The alarming prospect of widespread defaults by viable firms caused by the COVID-19 pandemic has prompted various proposals for financial assistance from states. But firms might face financial distress before these measures become effective. Smaller firms with concentrated debt may be able to informally negotiate an extension of maturity with their lenders. Debtors with bonds outstanding may not be able to arrange workouts so easily. What they need is a novel form of relief.
More than half of European corporate bond issues are governed by UK or U.S. law. We suggest that emergency legislation be introduced to extend the maturity of outstanding bond debt. The basic idea would be to buy time for bond issuers, reducing the risk of premature insolvency filings and fire sales. In the UK context, we envisage primary legislation providing that, whatever the provisions in the bond contracts, English law-governed bond debt cannot fall due for payment within, say, 180 days of entry into force of the legislation. Acceleration clauses would similarly have no effect in this period, nor would debtors be required to create a sinking fund or post (additional) collateral. However, debt due to mature after 180 days would be unaffected. Debtors who could pay would not be prevented from paying. But a saving provision might need to be included to avoid penalties for early payment where debt contracts provide for this. Other jurisdictions, including, most importantly, New York, could introduce the same rule to deal with debt governed by their law.
An obvious objection to our proposal is that most jurisdictions already have a formal mechanism for shielding debtors from enforcement action by creditors in times of crisis. Under such procedures, debtors can obtain a stay with a view to negotiating a restructuring with creditors. The law typically provides that, where a court agrees, a minority of creditors can be bound to the will of the majority.
But conventional reorganization procedures are ill-suited to deliver value-maximizing outcomes for a large number of debtors in multiple sectors of the real economy who become financially distressed at the same time. Reorganization procedures are complex to administer and require extensive court involvement. The experience of other large-scale corporate crises suggests that bankruptcy courts can quickly become overburdened. This seems a particularly acute risk in the current crisis, given that COVID-19 is also straining courts in other ways: Court closures are highly likely, and any virtual equivalents will not be ready soon. Most important, the negative signal associated with court-supervised insolvency procedures causes the value of financially distressed firms to fall. Hence, non-court solutions should be preferred.
Our proposal would have much greater impact if the courts of other jurisdictions would treat the bond contracts as validly altered by the emergency statute, for a great deal of English law-governed debt has been issued by non-UK corporates. The concern would be that the statutory amendment amounts to an impermissible interference with property rights protected under international human rights law. However, there must surely be a powerful case that this time-limited measure is fully justified in the public interest, as permitted by the European Convention on Human Rights, given the extraordinary economic imperative for the measure.
Our proposal may not be sufficient to avoid unnecessary bankruptcy filings: If directors are subject to a mandatory filing rule, this would also need to be relaxed. English law does not impose a mandatory filing rule on directors. Instead, directors run the risk of personal liability for “wrongful trading” if they keep running firms destined to end up in balance-sheet insolvent liquidation or administration without taking appropriate steps to minimize loss to creditors. Our proposal would indirectly, and we suggest beneficially, affect the operation of this rule by giving directors greater comfort that their companies can avoid the unnecessary opening of insolvency proceedings.
The moratorium will mean that some businesses that should have deleveraged already will be given more time than they deserve. But the ex ante effects of being overly generous to these debtors should be limited, given the highly exceptional nature of the crisis.
This post comes to us from Horst Eidenmüller, Freshfields Professor of Commercial Law at the University of Oxford; Luca Enriques, Professor of Corporate Law at the University of Oxford; and Kristin van Zwieten, Clifford Chance Associate Professor of Law and Finance at the University of Oxford. A version of this post appeared on the Oxford Business Law Blog, here.