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The COVID19 pandemic; Golden times for distressed M&A but also relief for debtors and creditors

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Netherlands

Since the first lockdown of eleven municipalities in Lombardia, in February, many countries all across the globe have followed the Italian example in an attempt to halt the spread of the COVID19 virus. Whilst some are cautiously easing restrictions, it is expected to take a long time before the world has returned to its normal pre-pandemic pace.

Until the virus is conquered and the pandemic is over, numerous companies will struggle to survive and a large number of them will fail in their attempt. Whilst governments may bail some out, sadly for many small and medium businesses, this will not be the case. For others though this may provide an opportunity.

Opportunity beckons

Last January, according to Fortune magazine, private equity firms alone had a staggering US$ 1.5 trillion in unspent cash in their coffers. Add to that the war chests that larger companies and corporations still have, and financial institutions that find debt financing abhorrent but look favourably upon acquisition financing, and one can see golden times dawning for strategic investors and their likes, who have the guts and the money to make acquisitions now.
Many jurisdictions have enacted legislation to give debtors extra (financial) breathing space during the COVID19 pandemic. For instance, in Germany, pre-COVID19, a director could be liable for additional debt incurred by the company from the time the company should have filed for insolvency, i.e. when the company is illiquid or over-indebted. Now, if the company was solvent on 31 December 2019 it does not have to file for insolvency until 30 September 2020, unless the insolvency is not due to the COVID19 pandemic or if there is no likelihood that the illiquidity can be remedied.
More or less similar relaxation of the pre-COVID19 rules apply in Luxembourg, Ireland, the UK and Spain. In the Netherlands, the Act on Court Confirmation of Extrajudicial Restructuring Plans is expected to enter into force any day now.

What does this mean?

These measures allow both debtors and investors some extra time to devise restructuring plans. Often, debtors go bankrupt because they see no way out of their financial problems and simply act too little too late. Such bankruptcies might have been avoided, had rigorous measures been taken earlier.
Deferring payments does not make debts disappear; they just have to be paid later, having been increased by interest and collection costs applied by creditors. This is a lose-lose situation for not only the debtor and the creditors, but for all stakeholders, resulting in - amongst other things - loss of shareholder value and employment. Although shareholders may not like the idea of being diluted or even lose their shareholdings entirely, this will be the outcome in case of bankruptcy any way. So why shouldn't shareholders take social responsibility and at least save jobs and prevent creditors from being unnecessarily harmed by issuing new shares to an outside investor, or by selling the company if it is, or the parts of it that are, considered to be viable as part of a restructuring plan? Company directors must also explore all reasonable opportunities to limit damage, if the business is in distress. If they do not and have put the company into liquidation unnecessarily, they might be held personally liable. In a recent study, EY argued that private equity firms somewhat missed the boat in the previous financial crisis and won't make the same mistake again. It expects private equity firms to quickly make investments in struggling companies. They have strong relationships with banks and other lenders, and more operating expertise than in 2009. Although the latter may not apply to other private investors, it is obvious that the crisis provides them an opportunity as well.
However, the legislative relief mentioned above is only temporary and does not mean that in these difficult times everything is suddenly allowed. Trading in distressed assets, as well as devising restructuring plans always requires special care, and specialist advice certainly helps limiting liability issues. Redundancies, arrangements with creditors, selling off business units, whether they be the unprofitable or the profitable ones, generally causes much ill will and should be handled with caution.
As with all things in life, a careful strategy from the outset can increase profit and limit later liability, and we hope the investor community can see the great opportunities that will be available to it.

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