Elephant Traps and imaginative solutions in cross border restructurings
By Alan Tilley
Posted: 13th June 2018 08:32
Such is the global reach of business today that even the smallest US mid-market companies may have overseas operations. For European companies operating in the EU single market it is almost the exception rather than the rule. Thus, when a company hits liquidity pressure in one subsidiary or a distressed investment opportunity transcends national boundaries the rules of engagement in distressed restructurings change, sometimes dramatically. For Europeans where jurisdictions are more creditor friendly than the USA and where efforts to harmonise restructuring process are underway, there is a greater familiarity with the problems of cross border transactions, if not always complete comprehension. For US companies with a Chapter 11 mindset and less regulated labour markets, the issues can be more fraught. Without proper advice US companies can walk unknowingly into a minefield of confusion and unpredictability.
The main dynamics in near insolvent or insolvent restructuring are the same wherever. It is the laws that are different. Definitions change and can be misunderstood. Insolvency triggers vary and legal interpretations of “payments falling due in the normal course of business” as the common liquidity trigger is not the same on both sides of the Atlantic or even on both sides of the English Channel. In Europe’s biggest market, Germany – which normally features in most trans-Atlantic restructurings – balance sheet over indebtedness is often a determining factor. This is particularly so in a jurisdiction where directors’ liabilities extend more readily to criminal, civil and onerous financial penalties. German directors are very aware of their potential exposure and their legal advisors quick to inform them. Judgments of risk may vary but those directors of subsidiary companies without equity positions are understandably more risk adverse than equity owning directors of family businesses. More than one US company has been faced with the threat of a local German director dashing to file whilst with more careful management a filing could have been avoided.
Liquidity management in a multi country organisation structure is critical to avoid an insolvency event in one subsidiary tripping a domino effect across the group especially where there is intercompany trading. Local companies usually have local directors, local banks and local accounting regulations. Mindful of self-interests the local CFO of sales entities will be under pressure to squirrel away cash, prefer local suppliers at the expense of intercompany payments, understate cash balances in group cash flow reporting, all putting pressure on the manufacturing entities’ supplier credit lines. Tight group level treasury management is essential.
Restructuring often requires labour downsizing. Layoff rules, costs and union reactions vary enormously. Countries where the most vigorous labour protection laws exist and where Unions are only too ready to leverage them are France, Italy and Spain. Recent changes to the laws in these countries have made downsizing more predictable but not necessarily less costly. In France, the new “Macron laws” are untested. Whilst Germany has rigid rules it also has Unions readier to constructively negotiate. Patience and strong negotiating skills plus knowledge and respect for the laws will achieve better results than strong arm tactics. Although it comes at a cost it is more predictable than confrontation. The same applies to France where the Social Plan protective regime is well documented. But it is a myth to say downsizing is impossible. Properly managed and with due respect for process it can be achieved. It is just expensive, but even more expensive if not properly handled, and sometimes more expensive longer term if not faced up to when economics demand action. There exits an aggressive group of lawyers only too keen to pick up post redundancy claims of improper process to pursue through courts where sympathies lie with the employees.
But elephant traps lurk in the most unsuspected corners. Take this example of a US company with overseas subsidiaries, in work out and in default with a Canadian bank. At the parent company level, the restructuring was proceeding in an orderly manner, non-core entities disposed of, and a profitable and saleable core business achieved. Important to the new entity was its European business with tentacles across the EU and into East Europe but managed from a German subsidiary. Extensive downsizing and management changes had turned the European business around from extensive losses to breakeven and a forecast small profit. A liquidity trigger had been avoided to keep the business from German insolvency but sitting on the balance sheet was a large intercompany loan, a legacy of past restructurings. The loan could not be repaid which raised a balance sheet over indebtedness issue. Unless it was forgiven the directors would need to file. The parent had fully reserved the loan but under German tax law debt forgiveness in a restructuring is a taxable event. The size of the potential liability threatened not only the German subsidiary but the whole group, its sale prospects and the Canadian bank’s recovery prospects. Various alternative scenarios were examined but each failed to remove the tax risk. It seemed nothing short of a change in the law to provide tax exemption to the restructuring gain would suffice. Changes to the law are in consideration, but the time line is frustrating sale prospects. At the time of writing law changes are still in limbo. An alternative solution is available and under wraps if needs be; a COMI shift of the German company to the UK where after disposal of the operations to a German Newco the Oldco can be liquidated with any residual tax liabilities written off in a UK process. Thus, imaginative restructurings are still available to overcome local national restructuring hurdles albeit time consuming and costly.
Since the high profile trans-Atlantic and pan European restructurings such as Global Crossing, Collins & Aikman and Schefenacker of the early 2000’s much progress has been made in changing legislation to facilitate cross border restructuring. But misunderstandings and issues still exist that can frustrate the best laid plans. Forum shopping may still be necessary for optimum results. However, a more informed and experienced group of lawyers and restructuring professionals has developed to help companies navigate the complexities. But beware, unexpected elephant traps still exist to catch the unwary.
Alan Tilley is a founding Partner of BM&T with significant expertise in operational and financial turnaround and cross border restructuring having worked on over 50 cases, managing the complex issues in preserving enterprise value in the zone of insolvency and identifying new sources of capital for viable businesses emerging from distress. He is a frequent speaker on Trans-Atlantic and cross border European restructuring and has written several articles on the subjects. He was Insolvency & Rescue UK Turnaround Manager of the Year 2010, winner of TMA Global International Turnaround of the Year award 2011 and TMA Europe Turnaround of the Year 2015. He is the author of the UK Chartered Accountants best practice guideline on Turnarounds. BM&T is based in London with offices in Romania and Greece. BM&T is a founder of European Restructuring Solutions, an association of independent turnaround boutiques in UK, France, Germany, Italy and Spain, and are the European associate of Conway Mackenzie, USA. BM&T, ERS and Conway Mackenzie have a global footprint of 19 offices and 200 professionals.
Alan can be contacted on + 44 7950 808777 or by email at email@example.com