Adam Paul and Joaquin M. C De Baca are quoted in this article.
If anyone was holding out hope for a tidal wave of corporate bankruptcies in 2022, it’s time to abandon ship. If that was part of your 2023 budget, don’t get on the ship altogether.
As the domestic and global economies slide toward recession at the end of 2022, leading bankruptcy practitioners aren’t calling when—or even whether—corporate bankruptcies will pick up in a way that corresponds with most professionals’ understanding of the amount of insolvency lurking in the market.
Yet, restructuring practices that slowed down are picking back up, and those that stayed busy are fielding inbound inquiries at a rate rivaled by the Great Recession. Refinancing is more difficult than it was a year ago. Covenants in credit agreements are tightening. Lenders are demanding greater concessions from borrowers. Sluggish bankruptcy dockets betray the realities of rising costs and interest rates across sectors, leaving more companies with fewer options heading into 2023.
“We’ve been in all-out mode,” said Thomas Lauria, global head of financial restructuring and insolvency at White & Case. “We’ve had a hard time getting everything staffed and staying on top of everything. I haven’t seen this volume of assignments since the crash of 2008 and 2009.”
To break down the current moment in the restructuring practice and venture an informed guess at where it’s headed next year, we spoke with eight leading practitioners about what they’re seeing in insolvency.
In-Demand Out-of-Court Restructurings Obscure Insolvency Levels
Commercial Chapter 11 filings have remained slow since 2021, compared with 2020 and 2019, according to Epiq data. Large, public company bankruptcy filings have been similarly depressed, with five in 2022 and eight in 2023 compared to the 56 large public filings in 2020, per the Florida-UCLA-LoPucki Bankruptcy Research Database.
Yet depressed filings rates are only part of the story. Until recently, widespread liquidity and low interest rates favored out-of-court restructurings, and Mayer Brown restructuring partner Joaquin M. C De Baca said he doesn’t expect that market preference to change substantially, even as credit markets tighten.
“The preference, at least from my sponsor clients, is to do something outside of a formal insolvency process,” he said. “I do think you will see a slight increase in Chapter 11 filings, but I don’t think it’ll be a tsunami of filings.”
McDermott, Will & Emery restructuring partner Kristin Going said she also sees the trend of out-of-court solutions remaining highly in-demand, and predicted the trend will continue into 2023.
Some of the current out-of-court activity may also end up in bankruptcy court in the near future, predicted Sidley Austin global restructuring lead Stephen Hessler.
“From a restructuring perspective, workout activity is increasing as it is becoming harder for distressed borrowers to fix over-levered capital structures out of court, where readily available credit is needed to facilitate consensual outcomes,” Hessler said. “It may take some time for this distress to translate to an uptick in Chapter 11 filings, but we are already seeing companies exhaust the capital market solutions.”
Rising Demand Isn’t Industry-Specific …
Climbing interest rates are driving demand for restructuring across all market sectors, despite the fact that some areas remain softer than others.
“I continue to believe that interest rates are going to be the single biggest influence on demand,” said Going. “Even if rates don’t continue to creep higher, we are already in an interest rate environment unlike anything we’ve seen in over a decade.”
Rather than by industry, insolvency waves are more likely to crest along lines of companies’ overall financial health, Lauria said.
“What you see is companies that took advantage of the great availability of cheap financing since the crash of 2008-09, which have levered up their balance sheets to a point where—at current market interest rates—they not only cannot afford financing, but financing just is not available,” Lauria said.
Weil, Gotshal & Manges restructuring co-chair Gary Holtzer said the extent to which capital providers are concerned about advancing new money and extending existing maturities—which may be greater in certain business segments—”will inform the length of the next restructuring cycle and how widespread it is across sectors.”
Companies with floating debt instruments are feeling compounded financing pressures, Hessler said, also noting that the more interconnected nature of modern industries means insolvency in one sector is more likely to transfer to others.
Supply chain interruptions are also impacting companies across sectors such as retail, nursing homes, and health care facilities, said DLA Piper Miami managing partner and U.S. healthcare sector chair Joshua Kaye. “These companies seem to be out of runway, having exhausted their access to capital through government stimulus programs and their other financing sources.”
… But Some Sectors (Crypto) Are Driving Demand Right Now
That said, several industries are exhibiting particular distress as of late, starting with Wall Street’s favorite punching bag: crypto.
“We’ve seen a lot of what I’d characterize as crypto contagion, which will continue into 2023,” said Adam Paul, Mayer Brown global restructuring co-lead. “We’re representing an investment banker on FTX—we’ve had a lot of in-bounds on FTX.”
Commercial real estate and REITs are also particularly frothy right now, said Nelson Mullins Riley & Scarborough bankruptcy chair Gary Freedman, as properties reliant on retail and hospitality feel the squeeze of rising rates, high wages, and the end of federal funds. Retail is perennially in trouble, restructuring professionals said, and so too are many firms in the energy sector.
Despite the industry-agnostic nature of insolvency right now, Freedman said Nelson Mullins’ industry-based triage system helps the firm respond to client needs with attorneys who have experience in their sector.
“We are gearing up again and looking at softening in various industries,” Freedman said. “So if a present or future client in a particular industry has a financially or economically distressful situation, we have a team ready to parachute in to take care of it across the spectrum.”
McDermott’s practice has been busiest in crypto, life sciences and health care insolvency work, said Going. “I know from talking to people at holiday parties that if you aren’t working on something in the crypto space, things are pretty quiet.”
2023 or Bust
“Some time next year” is the going projection for when insolvency activity will pick up to meet the amount of distress in the market. If that feels unsatisfying, imagine having been asked the same question since the end of 2020.
“We’re expecting a bit of a bumpy road going into 2023,” Freedman said. “There are various signs in the economy: increased inflation, rate hikes and supply chain issues.” Going said she expects bankruptcy filings and out-of-court restructurings to pick up in the second quarter of 2023.
While interest rates continue to rise, a seller-friendly market grapples with diminishing company valuations and rising costs of capital. In other words, what levers up must come down.
“The lion share of buyers may be unwilling to risk losing a transaction by revisiting a purchase price, which could lead to more and more companies becoming subject to much greater leverage ratios without the underlying financial strength to support the incremental debt,” Kaye said. “As these companies look to scale and grow, their financing ratios could become more suspect, which inevitably leads to a greater degree of pressure for bankruptcy filings. “
Reprinted with permission from the 12/20/22 edition of The American Lawyer ©  ALM Properties, Inc. All rights reserved. Further duplication without permission is prohibited.