Insolvency 2023

Insolvency: An Overview

This 2023 Insolvency Global Practice Guide is a guide for legal and non-legal professionals to the differing legal regimes that apply to business restructurings, reorganisations, rehabilitations, insolvencies and liquidations in the 44 jurisdictions covered by this publication. The contributing firms and authors are well-versed in the restructuring and insolvency practices and laws of their respective jurisdictions. They provide concise, high-level summaries of country-specific debtor and creditor rights and legal alternatives (statutory and non-statutory) for the restructuring and resolution of financially distressed and insolvent businesses. The contributors also provide all-important professional insights into current trends and developments in their local markets.

The information and summaries in the Guide are not provided as legal advice or opinions of any kind, and should not be relied upon as such. Readers should consult the contributors or other qualified legal and non-legal advisers when seeking to identify and understand what rules and practices might apply in particular situations and jurisdictions.

Evolution and State of Financial Restructuring Markets

The Guide summarises legal regimes that often reflect an evolution towards current best restructuring and insolvency practices. Local laws and related practices that apply to creditor rights, financial restructurings and business insolvencies are typically unique, complex and jurisdiction-specific. Such laws and practices may be long-standing or reflect recent changes and global trends. While it is difficult to generalise about global trends, the following observations may be of interest.

Globalisation of Practice

Best practices in financial restructuring and insolvency-related practices have evolved over several decades to address the globalisation of business, financial markets and debt-trading. Legal regimes in many jurisdictions have adapted and changed in response to cross-border M&A activity and private equity investments; the immense growth in distressed investing and secondary loan trading in international debt markets; and the development of cross-border and international restructuring and insolvency laws, treaties, regulations, organisations and best practices.

The international nature of today’s capital markets and business enterprises requires that legal, judicial and professional practices recognise and resolve cross-border issues arising when a company’s domestic and foreign investors, creditors and operations are impacted by an insolvency or financial restructuring. Differing foreign legal rules, regimes and policies may apply simultaneously and must be harmonised.

Thirty years ago, few restructuring professionals and firms were known to have the significant international restructuring contacts, capabilities and expertise needed to navigate cross-border insolvency situations. Since then, the cross-border restructuring and insolvency practice has grown and matured. The International Association of Restructuring, Insolvency & Bankruptcy Professionals (INSOL) and the Turnaround Management Association (TMA) are both worldwide associations of thousands of restructuring professionals focused on international capabilities and best practices for cross-border situations.

Uniform laws and practices for cross-border insolvencies and financial restructurings have been advocated by professional associations and enacted in various jurisdictions. INSOL formulated the INSOL Global Principles for Multi-Creditor Workouts. In 1997, the United Nations Commission on International Trade Law (UNCITRAL) established the Model Law on Cross-Border Insolvency (Model Law). The Model Law has been enacted in 58 states and 61 jurisdictions. It provides that a country’s national courts must recognise insolvency proceedings that have been commenced in another country.

There is a continuing need for laws that foster business rehabilitations rather than liquidations, because rehabilitative and “rescue” regimes preserve jobs and the going-concern value of insolvent companies.

New Participants and Competition

Over the last two decades, there has been a fundamental change in who typically holds “debt for borrowed money” in financially distressed company situations: traditional, institutional commercial bank lenders have been replaced by hedge funds and other strategic, private distressed debt investors.

In years past, the senior creditors of an insolvent company often were its relationship bank lenders. Banks predictably continued to hold distressed debt through workout or other restructuring or insolvency negotiations and proceedings. Over time, new and different types of strategic and opportunistic investors, including hedge funds, entered restructuring markets to acquire distressed company debt from banks and other traditional lenders.

The impact of hedge funds and other non-traditional investors on financial restructuring and insolvency processes was mixed. On the one hand, they often made restructurings more complicated and litigious as well as unpredictable because such investors often sell and assign (or acquire) their debt positions during a pending restructuring, thereby potentially upsetting restructuring negotiations and agreements between a company and its creditors. The practice of using “restructuring support agreements” and “lock-up agreements” was developed to manage risks posed by debt trading; such agreements bind a debtholder and its successors and assigns to restructuring terms agreed to by the debtholder, thereby providing certainty to those who negotiate and reach restructuring agreements, and flexibility for debtholders who may want to trade their claims freely.

On the other hand, hedge funds and other non-traditional investors brought money, speed and sophistication to the restructuring landscape. They are creative investors, particularly well-suited to driving restructurings to conclusions, and have the wherewithal to invest new money to expand the solutions to a distressed company. They provide liquidity to a market that may otherwise be constrained.

Sophisticated US hedge funds and other strategic investors who previously focused primarily on distressed US company debt (using the US Chapter 11 process to achieve outsized returns and debt-to-equity conversions giving them equity control of reorganised companies) have expanded the scope of their investment activities and strategies to target financially distressed foreign companies worldwide. While many non-traditional investors remain focused on debt of North American companies because distressed debt markets there are more developed than in other jurisdictions, opportunistic investors are now active in non-US jurisdictions where distressed debt markets are less mature. In recent years, major debt funds have been raising significant capital earmarked for deployment in Europe and elsewhere globally in anticipation of expected economic changes and foreign financial distress situations that will present opportunities for such investors.

It is important to note that the increased numbers of non-traditional restructuring and distressed debt-market participants have increased competition for sometimes limited investment opportunities. As a result of such competition, risk is sometimes underpriced when distressed debt is acquired.

Pre-negotiated Processes

Thirty years ago in the USA, distressed companies often commenced traditional Chapter 11 bankruptcy cases under the supervision of a federal bankruptcy court without any pre-negotiated outcomes or reorganisation plan terms in mind at the outset of a case. In traditional Chapter 11 cases, it typically took a year or much longer to negotiate and confirm a reorganisation plan. Over the past three decades, more efficient, speedy and less expensive Chapter 11 bankruptcy case strategies have developed. There is now a general trend in favour of consensual strategies negotiated out of court for efficient in-court resolution of financial distress, in place of lengthy, formal, non-consensual judicial proceedings. A company and its lenders and other major stakeholders may employ a “prepackaged” or “pre-negotiated” Chapter 11 case strategy to achieve relatively rapid case progress milestones and deadlines, and outcomes that in the past might have taken several years to accomplish in a traditional Chapter 11 case. Restructuring professionals, companies and major financial stakeholders often prefer out-of-court workouts and prepackaged or pre-negotiated restructurings rather than disorderly, uncertain and often litigious bankruptcies, liquidations or receivership-type insolvency proceedings that may result in high professional fees, delay, unnecessary litigation and loss of going-concern values.

Increased Litigation

With the entry of non-traditional distressed debt investors and other opportunistic participants, litigation has become a much more common strategy for achieving or negotiating recoveries in insolvency and restructuring proceedings. When there is uncertainty about available value or who is entitled to it, valuation litigation and inter-creditor disputes may dominate insolvency proceedings. Likewise, avoidance actions and litigation claims against third parties (including former owners, management, directors, officers and auditors) may represent meaningful sources of recovery. The settlement or assignment of complex litigation claims during a proceeding may be the basis of a plan of reorganisation or liquidation. The frequency of litigation may increase as specialised investment funds that are focused on insolvency-related litigations become more active; they invest in and fund litigations in return for a share of litigation proceeds. 

Sales of Financially Troubled Businesses More Common

Sales of all or substantially all of an insolvent business’s assets as a going concern “free and clear” of liens, claims and encumbrances are now common in Chapter 11 cases and other formal proceedings when a standalone reorganisation or rehabilitation of a business is impractical or impossible. Proposed sale transactions may be market-tested and negotiated before formal insolvency proceedings are commenced. In the USA, a pre-negotiated sale process for an insolvent business may be proposed and effectuated quickly with court approval following commencement of a Chapter 11 case, especially when a sale has affirmative support of senior secured creditors. Senior creditors often provide funding for a pre-planned Chapter 11 sale case in order to preserve a business’s going-concern value that may be lost in the absence of such funding. After a court-approved sale, a Chapter 11 company and its creditors may negotiate and seek bankruptcy court approval of a Chapter 11 plan of liquidation that distributes sale proceeds to creditors.

What May Lie Ahead

During the COVID-19 pandemic, following a brief spike in business restructurings and insolvencies across the globe, many borrowers took advantage of ultra-low interest rates and a borrower-friendly market to refinance their outstanding debt. However, as that debt matures (or borrowers default) in the coming months and year, borrowers will be faced with tighter lending conditions and more expensive capital, driven largely by lasting inflation and high interest rates. Some borrowers will be able to weather the storm, while others will be forced into bankruptcy or to pursue distressed transactions (including M&A).

Indeed, as reported by FTI Consulting, in the first half of 2023, business bankruptcy filings and rated corporate debt defaults in the USA rose steadily, despite the absence of a recession. There were 100 large Chapter 11 bankruptcy filings in the first half of 2023, compared to 103 filings in all of 2022, and 118 filings in all of 2021. Nearly half of the filings in the first half of 2023 were of middle-market companies with liabilities greater than USD250 million, and 18 were so-called “mega” cases (ie, cases with liabilities greater than USD1 billion). As for corporate debt defaults, S&P reported 84 global corporate debt defaults among rated issuers in the first half of 2023, compared to only 38 in 2022 – ie, corporate debt defaults have more than doubled year-over-year.

This acceleration in bankruptcy filings is a global trend. Allianz reports that the number of bankruptcies will increase by 21% worldwide in 2023. In a report by Allianz, more than half of the 44 countries analysed are expected to exceed pre-pandemic levels of insolvencies in 2023. A much more limited increase in bankruptcies worldwide is predicted for 2024 – only 4% compared to 21% for 2023. Nevertheless, this increase is expected to push three out of five of the 44 countries analysed over their pre-pandemic levels of insolvencies.

The increase in US business bankruptcy filings corresponds with cautious optimism regarding the US economy. Despite interest rates and inflation, some economists now believe that the US will avoid a recession in 2023. As of mid-2023, the Fed staff is no longer predicting a mild recession for the end of 2023. Other economists disagree, citing high interest rates and tight lending standards, among other things. 

On the topic of interest rates, in the third quarter of 2022, interest rates in the United States were sitting in the 3.0–3.25% range, and rates continued to increase in the latter part of 2022 and into 2023 (a total of 11 times between March 2022 and July 2023). Currently, interest rates are sitting in the 5.25%–5.5% range. In recent months, Fed Chair Jerome Powell maintained that another rate increase may be necessary to bring down inflation to the 2% target for 2023. Inflation was measured at 3.7% in August 2023. 

One area where 2022 concerns seem to have somewhat subsided in 2023 is in the area of labour shortages. The 2022 Insolvency Global Practice Guide cited record high resignations and concerns that worker shortages would last for years to come. While record high resignations did take place in 2021, according to the US Chamber of Commerce, hiring rates have outpaced resignation rates since November 2020. In other words, the majority of workers are quitting and being re-hired elsewhere, rather than remaining out of the workforce. However, certain industries continue to feel the impact of the so-called “Great Resignation”; namely, industries that require workers to be in-person and have traditionally lower wages (ie, food service and hospitality).

Globally, as reported by Bain & Company, several key measures indicate a heightened recession risk. The eurozone’s growth rate has slowed (0.6% YOY for second quarter GDP), and decrease in inflation has been slower than its US counterparts. Bain & Company cites structural challenges facing Europe, including the ongoing war in Ukraine, which has significantly impacted the mobility of people and goods across the eurozone. In the Asia-Pacific region, Japan’s inflation reached a four-decade high in mid-2023 at 3.3% YOY, while inflation in China fell slightly below zero to -0.3% YOY (entering deflation). However, growth remains slow.

All things considered, significant uncertainty lies ahead both domestically and globally.