Survival has become the preoccupation of businesses everywhere as they try to stay afloat through the economic storm brought on by Covid-19. Governments have launched support packages to help companies through the downturn, but the grim truth is that not all will make it. Even before today’s crisis businesses had taken on unprecedented levels of debt. Combined with the near-total lockdowns that brought most economic activity to a halt, it is inevitable there will be a flood of bankruptcies. In the US, some big brand retailers, including J Crew, have filed for Chapter 11. In the UK, a recent survey revealed almost half of all businesses do not have enough cash reserves to last them more than six months.
The bankruptcy process is disruptive for any business, even in normal times. The immediate concern for policymakers today must be to ensure that the system is not overwhelmed by a wave of corporate failures. Even if companies need to be restructured after the crisis has eased, the key for the moment must be to flatten the curve of bankruptcies. The risk otherwise is that the legal infrastructure, notably the courts, becomes swamped.
Bankruptcy is an essential mechanism that allows free markets to work efficiently. Good bankruptcy procedures speed up the movement of capital and workers from activities that have become unviable to productive ones. As governments look at ways to wean companies off state support measures, it is vital that viable economic activity can continue. A flexible approach is important. Companies must have the breathing space to restructure the debts they took on to keep them alive during the crisis. This applies in particular to otherwise healthy businesses; the goal must be to eliminate debt overhangs without eliminating productive business activities along with them. Economies cannot afford to lose companies that have specific human and social capital which cannot easily be recreated.
The US system is a good example of what is required. Chapter 11 of its bankruptcy code gives protection from creditors while a company reorganises, unlike in Europe where insolvency procedures often lead to liquidation. Companies can also access “debtor-in-possession” financing which is provided by existing or new lenders to cover a reorganisation. Such loans take priority over other creditors and help to avoid viable businesses being wound up. The restructurings of the Detroit auto giants after the 2008 financial crisis were notable successes.
Even the US system might not be able to cope with the flood of cases building up. Chapter 11 has a poor record with small and medium-sized businesses as the costs are significant. A paper by the Brookings Institution proposes a number of sensible ways to adapt the process, including pre-packaged bankruptcy procedures, where companies agree a restructuring plan in advance. In the UK, the government has announced changes to insolvency laws to give companies extra time to restructure. Suspending the wrongful trading law will shield directors from liability if they continue paying staff and suppliers even if there are risks the company could become insolvent.
Above all, governments must make sure bankruptcy systems can adapt quickly. More resources should be made available if needed. Parallel procedures can be put in place such as pre-packaged restructuring, temporary non-bankruptcy debt standstills and debt-to-equity swaps for those that cannot pay back state aid. Helping companies to restructure early — and quickly — should be the objective.
Source: Economy - ft.com
