning:

• the ICAEW UK Business Confidence Monitor (BCM) has moderated in Q3 2007 from a Q2 peak of +11.5 to a relatively weak +4.8;
• the BDO Optimism Index shows a sharp fall in August, from 101.9 to 101.2, confirming the impact of the US sub-prime crisis on UK businesses. This drop takes the Index to its lowest score since November 2005 and whilst business optimism has been decreasing slowly since July 2006, it appears that the impact of the turbulent financial markets has accelerated this trend; and
• the Nationwide Consumer Confidence Index fell back in August reflecting the impact of five interest rate rises over the past year. The main Index fell by two points, but it was not alone. All indices fell in August, the first time since December 2006 that all four measures of confidence showed a downturn in the same month.

For a reminder of how the credit crunch derived from the US sub-prime contagion via risk reappraisal amongst lenders and hedge funds, how CDOs, CLOs and SIV-lites were ideal vectors to spread the disease around the world, and the impact on bank lending, read "While you were away - fear and loathing in the markets" from The Times.

Other recent indications of the state and direction of the economy are:

• US business bankruptcies are on the rise, reports Bob Eisenbach, quoting Euler Hermes, who continued to forecast a small rise in the UK. After we reported Euler's November '06 forecast in a previous post, Geoff Swire commented when the UK's June insolvency figures became available that the forecast had been pessimistic. I suspect it was a timing issue and that corporate insolvency statistics in Q3 will rise in the UK, albeit by less than in the US.
• The world has changed dramatically: Germany’s Chamber of Industry has been flooded with distress calls from family Mittlestand firms unable to roll over credit lines and in Canada and Australia, junior mining finance has dried up almost entirely, according to Ambrose Evans-Pritchard on his Telegraph blog post "Brace yourself for the insolvency crunch".
• If the liquidity crisis continues it will will become an insolvency crisis and the banking industry will be hardest hit, according to Panmure Gordon.
• Insolvency firms are likely to be busy dismantling failed investment vehicles, with the most likely suspects being the quantitative hedge funds and funds focused on CDOs that have fallen foul of market conditions, writes Antonia Rawlinson "Uncertain times call for certain measures" in The Lawyer.
• "The M&A boom is over and law firms must adapt" agrees James Rossiter in The Times - restructuring is now the hottest game in town.

So what does all this mean? Yes the capital markets are in turmoil, banks are lending much more cautiously and some high risk investment vehicles are failing, but essentially this is only a liquidity problem. Its effect though is that stressed businesses will no longer be able to borrow their way out of trouble as they have become hard-wired to do over the last 3 years.

Crisis cash management and operational and corporate restructuring will come back into vogue as refinancing becomes passé. Only if stressed businesses fail to seek appropriate and timely assistance will the business insolvency statistics really start to rise.

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The New York Times DealBook blog reports a Boston Globe article interviewing private equity firms TA Associates and Thomas H. Lee Partners (thanks again to Bob Eisenbach for flagging this here). The article reinforces the view we expressed in an earlier post that lax credit standards could magnify default rates in an economic downturn.

A private equity investor borrowed at 2.25 per cent over LIBOR. When the target investment defaults, the investor can "toggle" its loan repayments into "payments in kind", borrowing more from the lender (at a 0.5 per cent interest premium) to make loan repayments. No real penalty for loan default then - hence, "covenant lite"!

This shouldn't be a problem when the odd investment defaults, but it makes a hard landing more likely than a soft one when the economy turns.

Do you think the debt bubble is encouraging private equity to store up problems, or is there enough liquidity in the system to weather any run of defaults? Let us have your comments.

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Schefenacker reports that its bondholders have agreed today, at a company voluntary arrangement meeting, to take:

• EUR 7.5 million cash;
• 5% of the equity; and
• warrants that could raise the equity to 15%.

The shareholder, Dr Alfred Schefenacker, retains 25% of the equity but has contributed:

• EUR 20 million of new money;
• his personal equity in the Engelmann subsidiary; and
• the cancellation of EUR 100 million of shareholder loans.

Senior creditors now hold 70% of the equity.

The success of the migration now depends on the operational restructuring that Stephen Taylor has been managing during the last few months of stakeholder negotiations - he claims "a solid first quarter performance".

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The credit that is fuelling leveraged buyouts and other private equity deals may become tomorrow's problem, according to a recent post by Bob Eisenbach. The US Bankruptcy lawyer draws on articles in the Financial Times and the Guardian (courtesy of a New York Times blog).

Sub-prime mortgage lenders are suffering in the US just now and commentators are drawing parallels to suggest that lax credit standards in the corporate arena could magnify default rates in an economic downturn. The problems will be exacerbated by investors who have chased returns and moved towards more illiquid hedge and buyout funds.

Do you agree? Are you seeing rising default rates? Send us your comments.

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Debtors migrate but creditors forum shop.

Robert Hickmott and Alex Ballman write in Legal Week about how the trio of German cases:

• Deutsche Nickel


• Hans Brochier


• Schefenacker

illustrate the post-Eurofood attitude to COMI (centre of main interests) under the European Insolvency Regulation.

It has been established through cases like Staubitz-Schreiber that debtors can move their COMI, and this facility was used in the Collins & Aikman restructuring and insolvencies.

But forum shopping, where creditors race to their court of choice, is what the European Insolvency Regulation sought to avoid.

With COMI now established as elsewhere than the place of a company's registered office only as a result of factors that are both objective and ascertainable by third parties, such cynical or opportunistic forum shopping by creditors is rightly deprecated.

There are many reasons why a debtor might choose to make use of an alternative insolvency regime by moving its COMI, such as:

• to give UK and US stakeholders comfort that a flexible and familiar (UK) restructuring environment will be available;


• to make use of Insolvenzgeld funding (Germany & Austria);


• to avoid Acquired Rights Directive/TUPE problems with employees (Netherlands);


• to enhance employee protection (France); or


• to use DIP financing (Sweden).

But it will be critical, as the Hans Brochier directors discovered, to get the details of the COMI move right.

The Deutsche Nickel mechanism - conversion to a limited partnership and transfer of the assets and liabilities to the new general partner (in that case an English company) by universal succession - is a specific form of migration that nevertheless requires a COMI to be established in another jurisdiction.

Migration is the acceptable face of forum shopping, and we will see more of it!

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Bondholders may not find 5% of the equity an appealing prospect, but the level of pain to be borne by Schefenacker's existing shareholders is yet to emerge.

The company has announced replacement of €250m 1st and 2nd lien debt and €200m of subordinated bonds with new debt of €305m:

• €25m senior revolving credit
• €170m senior term loan
• €110m mezzanine

Some of the €55m "new money" is said to come from a mezzanine investment from the group's owner, Dr Alfred Schefenacker, who is also transferring minority interests in Schefenacker Engelmann Spiegel GmbH to the group. His shareholding in the group is to be reallocated in part to the senior lenders.

The value of his financial contributions and the extent of his the equity dilution may be enough to make the deal work. The company says it doesn't need bondholder approval, but neither has it yet announced the detail of the restructuring mechanism. . . .

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Bloomberg.com reports progress in the restructuring.

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Schefenacker AG, the €930m turnover automotive parts group manufacturing rear-view mirrors with 7,900 employees in 33 locations worldwide, which was founded in Esslingen (near Stuttgart), Germany in 1935, has become Schefenacker PLC with a registered office in Portsmouth, UK. (Were some reports of the company moving to Brighton a mis-translation of Britain?)

In a move redolent of the Deutsche Nickel restructuring in 2004/05, the owner of this typical Mittelstand family business, Dr Alfred Schefenacker, is likely to be diluted to below 4%, with the majority of the equity passing to bondholders in a debt for equity swap. German debt for equity deals are rare and don't often go below 10% equity retention, but greater dilution is the norm in the UK.

Binding all creditors with a 75% majority vote is posible in the UK through a Company Voluntary Arrangement or a s425 Companies Act 1985 Sceme of Arrangement, whereas in Germany a small minority could hold out. This stage of the deal has not yet been reached, but is expected to be thrashed out between the 90% of creditors said to be based in London.

Further incentives for the choice of mechanism include the German "21-day rule" where German management face criminal sanctions if they fail to file for insolvency within 21 days of the company being unable to pay its debts as they fall due. The more flexible UK test - a reasonable prospect of avoiding insolvent liquidation - and the absence of criminality facilitates consensual restructurings like this one.

Another factor is the bondholders' perception that they have more control or influence in the UK system, which is less dependent on court involvement than Germany.

The group's recent history involved the acquisition of Britax Vision Systems in 2000, which resulted in too heavy a debt burden. Refinancing in 2005 put some €400m in hedge funds' hands. Q3 2006 figures were below target and on 19 October 2006 the company announced the appointment of Dr Burghard Knolle of AT Kearney as CRO/COO. At that time Hedgeco.net reported bonds trading at 30% and loans at 85%.

On 12 December 2006 the company announced the appointment of Stephen J. Taylor of Alix Partners as CRO

Reuters reports an estimated enterprise value of €200m, based on a conservative distressed multiple of four times a projected EBITDA of €50m (down from €78m in 2005). €50m of senior debt and €155m of second-lien debt is expected to be paid back.

Who else is involved? (sources: Legal Week, Global Turnaround)
Company advisers:

• Freitag & Co


• Allen & Overy - David Frauman, Mark Sterling

Senior Lenders (GE):

• Freshfields - Ken Baird, Lars Westpfahl


• Deloitte

Deutsche Bank (senior & second lien):

• Latham & Watkins - John Houghton, Frank Grell

Second Lien Holders:

• Houlihan Lokey - Peter Marshall, Joe Swanson


• Cadwalader - Andrew Wilkinson, James Douglas

Bondholders:

• Bingham McCutchen - James Roome


• Close Bros - Matthew Prest

OEMs:

• Clifford Chance - Mark Hyde, Kolja von Bismarck

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