COVID-19: Business Restructurings - Part One
Businesses confront the most significant challenge in a generation as their markets shrink, change or disappear. Having navigated the initial phase of the crisis implementing a series of cost saving and liquidity measures, companies are now progressing to the next phase. For most, including many who were strong heading into the crisis, this next phase will be the most challenging as businesses look to replace lost revenues and “future proof” their organisations. Whilst for some this phase will present an opportunity to refine operations and improve efficiencies, for many it represents simply an existential threat.
The likelihood therefore is that increasingly we will see companies undertaking not just a financial restructuring - where the business looks to reschedule or refinance its debt - but also a broader business restructuring involving a root and branch review of all operational aspects as organisations adapt to the Covid era and re-engineer not just their balance sheets but their entire business models.
Part one of this article examines the wide range of matters which will fall for consideration in the context of those broader business restructurings and the second part will explore the options, implications and processes involved in a financial restructuring.
Workforce
The government’s job retention scheme has been modified such that:
furloughed employees can be brought back to work part time from 1st July
employers must contribute progressively to the employment costs from August
the scheme will end on 31st October A range of issues now confront businesses:
budgeting for and financing those new costs
how and whether to take advantage of the part-time arrangements (e.g. whether contractual arrangements will need to be reviewed, ensuring that systems are in place to meet the reporting requirements)
the possible need to make redundancies at the 31st October end date and the timing impact of any consultation required
As businesses contemplate a return to the office a number of factors fall to be considered:
Compliance with government guidelines on working safely. Businesses will need to undertake a risk assessment which in the case of organisations of more than 50 employees must be placed on the website. Employee confidence will be key and detailed planning ahead of re-opening offices will be essential to that both in terms of HR policies and infrastructure.
Many employees will continue to work remotely on a full or part-time basis. Businesses must adapt to the new ways of working and IT systems will need to be robust. Similarly maintaining the organisation’s productivity and ensuring that employees working remotely remain focussed and engaged will be key.
Organisations will need to assess whether they have the
requisite skills in their teams to adapt to the changes in their business model. This may mean training, recruitment and redundancies.
The well-being of the workforce will be of paramount concern to businesses. Flexible working makes this both more challenging and more important to monitor.
HR and IT infrastructures and policies will need to be reviewed and updated to cater for these new conditions. The bursting of the dam created by the government’s job protection scheme is likely to see a swathe of redundancies and these combined with employee health and safety guidelines on return to work, absenteeism and data subject access requests are likely to place significant strains on HR teams.
Where a business operates cross-border it will need to assess these issues in each of its locations by reference to the local legal and regulatory requirements.
Executive Remuneration
In addition to furloughing, many employees have been required to take pay-cuts as part of a business’s financial measures. The challenge for many businesses is to balance the need to make savings whilst simultaneously rewarding the loyalty of those members of staff who have suffered a reduction in pay and retaining and incentivising key senior management.
Where share incentive or bonus schemes are already in place businesses may need to review their terms to assess whether any adjustments need to be made to reflect any impairment to the business arising from the crisis and to ensure that the performance conditions remain meaningful.
Commercial Contracts
Business failures can have devastating effects along the supply chain. Many organisations are considering what action they can take to mitigate their risk.
Uneconomic contracts
Many businesses have been confronted with looking to escape or renegotiate contracts which are economically unviable or not fit for the new purpose. This has led to lawyers scrutinising early termination rights (e.g. via force majeure or material adverse change provisions) and contractual frustration. The ability to exit loss-making contracts and replace them with new profitable revenue will be a continuing challenge for businesses navigating the next phase (see below).
Early warning
Businesses should consider provisions which will give them advance warning of financial distress (e.g. access to financial information) and limit their financial exposure (e.g. by amending payment terms).
Exposure
Businesses should also review their credit insurance options, supplier/customer dependency and contingency plans.Flexibility
The uncertainty in demand – when and how it will return – is a common issue facing businesses. Many assume that it is likely to be volatile and unpredictable. It will be vital for a business to be as agile as possible during this phase meaning that contracts will be reviewed with customers and suppliers to minimise the company’s exposure to fixed costs and long-term commitments (such as incorporating appropriate termination provisions).Routes to market
Businesses may have to find alternative ways of reaching customers e.g. in the event of the failure or unavailability of a logistics partner – not all businesses which emerge from lockdown on the same day or at the same pace. In addition many businesses will be looking closely at their supply chains particularly those which are multi-jurisdictional. The risk and management associated with lengthy chains is something all businesses will seek to mitigate. Time will be of the essence (no pun intended) and existing contracts will need to be reviewed to assess liability and new ones entered into to mitigate exposure.Corporate Insolvency and Governance Bill
This is expected to be enacted in the next few weeks and will have a significant impact on the supply chain generally. In particular:Retrsopectively with effect from 27th April, winding up petitions based on a statutory demand served between 1st March and at least 30 June 2020 (likely to be longer) cannot be brought by a supplier unless (in effect) it can establish that the customer’s financial position is not Covid related.
Where a customer enters an insolvency procedure, contractual rights triggered by that process will become unenforceable (e.g. termination).
During the insolvency procedure, suppliers cannot make payment of outstanding pre-insolvency invoices a condition of continuing supply.
In short, suppliers could be forced to continue to supply a customer even where the customer enters an insolvency procedure and previous invoices remain unpaid.
Consequently suppliers should review their contracts with customers who they consider to be in financial distress. Possible protections range from payments on account, guarantees, flexible (e.g. short fixed) terms and re-classifying unpaid debts with a view to securing improved priority in an insolvency process.
Intended to buy time for businesses who were solvent pre-Covid, the legislation could yet unintentionally spread the financial contagion.
Services/Products
Many companies will be forced to appraise their products or services and whether these remain relevant to the changing markets. As part of that exercise businesses may take the opportunity to stop certain loss-making activities, assess whether essential activities can be done differently - and whether an activity is any longer “essential” - and focus resource and investment accordingly.
This re-designing of the business will impact on all aspects from contractual relationships (IP licences, designers, suppliers, customers, sub-contractors, distribution and logistics) to workforce skills and real estate requirement.
Real Estate
All businesses are looking closely at their real estate requirement as they look to “right-size” their operations and reduce costs. The current trend towards flexible working means that businesses will need to assess not just the amount of space needed but how it is used. The need to ensure a safe environment for workers means that many businesses are considering moving to a mix of office and shared space.
Commercial tenants are also discovering a new world relationship with landlords and flexibility on aspects from break rights, to assignment, sharing and sub-letting. Standard long term leases commitments are likely to be a thing of the past.
M&A
As part of its costs savings and business reconfiguration many companies will be assessing under-performing or non-core divisions and contemplating a divestment programme. Where there is a distressed aspect to the process deliverability and limited seller recourse is likely to be more important to sellers than price (valuation in the current market being more of an art than ever).
On the other hand the current environment will present opportunities for strategic buyers looking to bolster gaps in services or supply-lines. It is likely that buyers will be extra discerning and diligent meaning longer M&A timelines.
It will be a particularly interesting time for private equity sponsors. Whilst many may be sitting on significant funds many are also likely to be looking at their portfolios and analysing which investments to let go. This also gives PE the opportunity to allocate resources to those businesses which have longevity. Capital and time are particularly precious commodities and will need to be invested carefully in the coming months.
Insurance
As businesses were forced into temporary closure by lockdown many turned to their insurers. They have discovered however that classic business interruption insurance may not cover Covid-19. Typically “BI” is added to a business’s all-risks insurance programme rather than sold as a standalone policy, and covers loss of income that a business suffers as a direct result of physical damage to insured property. Therein lies the rub. The pandemic has not as a rule led to property damage.
Many businesses will be looking more closely at the fine print in future discussions.
That said businesses may still have a route to indemnity but will need to check their policies carefully, act promptly and ensure their claim complies with the policy conditions.
Cyber-security
Lockdown has produced a fertile ground for fraudulent activity with many businesses experiencing heightened cyber security risk with large numbers of staff working remotely, the growth of personal devices being used for business and ransomware attacks against critical infrastructure.
Closing thoughts
Organisations will be confronted with an array of challenges as they navigate the next phase of the Covid crisis. The organisation’s ability to adapt to change will have a significant bearing on their recovery and growth. Experience will be at a premium in making these decisions.