The Value of Informal Workouts and the Framework to Guide their Development in the Asia-Pacific
By Scott Atkins (Norton Rose Fulbright Australia) and Dr Kai Luck (Norton Rose Fulbright Australia)
Contextual setting
Informal workouts encourage cooperation and collaboration among creditors. They proceed on the basis that, where a company is viable, notwithstanding current financial difficulties, it is in the interests of all creditors to work together by refraining from immediate enforcement action and devising a unique restructuring plan with expert guidance that will eventually see the debtor return to profitable trade.
In that event, financiers, suppliers and landlords, as well as employees, will benefit from an ongoing trading relationship with the company, rather than just ‘getting out quick’ and taking whatever they can in a formal insolvency process – complete with enforcement moratorium exceptions for major secured creditors under the insolvency regimes operating in each jurisdiction in the Asia-Pacific. That kind of enforcement-heavy approach destroys enterprise value and effectively ends any prospect of a successful rescue attempt for a viable company.
While most insolvency regimes in the Asia-Pacific cater for a range of formal rescue processes, the informal rescue process is typically underdeveloped. Australia made some movement on this front with the September 2017 introduction of a restructuring safe harbour from insolvent trading in new section 588GA of the Corporations Act 2001. Nevertheless, this only incentivises directors to pursue an informal rescue. It does nothing on the creditor side of the coin, and creditors remain free to enforce their claims during an informal restructuring. Indeed, with the dominant individualist creditor enforcement culture in most Asia-Pacific nations – in contrast to the debtor-friendly process in the United States and the more developed creditor cooperation system in the United Kingdom – informal workouts negotiated with extensive creditor consultation and collaboration remain the exception rather than the norm.
Yet, with the peak insolvency period fast approaching as government support measures in response to the pandemic are scaled back across the Asia-Pacific in coming months, now is the very time that informal workout principles need to be prioritised as part of the law reform and policy agenda.
Informal workout principles
The key underlying principles that now reflect best practice informal workout processes across the world can be traced back to the so-called ‘London Approach’.
The London Approach was first developed by the Bank of England in the 1970s as part of a design for the Bank to become more actively involved in insolvency processes by assessing the prospect of viability and pursuing rehabilitation when appropriate to improve recovery prospects and the overall position of its loan portfolios.
The main principles of the London Approach were minimising losses through coordinated negotiations and avoiding unnecessary liquidations of viable companies. Banks were encouraged to be supportive until viability could be assessed, and to refrain from immediately appointing a receiver. Banks were also tasked with taking the lead role in negotiations with other creditors, sharing all information equally with a view to a collective decision being made on a workout plan.
The motherhood goals and aspirations inherent in the London Approach have since been refined in considerable detail in various international insolvency frameworks, including:
- Provisions of the World Bank Principles for Effective Insolvency and Creditor/Debtor Rights Systems;
- Components of the UNCITRAL Legislative Guide on Insolvency Law; and
- INSOL International’s International Statement of Principles for a Global Approach to Multi-Creditor Workouts.
The INSOL Principles have been the most influential. The First Edition was published in October 2000 and the Second Edition was released in April 2017. The INSOL Principles have since been endorsed by the World Bank and the Bank of England, becoming the new ‘gold standard’ for informal restructuring principles.
The INSOL Principles provide the following key guidelines to inform best-practice informal workout processes:
- The interests of all creditors are best served by coordinating their response to a debtor in financial difficulty;
- All creditors should agree to a standstill period on enforcement so they can properly evaluate the debtor’s financial position and investigate the potential for a workout;
- Conflicts of interest in the creditor group should be identified early and dealt with appropriately;
- One or more creditor committees ought to be established, with the benefit of professional workout advisors, as the potential for a workout is investigated and progressed;
- The debtor should provide, and allow relevant creditors and professional advisors reasonable and timely access to, all relevant information relating to its assets, liabilities, business and prospects, to enable proper evaluation to be made of its financial position and any proposals to be made to relevant creditors; and
- Any new financing provided should be accorded super-priority status.
The INSOL Principles are likely to be endorsed and further developed as part of the Asian Principles of Business Restructuring, currently being drafted in a partnership between the International Insolvency Institute and the Asian Business Law Institute and expected to be published in early 2021.
As part of the law reform and policy agenda to give distressed but viable businesses the best chance possible of continuing to trade in the long-term – particularly important in the new economy we now find ourselves in – consideration ought to be given to the formal adoption and endorsement of the INSOL Principles, as developed in the impending Asian Principles of Business Restructuring, by central banks throughout the Asia-Pacific, as well as individual banking industry bodies.
The need for a mandatory enforcement moratorium to support informal workout principles
Nevertheless, because the INSOL Principles are, at the end of the day, voluntary and unenforceable, they should ideally operate in conjunction with a backup mandatory legislated enforcement moratorium applying during periods of informal restructuring. There is no such moratorium currently in operation in Australia or any other region in the Asia-Pacific.
However, the United Kingdom provides a useful model that could be readily adopted in the region. Notably, under the Corporate Insolvency and Governance Act (UK), which came into effect on 26 July 2020, directors may now apply to the court for an initial 20 business day ‘Part A1’ enforcement moratorium under the Insolvency Act 1986 (UK), which can be extended for a further 20 business days without creditor consent or indefinitely with creditor consent, while a restructure is negotiated. This requires the appointment of an expert monitor who must form the view that it is likely a moratorium would result in the rescue of the company as a going concern, an important commencement safeguard to prevent creditor exploitation. The moratorium is broad-based and extends to the enforcement of claims by landlords and secured creditors.
A prohibition on the enforcement of ipso facto contractual provisions during the negotiation of an informal workout – also introduced in the UK as part of the Corporate Insolvency and Governance Act reforms – would further enhance the prospect of a successful rescue. While some jurisdictions in the Asia-Pacific, including Australia and Singapore, already restrict the enforcement of ipso facto clauses during formal restructuring processes, they do not extend the prohibition to the negotiation of an informal restructure.
Concluding remarks
A strong informal restructuring framework is a critical component of a best-practice insolvency regime. The INSOL Principles provide a useful overarching framework for creditors to negotiate and cooperate to investigate the viability of a distressed company and to work together to progress a restructuring plan if it has a reasonable prospect of success. In combination with a mandatory enforcement moratorium, the INSOL Principles – and the further development of those Principles in the impending Asian Principles of Business Restructuring – provide a model for all Asia-Pacific jurisdictions to implement locally.
The importance of doing so is especially critical with the influx of insolvency cases expected right across the region as businesses continue to navigate the difficult and rapidly evolving economic and financial circumstances caused by the pandemic. The countries that take this opportunity to enhance their informal restructuring frameworks will position themselves for sustainable economic recovery and growth, and will attract important foreign investment dollars from creditors wishing to invest in jurisdictions that have an efficient, fair and effective insolvency system.