The Walking Dead

With credit conditions tighter, more companies will be pursued by their creditors. But restructuring is becoming increasingly complex, contentious, and costly.

Mention the name Schefenacker to the London bankers, lawyers and advisers who specialize in turning around insolvent companies, and you are likely to be greeted with knowing smiles. Schefenacker, which makes mirrors for carmakers such as BMW and Mercedes, almost went bust late last year. In April it emerged from a tortuous restructuring, during which it moved its headquarters from Germany to Britain to take advantage of the flexible insolvency laws there. Along the way, its debt burden was cut by 47% and its founder had to give up three-quarters of his shares to creditors.

These things happen in business. But the reason for the gleam in the eyes of the London specialists is Schefenacker’s bill for legal and advisory work: well over €40m ($59m). Compared with the £121m ($242m) that British Energy paid between 2003 and 2005 to its advisers when it got into trouble, this might seem small change. But Schefenacker, with total debts of €429m, was a tiddler next to British Energy. The nuclear-power company’s restructuring involved £16.2 billion-worth of liabilities (£1.2 billion of debt and £15 billion for storing, reprocessing and disposing of spent nuclear fuel and for decommissioning power stations).

Expect more Schefenackers, courtesy of the credit crunch. As America’s subprime-mortgage crisis has taken hold, credit conditions have suddenly tightened. In addition, rich economies look set to slow down — perhaps uncomfortably abruptly. The rate of corporate bankruptcies therefore looks sure to rise; and to stave off insolvency, many companies will have to reach agreement with their creditors on a restructuring of their debts.

Since mid-September an index of the cost of protection against defaults by low-rated American companies has soared. Moody’s, a rating agency, predicts that the proportion of low-rated companies that default on their borrowing will rise from 1% to 4.2% within a year. And BDO Stoy Hayward, an accounting firm, thinks that in 2008 the number of British businesses becoming insolvent will go up by 9%, to a five-year high.

However, not all firms that go bust will be as lucky as Schefenacker, which at least kept its business more or less intact. Many firms undergoing restructuring could end up like corporate zombies, unable either to revive or to die while their creditors haggle over what should be done.

Changes to bankruptcy laws in both America and Europe in recent years ought to have made it easier to revitalise or kill off ailing companies. But companies’ finances have become much harder to unravel. Offered cheap money on easy terms, companies — just like consumers and homeowners — have borrowed far more than they used to. The type and complexity of debt have grown too, as have the range and number of creditors.

All this has increased the potential for conflict when a company becomes insolvent. A high level of debt, relative to a company’s assets, means that a good proportion of creditors will be left with nothing. Because any restructuring plan has to be approved by a majority of creditors, the ability of a group of lenders to hold out for a better deal has grown. Some institutions will have taken bets that a company will go bust, and so stand to make money if a restructuring fails. This sets the stage for long, fierce battles between different classes of creditor.

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