Chapter 11 Cases in 2022: A Tale of Two HalvesUpdated:
The past year in the world of restructuring – at least when it comes to in-court cases – was a tale of two halves. The first half of the year saw the fewest number of filings of any half-year period in recent history. The explanation many gave – which no doubt tells part of the story – is that the lack of activity was driven by a mix of significant amounts of restructuring activity having been pulled forward due to the pandemic and capital markets being as wide open as they’ve ever been.
But, to my mind, the major factor informing the first half of the year – and what really explains why so few companies ended up filing – was a kind of temporal oddity that I’ve talked about before regarding what will contribute to the next restructuring cycle. The first half of the year, for most companies, was the best of both worlds: the excess savings of consumers allowed companies to raise prices with relative ease, but the consequences of the Fed’s rate hike cycle (e.g., higher debt servicing costs for companies with unhedged floating rate debt, consumers curtailing spending due to economic uncertainty, etc.) hadn’t yet bitten.
Regarding debt servicing costs, here's a great recent chart from LevFin insights touching on this: for those that haven't hedged their floating rate debt, the rate hikes are beginning to bite...
In other words, the first half of the year saw companies have their cake and eat it too. They benefited from the inflationary environment (e.g., the ability to raise prices more easily without destroying demand) but didn’t yet feel the consequence of what the Fed was doing to do to try to tame inflation (e.g., raise rates at the fastest pace in the last four decades).
However, as we ventured into the second half of the year the Fed’s hiking cycle began to bite: capital markets activity slowed to a crawl, earnings began to show early signs of cracking, and those industries that benefited most from the easy money era of the prior two years began to have companies falling in rapid succession into bankruptcy courts.
While the past year was slow by historical standards, the last quarter of the year saw the most activity in two years -- and it wasn’t just driven by one industry due to idiosyncratic factors but involved a relatively wide swath of companies biting the bullet.
Notable Sector Trends
With a paucity of cases and a relatively strong economic backdrop for most of the year, there weren’t any sectors that saw an aberration in filing to the upside. Rather, the notable sector trends involve those that saw a sharp contraction from historic norms.
In any given year over the past decade, two of the sectors that produced the most filings were consumer discretionary (including retail) and energy. However, the past year saw consumers still burning through the excessive savings they built up through the pandemic while also getting outsized wage gains in nominal terms -- consequently, it was a great year for consumer discretionary with surprisingly few filings (and, as you’d expect, many of those that did end up filing were on distressed radars for a long time like Cineworld).
Meanwhile energy posted one of its best years on record. With strong energy prices not only being informed by the war but also by diminished investment in capacity -- a natural consequence of the lessons learned from how many energy companies through the mid-to-late 2010s over levered themselves in a sprint to build up capacity and then wound up needing to restructure during a tougher pricing environment (e.g., a classic example that’s gone full circle from over levering itself to build out capacity, filing due to a massively over levered capital structure, and now once again being a publicly traded company that’s erring on the side of being much more conservative would be Chesapeake).
Anyway, here's a breakdown from Reorg of the year that was, sector-by-sector…
Case Size Contracted
Even though the number of Chapter 11 filings ended last year roughly flat from the year prior – itself a very muted year – it wasn’t until the latter half of the year that we saw a meaningful number of cases over the $1b mark and began to see a trickle of $10-50b cases.
Note: For context, whenever you hear someone refer to a case size as being $1b or $5b or whatever, what they’re referring to is the amount of liabilities the company has.
As you can see in the graph below from Reorg, the number of very small cases (e.g., $10-100m) isn’t that far removed from where it was pre-pandemic. But the number of larger cases (e.g., those that would require restructuring bankers getting involved) is still well below the historic average.
This is why if you’re ever reading a story on Bloomberg, etc. and they say something like, “there’s been a notable uptick in Chapter 11 cases recently”, you can’t take it as per se meaning that restructuring bankers are much busier (although directionally it’ll likely be true).
With that said, even though last year saw only 21 cases over the billion-dollar mark, 15 of those came in the last half of the year which is more inline with historic norms (so we’re moving in the right direction – at least for our purposes!).
The silver lining of 2022 was that we had a return of cases in the $10-50b range after having none the year prior (the two most notable being FTX, advised by PWP, and Cineword, advised by PJT).
Below is a list of some other notable in-court cases from the past year over the $1b mark:
- Revlon: a freefall Chapter 11 with PJT being debtor-side
- Carestream Health: a pre-pack with HL being debtor-side
- Lumileds: a pre-pack with EVR being debtor-side
- Endo: a pre-negotiated case with PJT being debtor-side
- Core Scientific: a pre-negotiated case with PJT being debtor-side
And, of course, there’s been the smattering of large crypto cases that are talked about ad nauseam in the popular financial press (e.g., Bloomberg) such as BlockFi, FTX, Celsius, and Voyager. From a restructuring perspective, there are some interesting elements to these cases by dint of their lack of traditional capital structures, their unruly or unnavigable corporate structures, etc. but these cases are quite divorced from regular-way cases and aren’t as interesting as the amount of coverage in the financial press would indicate.
With that said, given their lack of meaningful capital structures and the number of depositors who are now creditors, there is a very robust claims market that you can follow in real time on Xclaim that will move substantially as the cases progress and more clarity is achieved on potential recoveries.
Something that I’ve written about many times is the continued rise of pre-packs over the past decade (especially for sponsor-backed companies). Per Reorg, just shy of 40% of all $100m+ cases were pre-packs which is roughly in line with the average over the past two or three years.
Note: In the guides I’ve always recommended that if you’re going to talk about an in-court case in an interview, then choosing a pre-pack is an obvious choice as there’s per se less twists and turns occurring in court given that everything is buttoned up pre-filing. As a result, reading through the disclosure statement and skimming certain parts (Article III) of the Plan or Reorganization will tell you more than you’d ever need to know for interview purposes.
Some notable pre-packs from the past year are Carestream and Lumileds, the former taking just over a month to get done and the latter taking just over two months. There weren’t any clean cut pre-packs that got done in a day like Belk or CWT in years past -- however, there’s the slightly more nuanced case this year of Seadrill New Finance that was confirmed in a day but that was part of the broader Seadrill restructuring. So, I’d shy away from talking about this in an interview as you don’t want to open up the can of worms of the broader Seadrill restructuring which was relatively complicated -- offshore drillers are always a pain, partly because of how they’re structured as I obliquely touched on by way of example in my post on upstream guarantees.
Note: Just to provide a little example, here’s a link to Carestream’s combined disclosure statement and Plan. If you flip to page seven, you’ll see that the table of contents of the disclosure statement provides a quick-and-easy overview of everything you need to know when discussing a deal in an interview (e.g., who the company is, how they got into trouble, how various classes are being treated, what the company will look like post-reorg, etc.).
Thinking About Torts
In any given year there’s normally an overarching theme or trend that bleeds through. In terms of out-of-court transactions, we continued to see progressively bolder – for lack of a better word – unsub transfers and non-pro-rata uptiers occur last year (e.g., Envision and Incora) that everyone loves talking about (these are gently introduced in the Serta guide).
However, in terms of in-court activity there weren’t any meaningfully innovative tactics tried that will have long standing implications. Sure, there were all the crypto filings, a sharp decline in cases from sectors that are normally well represented, etc. but that’s just sector-related stuff.
For example, we talked previously about the Texas-Two Step strategy for handling mass tort litigation that became notorious in 2021 – now that is an innovative and controversial in-court theme or trend.
Personally, it was my view that we’d see more pushing of the bounds of how tort claims were being handled last year -- with debtors basically adopting the "nothing ventured, nothing gained" mindset. But despite some of the biggest cases of last year surrounding mass tort issues (e.g., Aearo, Endo, and TPC) the Texas Two-Step – or any new novel permutation or offshoot of it designed to handle tort claims in-court – wasn’t meaningfully attempted (due to a fear the strategy could be upended in court, which seems increasingly prescient as a federal appeals court just rejected J&J's strategy). Here's what the 3rd Circuit said in their decision...
In many ways, the activity of last year wasn’t that surprising. The residual ramifications of how loose monetary policy was in the years prior, how much activity was pulled forward by the pandemic, and the margin expansion most observed for the better part of the year made for a more muted year typified by a ragtag group of cases.
In reality – if you look at the cases that were above $1b – it was a pretty wild smattering of crypto cases, tort-related cases, and a few other idiosyncratic cases (e.g., Reverse Mortgage Investment Trust).
There just wasn’t really that much in the way of large “classic” or regular-way cases like you normally have with a few exceptions like the pre-packs previously discussed (e.g., Carestream) or cases like Revlon or Cineworld that were circling the drain for years (with Revlon trying nearly every out-of-court option possible prior to biting the bullet and finally filing).
But the good news (again, for our purposes) is that the tide is turning -- and it’s doing so quite quickly. In just the first month of this year (2023) we’re getting plenty of regular-way cases coming down the pipeline (e.g., Bed Bath & Beyond, Serta, Party City, etc.). So this year promises a return to some level of normalcy -- and perhaps a little bit (or quite a bit) more than that.
Note: While it's always a good idea to have an understanding of the general restructuring landscape and what's been happening, if you're getting ready for interviews be sure to make sure you're focusing most of your time on studying what restructuring investment banking really involves and the classic restructuring interview questions that'll come up.