Business restructuring policies and practices vary widely across regions and nations. Local restructuring laws have often constrained efforts to restore health to struggling foreign operations. Recent global reforms in restructuring practices have significantly decreased many barriers to corporate turnarounds. The new environment provides opportunities for executives responsible for foreign investments.
Historically, most national restructuring laws and practices have mirrored local business and social culture. For instance, Asian business culture emphasises strategic relationships, long-term perspective and concern for the collective good over individual pursuits. So do Asian restructuring practices.
In Japan and Korea, government ministries and the keiretsu and chaebol systems of strategic relationships have traditionally pressured banks and other creditors to extend liquidity to troubled companies. Until recently, the side effect has been heavy indebtedness with little stimulus for corrective actions.
In contrast, European and South American business culture is more contractual and emphasises penalties, damages and accountability for failure. Most restructuring laws have lacked provisions to ratify out-of-court settlements, required technical insolvency tests prior to court protection, provided no relief from senior creditor action, and imposed stiff penalties on creditors and executives who have attempted and failed to rescue insolvent companies.
These systems have resulted in stand-offs between creditors that are hesitant to trigger a liquidation and incumbent managers who are more concerned with limiting personal liability than with taking remedial action. Such deadlocks have typically induced advanced states of decline prior to the implementation of meaningful restructuring action.
More even balance
The restructuring system in the US strikes a more even balance between creditors and debtors. This is a natural outgrowth of a business culture that rewards entrepreneurship, risk taking and value maximisation. US bankruptcy laws induce compromise by declaring a moratorium on all creditor action while empowering a company’s managers to work through structural problems. Examples include provisions that allow US debtors, even solvent ones, to cast aside and/or renegotiate burdensome agreements such as pensions, leases, labour agreements and supply contracts.
Although these actions can result in large damage claims against the company, other provisions encourage the shifting of pension liabilities to the government and renegotiation of remaining liabilities (including damage claims) down to a level that the bankrupt company can support. As a result, US bankruptcy law fosters corporate recovery and a return to competitiveness. This has also stimulated greater out-of-court compromises, as neither debtors nor creditors have a one-sided advantage in court.
American companies have used US law to speed up a return to competitiveness. The US steel, airline and automotive industries, for example, owe a large part of their survival to the rehabilitative aspects of the US system.
Change of tide
Many countries have routinely complained that the assistance provided by US law effectively provides a subsidy to US firms that have been weakened by foreign competition. But, after years of protest, many are reforming their own insolvency laws to favour corporate rescues.
Several of these countries have lessened the priority and/or size of labour and governmental claims, and removed certain barriers to rescue financing (see table). This trend in reforms appears to be gaining momentum.
If many countries implemented change nearly half a decade ago, why has the trend toward rehabilitations not been more pronounced? Recent strong economic conditions are a big reason but cultural bias has also been part of the problem.
As bank financing is the primary means of secured credit throughout the world, local banks have typically controlled restructurings efforts. Workout departments at these banks have often been constrained by local politics, strategic business relationships, and comfort and familiarity of traditional workout practices. In addition, lack of a rescue culture prevented the development of local managerial expertise in corporate rehabilitation.
All of these forces forestalled the initial practical implementation of reforms designed to foster corporate rescues. However, US restructuring specialists also needed years to adapt to the 1978 enactment of rehabilitation-oriented laws in America.
Adoption of rescue practices received a major stimulus in 2004 with the publication of the terms of the Basel II Capital Adequacy Accord. The agreement will impose stricter minimum capital requirements on major banks in the 13 G10 nations beginning in 2007. The central banks of many non-G10 nations are also expected to impose identical standards on local banks.
Since problem loans reduce capital, the effect of the new minimum capital requirements will be to tighten acceptable loan portfolio credit risk at banks throughout the world. Basel II has prompted many banks to divest non-performing loans aggressively, and US hedge funds and private equity firms have become the most aggressive buyers. As an example, the pace of annual distressed bank-loan sales from German banks to hedge funds is estimated at €25bn. By their nature, these funds need to generate above market returns.
Given their familiarity with US restructuring practices, distressed-fund managers have demanded similar tactics be employed in their foreign investments to boost performance and returns. To stimulate the process, distressed investment funds have called in US restructuring and turnaround advisers, who have decades of expertise in corporate rescues and have taken more aggressive approaches to operational and financial restructurings than local practitioners. The result: companies throughout the world are beginning to embrace new restructuring practices as a means of restoring operating efficiencies and profitability.
For example, the first true test of Germany’s 1999 reforms did not happen until Goldman Sachs snapped up the debt of major retailer Ihr Platz in 2005, retained outside advisers and subsequently forced the company to use the new legal provisions to reorganise. The speed and success of this restructuring shocked German insolvency experts.
Similar landmark restructurings include the turnarounds of German cable company ish, Norwegian drilling concern Stolt Offshore (now Acergy) and UK infrastructure services provider Jarvis. With these restructurings establishing new benchmarks for creative rehabilitative solutions, the global frequency and pace of such turnarounds should increase dramatically.
FDI professionals need to consider these changing dynamics when initiating and managing foreign investments. While the new laws, practices and cultures do not go as far as the US system in encouraging rehabilitations, they do present both opportunities and risks for foreign investors.
For instance, when initiating new investments, executives should revisit local insolvency laws to determine which nations might now provide the most suitable headquarters for regional operations. Under the EU Regulation on Insolvency Proceedings and US law, the concept of the ‘centre of main interests’ (COMI) has become increasingly important in determining which nation’s laws would prevail in a cross-border case. Domiciling and establishing meaningful operations (establishing COMI) in a country with rehabilitative laws could provide valuable leverage if an investment later requires a restructuring.
Acquisitive-minded executives should follow the lead of distressed investment funds. Foreign investors can reap rewards by targeting acquisitions of foreign operations in countries where new practices enable deeper business restructurings or facilitate the acquisition of insolvent companies as operating entities.
Practitioners should consider how the greater balance of power between constituencies might alter leverage between lenders, vendors, labour and management, and affect new foreign investments. They should also evaluate opportunities created by the new environment for optimising existing investments. The emergence of experienced, transnational turnaround managers provides a new weapon for overcoming complacency and implementing turnarounds and improvements. And lower barriers to rescue financing in some countries should offer more time to craft and enact turnaround plans. New limitations on labour claims during restructurings could translate into greater leverage for negotiating future wage and employment level concessions.
Foreign investors need to recognise the risks associated with recent change. Troubled competitors that might previously have presented weakened threats need to be monitored closely for restructuring activity. And the growing boldness and opportunism of distressed investment funds could wreak havoc on troubled investments with free trading debt.
FDI professionals need to keep abreast of global developments in restructuring laws and practices. Even in good times, there are numerous ways for shrewd executives to benefit from the introduction of new techniques in foreign markets.
Brian Cassady is a director at US-based turnaround consulting firm AlixPartners.