Evaluating the legacy and implications of COVID-era insolvency and restructuring reforms
It is the rare policymaker who prioritizes corporate restructuring reform, particularly when the economy is operating smoothly. However, the uncertainty around business liquidity and then solvency, as well as the risks to financial sector stability caused by COVID-19, led to something highly unusual in our arena: widespread and rapid insolvency law reforms—conceived, designed, and implemented in months, where ordinarily such reforms would take years. It is estimated that over 90% of countries enacted some form of insolvency reform in 2020. These reforms were typically part of a broader reform package intended to put the many businesses facing the complete destruction of their operating model into a sort of economic hibernation: out of the bankruptcy courts, and able to remain afloat until conditions stabilized. What were these reforms? Did they achieve what they were intended to? What lessons can be learnt from their implementation?
These were the questions that we sought to answer in the paper contributing to a special issue of the European Business Organization Law Review, titled ‘A Cross-Country Policy-Maker Perspective on Corporate Restructuring Laws Under Stress’. Key categories of reforms described in our paper are (1) increasing barriers for creditor-initiated insolvency filings; (2) suspending the legal duty of directors to file for insolvency proceedings; and (3) debt relief measures generally (everything from statutory extensions to repayment terms, freezes on the ability to enforce debts, including by suspending judicial proceedings).
In the paper, we recognize that complementing formal, court-supervised restructuring frameworks with more informal negotiation-based tools can encourage early restructuring as a way of managing high corporate debt levels, when a business is more likely to be turned around. Yet, informal workouts are often said to operate ‘in the shadow of the law’, meaning that their success is largely driven by the credible alternative of a formal insolvency proceeding, which typically is more expensive and time-consuming. So, the design of the more formal frameworks matters, too.
While there are important differences between the new restructuring procedures that were adopted during the pandemic, we identify the following common features:
- Private negotiation of a restructuring agreement with limited role for the court;
- The possibility of obtaining a court-ordered stay or a time-limited moratorium on individual enforcement actions;
- The possibility of accessing the procedure before the debtor is in a state of insolvency;
- Provision for making the agreed-upon restructuring plan binding on dissenting minority creditors, including on dissenting classes of creditors;
- The debtor remaining in control of day-to-day business operations;
- Protection for new financing from avoidance actions.
A key economic legacy of the COVID-19 pandemic is the extensive fiscal stimulus and the resulting budgetary constraints that this has placed on governments. The global value of stimulus since March 2020 is estimated by the IMF at USD $13.8 trillion, representing 10-15% of annual global GDP, with as much as 30% of GDP being committed to COVID-19 stimulus in some countries. As such, a critical feature of the current macro-economic climate is record public and private debt levels. Although governments acted quickly to keep debtors out of insolvency processes, they did not alter high levels of underlying indebtedness. In this worsening economic climate characterized by low growth, high inflation, fiscal tightening and high indebtedness, the question arises whether, in certain countries, the temporary emergency insolvency reforms measures have deferred, rather than prevented, high insolvency levels. Of course, it is also important to ask the counterfactual question, namely whether high insolvency and NPL levels could have been avoided without these expensive and disruptive measures.
We argue that it is still unclear as to whether the pandemic relief measures prevented widespread corporate distress or merely delayed it. This remains an open question now—with insolvency filings in many jurisdictions rising, but still below pre-pandemic levels. Given the numerous predictions of a tidal wave of insolvencies in the early stages of the pandemic, which did not materialize, forecasts appear to be less conclusive today. Nonetheless, the economic headwinds described above certainly provide grounds for apprehension that a rise in insolvencies is probable in the medium term. In previous financial crises, insolvencies have taken time to materialize—about thirteen quarters from the onset of the crisis. And the scale of Covid-19 stimulus—which would likely extend this timeline out even further—dwarfs that of previous crises. On the other hand, it is also possible that future economic turbulence will be minor, localized, regional or mirror the uneven economic recovery from the pandemic, in which rich-world countries have recovered and are set to continue recovering faster.
Companies now face new challenges due to the combination of the phasing out of many emergency measures used during the pandemic, such as payment moratoria, and new macro-economic concerns including high inflation, slow growth in many economies, Russia’s invasion of Ukraine and energy and food crises in many regions. Corporate leverage remains high in many countries, and there is an escalating risk that many corporates will prove unable to meet their debt-servicing obligations. There is more work to be done to ensure that the tools introduced or reformed during the crisis are fit for purpose in their particular context, and that the institutional framework necessary for their success is in place.
Antonia Menezes is Senior Financial Sector Specialist at the World Bank.
Harry Lawless is Financial Sector Specialist at the World Bank.
Disclaimer: The authors are members of the World Bank Group. The views expressed are their own, and do not necessarily reflect the views and opinions of the World Bank Group, its Board of Directors, or the governments they represent.
This post is part of an OBLB series on Corporate Restructuring Laws Under Stress. The introductory post of the series is available here. Other posts in the series can be accessed from the OBLB series page.
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