COVID-19: A Global Moratorium for Corporate Bonds?
The alarming prospect of widespread defaults by economically viable firms has prompted various proposals for assistance from states. Access to new finance can be facilitated by the state guaranteeing draw-downs on bank overdraft/lines of credit facilities, emergency loans, or, in the case of larger firms, by state purchases of commercial paper. However, firms might face financial distress before these measures become effective. Smaller firms with concentrated capital structures may well be able to informally negotiate an extension of maturity with their lenders, provided those lenders (typically banks) are given speedy and sufficient assistance from the state to enable them to make value-maximising accommodations to debtors. But debtors with fragmented capital structures may not be able to arrange workouts so easily. In this piece, we suggest a novel form of relief for corporates whose capital structures have been fragmented by bond issues.
Our proposal is this: that emergency legislation be introduced to extend the maturity of bond debt. The basic idea would be to ‘buy time’ for large corporates, reducing the risk of fire sales. In the UK context, we envisage primary legislation providing that, notwithstanding anything to the contrary in bond contracts, English law governed bond debt cannot fall due for payment within, say, 180 days of entry into force of the legislation. Acceleration clauses would have no effect in this period, nor would debtors be required to create a sinking fund or post (additional) collateral. However, debt due to mature after 180 days would be unaffected. Debtors who could pay would not be prevented from paying. However, a saving provision might need to be included to avoid penalties for early payment where debt contracts provide for this. Equivalent legislation could be introduced elsewhere to deal with debt governed by the law of other jurisdictions, including New York law in particular.
An obvious objection to our proposal is that most jurisdictions already have a formal mechanism for shielding debtors from enforcement action by creditors in times of crisis. Nudged by international development banks, most jurisdictions have one or more procedures in which debtors can obtain a stay with a view to negotiating a restructuring with creditors, the law typically providing that, where a court agrees, a minority can be bound to the will of a similarly situated majority. Where there is a ready market for the purchase of the business, such a renegotiation with creditors should be unnecessary (Baird 1986); where there is not, however (for example, because the debtor’s distress is shared by others in the same industry: Shleifer and Vishny 1992), such procedures can provide a route to value preservation by providing tools to overcome the coordination problems associated with renegotiation.
Given the availability of reorganisation procedures with statutory moratoria, why do we propose that the UK Parliament intervenes to directly lengthen the maturity of English law governed bond debt? Our primary reason is that conventional reorganisation procedures cannot be trusted to deliver value-maximising outcomes for a large number of debtors in multiple sectors of the real economy who become financially distressed simultaneously. Reorganisation procedures are complex to administer and, almost by definition (because their characteristic feature is the ability to bind dissenters to a change in rights) court-intensive. The experience of other large-scale corporate crises suggests that bankruptcy courts can quickly become overburdened (see e.g. Stone 2002 or Cirmizi, Klapper and Uttamchandani 2010). This seems a particularly acute risk in the current crisis, given that COVID-19 is also straining courts in other ways: physical court closures are highly likely, and any virtual equivalents will take time to be established. Most importantly, court-supervised insolvency procedures are associated with significant direct and indirect costs, causing a potentially fatal loss in value of the financially distressed firm. In this context, non-court based solutions should be prioritised. Hence our focus on statutory intervention at the contractual level.
Clearly, our proposal is only sensible if it can reasonably be expected that the courts of other jurisdictions would treat the debt contracts as validly altered by the statute, for a great deal of English law governed debt has been issued by corporates with assets (and even centres of main interests) abroad. Would foreign courts resist this on the basis that doing so would be manifestly contrary to the public policy of their state? The obvious concern would be that the statutory amendment amounts to an impermissible interference with property rights (protected under international human rights law) but for the reasons set out immediately below we think that the interference is fully justified. As such, we are optimistic about the efficacy of our proposed intervention abroad.
We acknowledge that a modification of contractual rights is likely to be characterised as an interference with property rights for the purposes of Article 1 of Protocol 1 of the European Convention on Human Rights. However, there must surely be a powerful case that this time-limited measure (which would preserve bondholder rights other than in respect of the length of maturity) is fully justified in the 'public interest', as permitted by Article 1 of Protocol 1, given the extraordinary economic imperative for the measure. Concerns about proportionality could additionally be met by providing for sectors to be carved out from the scope of the intervention in subsequent regulations, which might be valuable for those (few) sectors that do not need it (such as groceries distributors or medical equipment producers).
We recognise that our proposal may not be sufficient to avoid unnecessary filings: if directors are subject to a mandatory filing rule, this would also need to be relaxed. This possibility is already being explored elsewhere, as charted by Aurelio Gurrea Martinez in a forthcoming post. English law does not impose a mandatory filing rule on directors. Instead, directors run the risk of personal liability if they know or ought reasonably to know that it is inevitable that the debtor will end up in balance sheet insolvent liquidation or administration, and they fail from that point in time to take every step with a view to minimising potential loss to creditors that they ought to have taken (ss214/246ZB of the Insolvency Act 1986). Our proposal would indirectly, and we suggest beneficially, affect the operation of this provision by giving directors greater comfort that the unnecessary opening of insolvency proceedings can be avoided. To put it another way, insolvency proceedings may no longer be an inevitability with our proposed extension in maturity. If even with the benefit of this intervention (and the other battery of interventions from the state) directors still know (or ought to know) that insolvency proceedings are inevitable, then under the current law they will have to take every relevant step. But English courts will only ask what it would have been reasonable for the particular director to do; the courts must resist invitations to use hindsight; and they can only order compensation be paid where the failure to take appropriate steps is causally linked to loss suffered by the company (see e.g. Grant v Ralls).
We recognise that our proposal will mean that some businesses that should have deleveraged already will be given more time than they otherwise should have been given. But for the reasons we have set out we do not think that now is the right time to require courts to supervise reorganisations, and doubt that (at least for most industries) there will be ready markets for going concern sales. The ex ante effects of being overly generous to these debtors should be limited, given the highly exceptional nature of the crisis.
Kristin van Zwieten is Clifford Chance Associate Professor of Law and Finance at the University of Oxford.
Horst Eidenmüller is Freshfields Professor of Commercial Law at the University of Oxford.
Luca Enriques is Professor of Corporate Law at the University of Oxford.
YOU MAY ALSO BE INTERESTED IN