The U.S. corporate bankruptcy space has seen a mini boom over the last two years, predominantly fuelled by two sectors—retail and oil & gas (O&G). Historically low crude oil and natural gas prices precipitated an O&G swell of in-court reorganization strategies, while Amazon and the ever-changing dynamics of e-commerce contributed to retail companies, large and small, also filing for bankruptcy in large numbers.
Along with these sector-driven waves, Debtwire has noted the clear rise of pre-packaged and pre-arranged plans, with an ever-increasing number of large corporate debtors often getting at least a roadmap hammered out with their major creditors before filing bankruptcy petitions. However, despite this trend towards pre-baked deals and away from the more expensive and unpredictable “free-fall,” the bankruptcy landscape continues to be littered with numerous high-profile liquidations and abandoned transactions.
So how much of a difference do lock-up agreements make towards achieving a higher level of restructuring success, or is the sector truly the best predictor of bankruptcy outcomes? With more than two years of data in hand, it seems like a good time to take a look back at the recent restructuring cycle and tease out a number of the trends.
Bankruptcy Entrances—Soft Landings & Free Falls
When a large company with heaps of institutional debt files for bankruptcy, there is often a direct balance sheet-related trigger behind it all, whether it’s an impending maturity date, upcoming coupon payment, or liquidity crunch rendering the company unable to pay its creditors. Yet, these trigger events can generally be forecasted, making bankruptcy planning a best practice for a successful reorganization process.
The company’s obligations to creditors, and how the underlying claims are going to be treated in a restructuring, lie at the heart of this process. To ultimately exit bankruptcy, companies need to garner sufficient creditor support to enable a bankruptcy court to approve a proposed restructuring. At a bare minimum, a plan of reorganization can only be confirmed at least one impaired class creditors of creditors supports the plan, needing favorable votes from at least two-thirds in dollar amount and one-half in number saying yes. However, any support a debtor can lock-up prior to filing—especially across the capital structure—minimizes costs and reduces the risk of unsatisfied creditors upsetting the restructuring.
This is why negotiations with key creditor constituencies can start months before a bankruptcy filing. As the bankruptcy waterfall prioritizes mounting professional fees and company valuations seem to melt while wearing the “debtor” label, it’s generally in creditors’ best interests to ensure that their obligor has as short a stay in bankruptcy as possible. And that means pre-baking as much of your restructuring deal as possible well in advance.
The most common mechanism used to cement creditor support is a restructuring or plan support agreement between the company and creditors that guarantees support for certain terms of a plan of reorganization that will be filed soon after the Chapter 11 petition. A variation on this theme is a pre-packaged plan, where the plan is not only fully-baked pre-filing, but also solicited for creditor votes, allowing the debtor to walk into court on day one with a confirmable plan. Where a company is seeking to restructure via an asset sale rather than reorganizing its debt stack, pre-filing sale processes are common, ideally accompanied by a stalking horse bidder. In contrast, companies that enter Chapter 11 with no plan or agreement in place are considered to be in “free fall,” attempting to formulate a strategy to restructure their obligations and/or sell their assets during the court process.
Pre-bankruptcy preparation strategies have been on the rise. However, since 1 January 2016, the most common Chapter 11 entry strategy for debtors with more than $10 million of funded debt remains the “free-fall” bankruptcy, with approximately half of the distressed companies entering with no agreement in place. Pre-packaged and pre-arranged bankruptcies combined were utilized second most, followed by pre-bankruptcy sale processes—each in close to 25% of Chapter 11s. But pre-planning remains on the rise, as over the last twelve months “free-fall” bankruptcies dropped down to approximately 45% of cases filed—still the most common entrance, but giving slightly to rising pre-packaged and pre-arranged bankruptcies (pre-bankruptcy sales remained flat).
Nonetheless, the frequent and increased use of pre-packaged and pre-arranged bankruptcies in many ways can be attributed to the sectors that have been dominating the bankruptcy space—and when the market turns it is not assured that this trend will continue.
The Need for Speed
O&G and retail specifically trend towards pre-filing prep not for best practices, but for survival due to specific sector concerns. With limited exceptions, few O&G or retail companies who have lengthy stays in bankruptcy end up successfully restructuring, making pre-filing lockups not just an expense issue, but a survival issue.
Oil & gas exploration and production (E&P) companies—the largest corporate type of bankruptcy filer over the last two-plus years—operate in a hyper competitive market, and were thus specifically incentivized to restructure quickly and beat their competitors to the punch. Also, the swinging oil prices that led to numerous bankruptcies in the space also impacted company valuations—a key driver in determining bankruptcy waterfall recoveries-- throughout the course of bankruptcy cases. One day secured creditors could be under water, the next day equity holders mobilize in hopes of recovery due to rising valuations. Further, E&P companies also have significant intercreditor litigation exposure due to the ever shifting and complex nature of those companies’ secured collateral packages, also tied to the shifting value of unextracted oil reserves.
Thus, O&G companies utilized pre-arranged and pre-packed bankruptcy filings at a significantly higher clip than any other sector to garner consensus early and mitigate dissent in the bankruptcy process. Over 40% of O&G filers over the last two-plus years used such a strategy, increasing during LTM to close to 45% of all O&G filers.
In that vein, O&G bankruptcies, were concluded much faster than the average case. Of the over 250 debtors that have entered and exited bankruptcy over this time period, close to 12% lasted 50 days or less, 24% lasted 100 days and under, 38% lasted 150 days or less, and 84% took less than a year. However, O&G cases, which comprise just over 30% of the bankruptcy market, represent approximately 45% of all cases that took less than 50 days and over 40% of the total cases that took under 100 days. It is worth noting that almost all cases in the technology and metals & mining sectors took less than a year to conclude.
In retail, industry specifics matched with Bankruptcy Code quirks also incentive swift restructuring processes. Distressed retailers in particular face time and liquidity concerns due to their large lease portfolio and strained vendor relationships. When matched with the Bankruptcy Code placing both (a) a priority on unpaid rent claims, making their 100% cash recovery a necessity in any plan (depending on the jurisdiction) and (b) a constraint on the time to determine whether to keep or dump leases—210-days from filing—retail companies become particularly sensitive to the ticking clock. In fact, the recent results in Toys “R” Us and The Sports Authority show the perils of retailers entering bankruptcy without a deal in place.
But despite these concerns, the data shows that pre-arranged support in retail cases remains rare, leaning more heavily towards sales and “free falls”. Less than 30% of retail bankruptcies in this time period included a pre-packaged or pre-arranged plan. Relatedly, despite the high value that could be gained from a quick bankruptcy trip, retail bankruptcy cases rarely exited within 100 days of filing. Less than 7% of retailers emerged within the first 50 days of filing, while approximately 16% of filers emerged in the first 100 days—both percentages well below the corporate averages of 11.5% and 24%, respectively.
This means that O&G creditors are more likely to coalesce around a deal that keeps them in the structure—even as the owners—after bankruptcy while retail creditors are more likely to take their sale proceeds and go home, giving a clear picture of what current investors and distressed players think about the future of those sectors.
Bankruptcy Results
Data shows that the existence of a lock-up agreement is a clear predictor of exit strategy, regardless of sector. Those without—our “free falls”—end in sales half of the time, while close to 20% included some form of debt equitization. Sale or no sale, just under 40% of “free fall” bankruptcies end in a plan of reorganization, while slightly more end in liquidations.
O&G bankruptcies in particular lean towards reorganization. Of the 77 O&G bankruptcies that closed over the last two-plus years, around 60% ended in a reorganization plans, the vast majority of which included debt-for-equity swaps. Only 35% of O&G cases utilized sale processes to exit bankruptcy, the same number then pivoting to liquidations. In contrast, retail and healthcare cases are more heavily weighted towards sales—over 60% of their cases utilize sales—while debt equitizations comprise between 20-25% of retail and healthcare bankruptcy outcomes. Interestingly, two-thirds of metals & mining bankruptcies ended with a reorganization plan, including approximately 60% with a debt equitization component.
Pre-bankruptcy creditor support is certainly the least expensive path and one of least resistance for a restructuring company, and pre-packaged bankruptcy plans are often considered the gold standard of restructuring transactions. But while we have seen this best practice gain increasing traction in the courts, a sector view shows us that this trend is tightly tied to O&G bankruptcies, where we can assume creditors are specifically incentivized to exit with retained ties to the companies, hoping for equity upside in a sector turnaround. But if that turnaround happens and the bankruptcy market refocuses entirely on retail and healthcare, creditor interest in reorganization looks significantly less likely, and we may see more lengthy, litigious and expensive “free falling” cases in the headlines.
