A version of this article appeared in the September 2019 issue of Financier Worldwide Magazine.
In the next few years, we can expect to see a rapid rise in corporate restructurings, insolvency issues and bankruptcies, as more than 60,000 corporate bonds with an S&P rating of BBB or below mature in 2020 and 2021, according to Bloomberg data. Certain industry sectors are already seeing widespread restructurings, most notably retail, which accounted for five of the 10 largest Chapter 11 filings in 2018, including Sears Holdings Corp., Claire’s Stores Inc. and Nine West Holdings Inc.
In addition, there are a number of trends gaining momentum in restructuring and bankruptcy situations that have direct implications for managing a company’s reputation and image with stakeholders:
Growth in covenant-lite loans
Covenant-lite loans have grown tenfold from 2007 to 2018, creating greater flexibility for companies to maneuver without lender consent. In 2018, covenant-lite loans reached 79 percent of total leveraged loans, according to PwC’s 2019 “Bankruptcy and Restructuring: Year in Review and 2019 Outlook.”
Covenant-lite loans generally have less protection for lenders and fewer restrictions for borrowers. This may allow companies to reduce transparency around financial condition, extend timelines to restructuring or even separate certain corporate assets to shield value. Frustrated lenders may oppose these strategies and mount public campaigns or commence litigation, which in turn may create anxiety and concern among a company’s stakeholders.
Restructuring reporters are increasingly savvy about covenant-lite loans and are now quicker to dive into a company’s debt documents in order to reveal what is possible or specifically restricted. This can create awkward, if not difficult, moments for companies when attempting to explain their actions to media.
Well-financed debtholders should be expected to talk directly to the media to frame the company’s actions as out-of-bounds or outright nefarious. Companies need to be prepared to educate their key reporters about the details of their loan agreements, and clearly articulate the benefits of any transaction or restructuring actions for the business and its stakeholders.
Rise in debt activism
Over the last 10 years, corporate America has seen an incredible rise in shareholder activism and the profound impact of equity activists on everything from board composition to corporate strategy to capital allocation. We are now seeing the emergence of another type of activism that can be equally fatal to a board of directors or its management team: debt activism.
Debt activists typically take a position in a company that is nearing a debt renegotiation or restructuring process and then exert outsized influence to achieve their objectives, often by using aggressive and public campaign tactics similar to what you would see from the most aggressive equity activists. Companies facing debt activists can expect provocative press releases and media coverage that are meant to publicly criticize if not shame management and their owners for actions they may be taking.
Litigation is a common strategy in debt activism, which creates additional reputational and operational challenges during an already precarious period for the company. Worse, debt activists have the ability to use complex financing instruments, notably credit default swaps, to attempt to manufacture certain outcomes for a debt negotiation process, such as a manufactured default.
Given the complexity of a debt restructuring process, debt activists have become particularly adept at making noise that helps to shape stakeholder perceptions, which can put pressure on a company and its management team. This may include making unfavorable assertions about the health of a company’s business or balance sheet, thereby creating anxiety and concern for employees or spooking supply chain partners, which can cause financial strain and accelerate a liquidity crunch.
Companies headed toward a potential debt renegotiation or restructuring process must be proactive about anticipating any potential debt activism and carefully prepare. This is consistent with what is now considered best practice for companies that face activism from equity investors. If there is the possibility of a debt activist mounting a litigation or PR campaign, the company must assemble a strong working team comprised of in-house and external legal counsel along with in-house and external communications counsel to ensure that the communications strategy is as effective as possible for all relevant stakeholders.
As always, the media loves a fight, so companies in these situations must maintain a proactive and ongoing conversation with reporters to ensure they understand the company’s position and the realities of what is allowable under their debt agreements.
Leaky debt community
There are a few key differences between debt and equity when it comes to corporate disclosure. First, debt agreements often do not require the same level and precision of disclosure, which loosens the typical guardrails for companies communicating material information to their employees.
Second, unlike equity holders, debt holders can actively coordinate and collaborate with the goal of forming validated groups that can more effectively negotiate with the company and its owners. Both of these features create a context in which information flows more freely and more rapidly within the ecosystem of interested parties, including media.
As a result, companies can expect reporters to learn about updates from confidential debt negotiations, hear about stakeholder concerns, such as those expressed by supply chain partners, or instantaneously receive in-house materials that a company distributes to internal audiences. Companies must be fully conscious of these inevitable leaks and be prepared for any damage control that is required in response.
Restructuring timeline accelerated by bankruptcy watch lists
Each step in a debt negotiation process, even if confidential, has the potential to drive media headlines and influence stakeholder perceptions. A typical restructuring process involves multiple rounds of behind-the-scenes negotiations between a debt issuer and its lenders. It is common for the details of these negotiating cycles to be leaked into the media, especially if the negotiation does not conclude with a favorable outcome, which is typical.
One milestone that can be particularly problematic for companies is the “blowout process” of “cleansing” documents. Upon the expiration or completion of a confidential negotiation process involving publicly held debt, information and terms presented as part of the confidential discussions are sometimes required to be filed publicly to meet certain regulatory disclosure rules. These documents may include new and potentially controversial details about a company’s financial status, its outlook and growth expectations, or proposed refinancing or restructuring terms. Companies can expect the media to eagerly spot these “cleansing” documents and quickly write articles that promote previously undisclosed information while framing the discussions as “failed talks.”
It is critical that companies and their communications advisers closely review any planned blowout materials and consider how key stakeholders will perceive the information so that proactive measures can be taken.
Restructuring tailspins accelerated by bankruptcy watch lists
A wide variety of media publications now maintain “bankruptcy watch lists,” which keep tabs on companies that may be vulnerable to a potential restructuring given weak balance sheets. “Top lists” are typically well-read and well-followed, so more and more publications have included these in their editorial lineup.
Unfortunately, self-interested parties are sometimes responsible for prompting a publication to consider adding a specific company to such a “bankruptcy watch list,” with the goal of raising awareness of the company’s weakened financial position. Once a company is on a bankruptcy watch list, it is impossible to remove itself without dramatically improving its financial performance or paying down significant portions of outstanding debt.
If a company finds itself on a watch list, it is imperative to educate the publication’s reporters about the sustainability of the company’s model and point them to bright spots in performance and operations. While this will not remove the company from the list, reporters will be more apt to incorporate these points into their articles for more well-rounded coverage. The inclusion of these points can help mitigate natural concerns from employees, customers and vendors about the health of the business.
During a corporate restructuring, insolvency issue or bankruptcy, a company and its advisers must not only think through the operational and transactional components, but also the reputational implications in order to put the company on a sustainable path. The trends discussed in this article can make managing through such processes even more challenging. The best recipe for success is for companies to be proactive in thinking about how these trends may be relevant to their specific situation so that they can appropriately prepare.
Lex Suvanto is global managing director, Financial Communications & Capital Markets.
Nicole Briguet is an account supervisor, Financial Communications & Capital Markets, New York.