The second wave of COVID-19 in France and the new lockdown confirm the unprecedented scale of the crisis that is impacting the country and the world in general. As of today, one certainty is that a return to a normal situation will take time and will depend largely on how quickly consumers recover from the overall impact of the pandemic outbreak, as counterbalanced by the measures implemented by the European governments to fight its effects. The only thing that can be predicted is that this "U shape" crisis is resulting in a large wave of large defaults and restructurings.
In this unprecedented era, dealing and managing uncertainty will be paramount for recovery.
As a result, restructuring practice is shifting from liquidity emergency treatment through amicable negotiations and covenant resets to a sector consolidation driven by M&A and complex lender-led transactions.
A liquidity toolbox for meeting urgent cash flow needs resulting from the COVID-19 lockdown(s)
In response to the health crisis, the French government very quickly introduced various tools intended to shield companies' cash situations. Bespoke regulations were implemented, as follows:
- French State-backed loans (known in France as "PGE");
- tax and social charges rebates and deferrals;
- the introduction of a temporary lay-off of the workforce (chômage partiel);
- simplified access to preventative proceedings; and
- the postponement of the legal representative's mandatory obligation to file for the commencement of an insolvency proceeding if the company is insolvent (ie, failing the cash flow insolvency test).
Most practitioners, however, believe that these governmental aid measures have artificially assisted suffering businesses. The very low number of requests for filing out-of-court amicable arrangements (mandat ad hoc or conciliation proceedings) or judicial proceedings (safeguard, reorganisation or liquidation proceedings) is leading practitioners to assume that many companies are "under financial artificial infusion".
Ultimately, while these measures were clearly necessary and successful as a short-term approach, they did not – and could not – address economic difficulties resulting directly from a dramatic plunge in revenues.
Vulnerability of certain industry sectors or a source of strategic opportunities for growth?
Even though the support from the French government mitigated the effects of the health crisis, certain sectors (notably consumer products & retail, automotive & transportation, media and tourism) have been hit especially hard due to specific restrictions imposed on their sector (eg, travel bans, the avoidance of public gatherings or the closure of countries' borders), ending up with shrinking revenues.
For some such undertakings, the conditions of a PGE were not met (for instance, if they qualified as "undertakings in difficulty" under European Regulation No. 651/2014) or their PGE application was refused by commercial banks – mainly as a result of the unpredictable outlook for the business, an insufficient cash forecast or a failure to build a robust and deliverable business plan.
In this volatile environment, there are high expectations on sponsors and shareholders, as they are the actual owners of businesses and should play a key role by curing technical or payment defaults through equity, by financing investments where RCF (revolving credit facility) lines have been totally drawn, by providing support for consolidation or M&A projects towards growth-generating businesses, etc.
However, and different to the liquidity crunch of 2008, significant amounts of financing and dry powder liquidity are available today.
This factor has fundamentally changed the restructuring paradigm and dynamics, especially where existing shareholders are not agile enough or supportive of a quick and in-depth turnaround.
That situation is clearly a new source of opportunity, both for liquidity providers (eg, hedge/investment funds specialising in distressed situations) eager to secure a return for their own investors, and also for the distressed company and its management, who must always consider the interest of the business as a going concern first, rather than the sole interest of a defaulting shareholder.
"Loan-to-own" is no longer a bad word – especially where French banks are reluctant to provide funding (due to their own balance sheet constraints and concerns) – the aim being to de-leverage the company so as to restore a clean balance sheet while injecting new money to help the company achieve turnaround, resizing and sustainable growth.
Far beyond the traditional restructuring and insolvency paradigms (that now belong to the past), this crisis highlights the need for multidisciplinary, urgent and efficient actions resulting in an increasing proportion of high-end/complex M&A transactions with a deep reshuffling of the corporate and debt structure.
The prospect of acquiring targets with an already strong underlying business model for the symbolic, de minimis, price of EUR1 is an attractive tool for some investors, such as private equity funds, hedge funds and special situation funds that have the skills, expertise and resources required to successfully turn a company around.
Whilst other company-led recovery strategies are possible for financially vulnerable targets (for example, share capital increases or bond issuances), depressed market valuations and lower levels of competition allow investors to create synergies, acquire a new product line or establish themselves in novel geographical areas.
Nevertheless, taking over a company short of liquidity has its own special issues, as evidenced by the constraints inherent in such operations and the quality of the investment expected by the target companies. In particular, financial investors may also use more specific tools if these transactions involve mechanisms such as the sale of securities or assets, as often contemplated when the target is financially viable.
The conversion of debt into equity is an effective way to successfully complete a distressed M&A transaction, as it strengthens the target company's balance sheet by carrying out a share capital increase, while also reducing its debt. Financial investors who have acquired high-yield or bank debt on the secondary market, often at a price below the nominal value, can thus skilfully convert their debt into capital at a lower price and with a guaranteed rate of return. The benefits of adopting a loan-to-own approach are especially striking when the target's securities are admitted to trading on a regulated market, since creditors will ultimately be able to benefit from the liquidity of their securities.
More "hostile" approaches exist: the exercise by a creditor of an efficient (ie, French law insolvency remote) security package based on a double-luxco or trust (fiducie) over the target securities or assets may also result in a change of control at the expense of the existing shareholder.
Although financial investors are the key players during the implementation of these distressed turnarounds, addressing and minimising the target's failures (and future challenges) requires the intervention and support of other players. In addition to the usual negotiations between the new equity investors and the target's shareholders, it is equally essential to co-ordinate with the lenders, security holders, management, lessors, suppliers, customers and employees of the target in order to ensure that the business, once acquired, remains viable. This is especially critical when a "traditional" mutual agreement procedure is initiated to address difficulties, such as ad hoc mandate or conciliation proceedings that have their own rules and timetables.
Against this background, the real source of the company's difficulties must be identified and understood (including any unaddressed financing needs), so that investors can provide the necessary funds to ensure the recovery of the target. However, such an operation often retains the usual features of all M&A transactions along with an inflexible timetable: financial, legal and tax due diligence is inevitably reduced, but should not be neglected. The provision of mandatory information, the consultation process of the work council and the stricter operation timetable should also be taken into account, in addition to any regulatory authorisations and clearances (for example, in the case of a sensitive sector or merger control) that must be obtained and requested at the appropriate time in order to avoid blocking positions or delays. It should be noted that an exemption from the suspensive effect of the merger control process may be granted (with certain conditions) in order to carry out a distressed transaction without prior clearance from the competition authority.
Furthermore, technical sale plans overseen by commercial courts, under reorganisation or liquidation proceedings, are also rapidly growing in popularity, to the extent that the government has loosened the regulations governing the potential takeover by a former management team. Although the purpose is to save as many employees as possible, this measure must remain strictly controlled and, in particular, must not be used as a pressure tool during insolvency proceedings to purely and simply write off the debt. Any alternative plan, whether from creditors or from a third party, must be discussed and negotiated to prevent abuse by managers who are likely to repeat the same mistakes.
Outlook: massive waves of consolidation, M&A distressed activity and equity restructuring
This crisis will inevitably act as a real wake-up call for some sectors or industries that need to reset and reshape their value chain completely, and will provide an opportunity to reassess their partnership models and M&A growth. The themes of discounting, cost rationalisation, digital acceleration, industry consolidation, and corporate innovation should be the highest priorities.
Business transfers and external growth create opportunities, so are traditional tools used to increase value. In the present context, they will be an effective means of reversing and protecting France's economic and industrial network.
To mitigate the overall damage during this period, there will be important and vital choices on who is the most well-equipped (existing or new) partner-investor and what strategy, models and organisational changes should be pursued, as well as what should not be pursued.
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