By Felicia Tan (TSMP Law Corporation)
The concept of “winner takes all” does not exist in insolvency disputes. But creditors willing to open a communication channel with debtors will do better than litigating for the last penny.
It started as a humble dry-goods store and cotton trader founded by Jewish immigrants in Alabama, and grew so quickly within three decades of founding that it had the wherewithal to help finance the state’s post-Civil War reconstruction. In modern times, it was better known for being the fourth largest investment bank in the United States. But Lehman Brothers, 158 years old when it spectacularly collapsed in 2008, gained most notoriety for its pivotal role in the unfolding of the global financial crisis.
The Lehman Brothers insolvency is still the largest in US history, with a staggering US$768 billion debt owed against US$639 billion assets owned at that time. Despite that deficit, hundreds of unsecured creditors (those whose debts are not guaranteed by assets) were repaid between 20 and 40 cents per dollar of debt, when a few cents per dollar was the norm.
The answer was insolvency mediation. The US Bankruptcy Court permitted Lehman Brothers to undergo non-binding mediation with its creditors, which allowed the firm to collect on debts owed, in order to repay some unsecured debtors.
Sadly, the fact that Lehman Brothers had successfully mediated through some difficult times in insolvency still remains obscure even after more than a decade, and the procedure continues to be neglected when resolving such disputes.
Understandably, creditors will want all their money back, so their first line of attack often is to sue. But truth be told, if the debtor is in financial distress, creditors are unlikely to be made whole unless their debt was secured by an asset or guarantee of higher value than the debt.
So the real question creditors should ask before they transact (or sue) should be: “How do I make sure I am repaid (almost) every penny even when the company is in trouble?”
What is mediation?
While mediation bears different meanings across jurisdictions and cultures, its common feature is the lack of authority. Parties choose a third-party individual to conciliate their differences, aiming for a win-win outcome, which is precisely what is needed in untangling knotty insolvency disputes. The mediator eschews finding fault, encouraging the parties to look beyond their quarrels and focus on a compromise instead. In the insolvency mediation context, it can also refer to types of negotiation without a designated or formal mediator. All roads lead to Rome: it is not necessary to take someone to court to get a resolution – a negotiated settlement can serve the same purpose.
This is illustrated in another mediation success story: Southeast Asia’s largest carrier Pacific International Lines (PIL). In early 2021, it restructured its US$3.3 billion debt by negotiating a consensual standstill from its key lenders, convincing them to suspend loan and interest payments. This avoided a court-granted moratorium, which would have engendered more commercial tension.
PIL achieved a record turnaround time of just a few months. Compare that with the years of unsuccessful court-ordered moratoriums “enjoyed” by the likes of Hyflux and Hin Leong Trading, which led to these household names eventually being wound up – tales of much ado about nothing.
The advantages of mediation
Mediation saves “face”. Neither party has to admit wrongdoing and any resolution, facilitated by the mediator who points out the matter’s pros and cons, is determined without fault. Through this, companies avoid burning bridges and an unnecessary bitterness if they were to work together on future projects.
Insolvency mediation is also unique in that both parties often agree that the debt is payable. That could mean that the quantum is not disputed. But the issue is cashflow. If parties are open to negotiating the repayment, creditors may achieve almost full repayment by accepting cash alternatives, such as other collateral (assets in lieu of cash), or equity (shares) in lieu.
However, if creditors refuse to offer any form of lifeline, the debtor may be forced to wind up its business or seek insolvency protection. Suing the debtor for the unsecured sums owed is just throwing good money after bad. On the other hand, opening communication channels, negotiating or mediating, are more likely to create opportunities – for example by helping the company recover as an ongoing business – to resolve the unpaid dues.
An example close to home is that of mainboard-listed Swiber Holdings Limited. The oil and gas giant commenced its restructuring under bankruptcy protection from October 2016. Over the past five years, Swiber’s restructuring proposals included various plans to keep the group afloat with new business ideas, and with the support of various pockets of creditors, its restructuring proposals remain open for discussion and the bankruptcy protection is valid till 30 December 2021.
So why have people held back from insolvency mediation?
Insolvency laws protect all creditors by allowing “clawbacks” (or reversal) of payments made by debtors within a certain number of years before the company went insolvent, if such payments are deemed unfair to some creditors. Examples of such payments are those made to persons connected to the company, made at an undervalue, or by preferring the recipient.
Such laws may cause some creditors to shy from negotiating debt repayments, who may fear that their negotiated settlements may run afoul of these laws, hence wasting time, effort and money should the resolution be simply reversed. However, while reversals based on look back periods are real, they are ringfenced by obvious questions that examine whether the payments are unfair. Most genuine transactions will not be affected.
Who will benefit from insolvency mediation?
Banks, financial houses, hedge funds and other institutional creditors have nothing to lose from voluntary insolvency mediation. Such secured creditors, whose debts are backed by fixed charges over valuable assets, and hence feel confident in their recovery probability should still remain open to mediation.
The ongoing Hin Leong Group saga demonstrates how even financial institutions like HSBC and Rabobank may have their rights affected by fraud, sham or reliance on duplicated cargo documents. Such creditors, even with security documents in hand, are facing competing claims over the same asset, and ought to be open to mediation.
Unsecured creditors, as in the Lehman Brothers case, have nothing to lose, as they are the last to be paid. The going rate of debt recovery in Singapore for unsecured creditors is only a single digit or low two-digit percentage. Mediation simply improves their chances and quantum of recovery.
Why insolvency mediation is important?
The apprehensively anticipated surge in global insolvencies did not materialise in 2020 or early 2021, despite the sharp drop in gross domestic product. This is mainly due to strong government support measures in many countries. But as these grants start to be phased out, zombie businesses will be taken off life-support and corporate insolvencies worldwide are forecasted to increase by 26 per cent in 2021, according to trade credit insurance and debt collections company Atradius.
In this landscape, insolvency mediation deserves more awareness. The Singapore (Mediation) Convention was open to all United Nations states for signature in 2019. Since then, 54 states have signed it, and it was given effect in Singapore on 12 September 2020. This was in addition to the Mediation Act 2017, which enables the recording of mediated settlement agreements as orders of court.
The Singapore Convention enhances the enforceability of cross-border, multi-party mediated settlements relating to commercial disputes. Such cross-border enforceability is vital with the rise of group corporate distress. It also enhances Singapore’s attractiveness as an insolvency mediation hub, because multinational corporations often forum-shop when deciding where to first seek bankruptcy protection.
Businesses, lenders and other creditors without a fail-safe security over a valuable realisable asset should always consider insolvency mediation as an option. After all, a bird in hand is worth two in the bush.
This article was published on 7 September 2021 in TSMP Law Corporation’s thought-leadership newsletter Forefront: By TSMP. It was front-run by The Business Times on 6 September 2021 under the headline “The importance of insolvency mediation”.