<<Who cares...>> Collapse Euroland and US
Up from the ashes
Mar 21st 2002
From The Economist print edition
economist.com
Amid a global wave of business failures, American firms are more likely to get a second chance. Unfair competition, or a lesson for Europeans?
THROUGH European executives' eyes, American bankruptcies are perverse affairs. First, failed managers often hang on to the helm well after their firms have officially gone bust. After companies seek safe harbour under Chapter 11, America's famous insolvency law, banks swoop in to lend them even more money. Next, lawyers help the firm restructure older debts, giving bosses months or years to run their businesses interest-free. Failure, American style, is nice work if you can get it.
This is caricature, of course, but it is easy to understand why European managers might feel hard-done-by. In Europe, where moves are afoot to make life easier for troubled firms, such perks are much envied. Britain has toyed for years with plans to relax its insolvency rules, and is now close to doing so. The European Commission, too, will put up ideas for bankruptcy reform later this year.
For now, though, European executives can only look jealously at the likes of Covad, an American telecoms company, which recently emerged debt-free from a four-month stint in the bankruptcy courts. It was able to erase all of its $1.4 billion in debt in exchange for giving bondholders 15% of its equity. Creditors, management and shareholders agreed the deal outside of the court. Their trip into Chapter 11 was but a formality. Covad even picked up new finance along the way.
Now consider the travails of Carrier1 International, another telecoms firm, but based in Europe. It also ran into debt troubles last year, and creditors balked at management's first offer of a debt-for-equity swap. By the time the company came up with new terms, Europe's patchwork of national insolvency laws—some of which make directors personally liable merely for letting an insolvent firm trade—made it impossible to carry on. The company has now been forced into administration; its assets are being sold off.
More such collapses may be on the way. Earlier this month, Energis, a British telecoms company, failed to meet a debt payment. It is now scrambling to convince its creditors to work out a deal before the administrators step in. But European law generally gives creditors more power, and less incentive to strike a bargain, than American law, which favours borrowers (perhaps, it is said, because some of the founding fathers fled to the new world to escape their creditors). Energis has only one month after its default before it falls into the hands of administrators, who often sack senior managers and take a knife to assets.
Quite right, some would say, especially those who see Chapter 11 as a prop for basket cases. This has been true of America's airline business in the past, and arguably of its steel industry today. But most American bankruptcies in this latest downturn have resulted in liquidation, as has historically been the case. Take Rhythms NetConnections, one of Covad's erstwhile American rivals. It filed for Chapter 11 at around the same time. But unlike its rival, it was deemed unsalvageable and was liquidated. More often than not, only those companies with a good chance of returning to health emerge from Chapter 11. That, say its supporters, shows that the law is doing exactly what it was intended to do.
Pre-packaged pain
Chapter 11 allows restructuring on three main fronts. First, companies caught out by disaster, legal liabilities or their own mismanagement can be forced to file for Chapter 11 out of desperation. But increasingly they can, like Covad, work out a deal in advance, and use the bankruptcy courts' tax and creditor-voting advantages—in some cases, approval is needed from only two-thirds of the lenders—to get the deal signed. Christopher Stuttard of BankruptcyData.com estimates that these so-called “pre-packaged” bankruptcies accounted for 8% of corporate failures in 2000 (by asset value), up from 4% in 1990. Third, Chapter 11's abundant case law also encourages out-of-court restructurings by letting borrowers and creditors know what to expect if they go to court.
While Britain is at the forefront in trying to emulate America's laws, much of continental Europe is still happy to rely on the state's heavy hand rather than on bankruptcy procedures. Holzmann, a German construction group, was saved from collapse two years ago by state aid. Now the company is in trouble again. As The Economist went to press, it was preparing to file for insolvency. If it is allowed to go bust this time, Holzmann would be Germany's biggest bankruptcy in decades—and the clearest sign yet that European governments are prepared to let capital markets work out business failures on their own.
Nobody expects radical changes to the European system to come quickly. Shagun Dubey, an insolvency expert with Ernst & Young, an accountancy firm, thinks that Europe will creep towards a hybrid of Chapter 11 and the current system, that would give managers of troubled companies less of a free hand than in America—frequent reporting to a trustee may become the norm, for instance.
The stigma of insolvency may be as big an obstacle as insolvency law itself. “Culturally, Britain is not sufficiently attuned to using insolvency...to return a restructured company to the hands of management,” says Mark Hyde, head of the insolvency practice at Clifford Chance, a law firm. Few banks in Europe are willing to lend to insolvent firms. Suppliers and customers, meanwhile, tend to treat bankruptcy as a scarlet letter.
Eurotunnel vision
For companies on both sides of the Atlantic, bankruptcy needs a clear goal. American firms are likely to fare far worse if they enter Chapter 11 groping for a recovery strategy, rather than having a plan in advance, says Peter Kaufman of the Gordian Group, an investment-banking boutique. In Europe, preparation for a financial solution is all the more important if default means a halt to trading. One hope is that Europe's less litigious culture might make companies and lenders more likely to plump for deals outside the courts. Britain, in particular, has some experience in this: Eurotunnel's reorganisation, for example. When the administrators step in, the European assets of only the biggest firms, such as Olympia & York, which built London's Canary Wharf, tend to be rescued.
Changes to practice are sure to come before changes in European law. Federal-Mogul, an American car-parts company, filed for bankruptcy in October, under both American and British insolvency laws. By co-ordinating its British bankruptcy with its Chapter 11 process, the company was able to keep its British businesses trading while in administration, with an eye to emerging as a single healthy company. This kind of approach, also used by firms such as ICO Global and PSINet, is a sign of things to come, says Jim Leshaw, a bankruptcy lawyer in Miami.
In the meantime, European firms need not feel too threatened by Chapter 11's advantages. When Chiquita, an American banana company, filed a pre-packaged bankruptcy last year, it was able to continue to compete with Fyffes, an Irish rival. But as Chiquita emerged from protection this week, its debt greatly reduced, a raft of companies lined up to make a bid. Rumoured to be among them was Fyffes, which, if it succeeds, might yet profit from America's forgiving ways. |
