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Overview of restructuring and insolvency activity

i Economic overview

Over the past year, from 1 May 2021 to 1 May 2022, the US economy experienced unprecedented growth but also suffered unprecedented inflation over the latter half of the period. In particular, the strong US post-pandemic economic recovery that began in the second half of 2020 and continued throughout the first quarter of 2021 accelerated through the remaining calendar year. Real gross domestic product (GDP) increased 5.7 per cent – the strongest economic growth since 1984 – compared with a 3.4 per cent decrease in calendar year 2020.2 Trillions of dollars in federal covid-19 relief spending and the development and widespread distribution of the covid-19 vaccine, which significantly alleviated covid-19 restrictions, largely fuelled the recovery and resulting economic gains in 2021.3

The equity markets similarly remained hot in calendar year 2021, continuing the remarkable bull market seen in the latter half of 2020. The S&P 500, Dow Jones Industrial Average and Nasdaq Composite each turned in solid performances, gaining 26.9 per cent, 18.7 per cent and 21.4 per cent, respectively, in calendar year 2021. These results show that investors largely discounted several negative developments during the year, including the contested presidential election, supply chain disruptions, increasing inflation, and the effects of the delta and omicron covid-19 variants, which threatened to slow the stock market gains.

However, the first quarter of 2022 has shown that the record economic recovery seen in 2021 might be slowing. US GDP fell at a 1.4 per cent annualised pace in the first quarter of 2022, missing the Dow Jones estimate of a 1 per cent gain for the quarter and a sharp decline from the 1.7 per cent growth seen in the final quarter of 2021.4 Inflation, which has been increasing since March 2021 and accelerated in October 2021, is at an overall level of about 6 to 7 per cent on a year-over-year basis, and supply chain issues have persisted.5 Facing continued increases in the first half of 2022, the Federal Reserve (the Fed) has pivoted from a decade-long monetary policy and begun to raise interest rates and withdraw emergency stimulus programmes in a bid to cool inflation. However, the Fed's recent moves to cool inflation, including an interest rate increase of 0.5 per cent in early May – the Fed's most aggressive move since 2000 – and a tapering of bond purchases, have sent jitters into the stock market.6

The lasting effects of the current war in Ukraine on the US economy remain to be seen, but continued impacts on global oil prices, lower demand from Europe for US exports and an increase in the price of the US dollar are expected by some analysts to create short-term issues.7 Gas prices in the United States are now approximately US$4.60 per gallon on average at the time of writing, up 46 cents from just a month prior. Although many of the underlying market dynamics that powered mergers and acquisitions (M&A) activity in 2021 are still present in 2022, increased regulatory scrutiny, particularly in respect of transactions involving special purpose acquisition vehicles (SPACs), might moderate the pace. SPAC transactions accounted for more than US$600 billion in transaction value and about 10 per cent of global deal volumes in 2021, but activity has cooled due to such increased regulatory oversight and pressure on the performance of SPAC initial public offerings in the latter half of 2021 and into 2022.8 Despite these factors, expectations for continued economic growth and dealmaking activity in 2022 remain strong.

In contrast, distressed debt levels remained particularly low after falling significantly in the latter half of 2020 into early 2021. Distress ratios for leveraged loans and high-yield bonds peaked above 30 per cent by issuer count in mid-2020 but stood at 1.6 per cent and 2.5 per cent, respectively, by the end of calendar year 2021.9

The robust market growth and resulting easy access to capital seen in the first half of 2021 continued to drive M&A activity in the United States, in line with the global deal market, through the second half of 2021 and into 2022. The US M&A market reached new highs in calendar year 2021, accounting for US$2.9 trillion in transaction value – up 55 per cent from US$1.9 trillion in 2020, when US deal value fell by 18 per cent over the prior year. US dealmaking ultimately accounted for nearly 60 per cent of all global deals with announced values in 2021 compared with less than 50 per cent in 2020.10

ii Restructuring trendsOverall filing and industry trends

The substantial economic growth and availability of capital over the last year have led to a slowdown in the restructuring market and demonstrated a recent trend towards mass tort filings among the large corporate bankruptcies, discussed in further detail below. Corporate bankruptcy cases hit recent lows in calendar year 2021, continuing a drop-off in filings that began towards the end of 2020. According to federal data, there were 14,347 business filings in calendar year 2021 compared with 21,655 in 2020, reflecting a 34 per cent drop, and 4,836 Chapter 11 filings compared with 8,333, a nearly 60 per cent drop.11 Industry analysts reported only 275 cases involving filers with at least US$10 million in reported liabilities in 2021, which was the first year in at least six years to record fewer than 300 such cases.12 The sharp decline in filings in 2021 follows 2020, which was the busiest year in the same six-year period.

Of the 275 large Chapter 11s, the real estate sector had the largest number of filings, with 28 per cent of the total. This was followed by consumer discretionary at 20 per cent, healthcare at 10 per cent, energy at 9 per cent, industrials at 8 per cent and financials at 5 per cent. The historically low number of filings in calendar year 2021 was not limited to a particular industry, however. Filings across all industries in 2021 were down 43 per cent year over year from 2020. Each sector saw a drop in filings compared with 2020, except for real estate, which equalled the number of filings in 2020, and utilities, which rose 57 per cent year over year, largely due to the impact of an unprecedented winter storm on power producers in Texas.13

Of the three most active venues for business Chapter 11 cases – the District of Delaware, the Southern District of New York and the Southern District of Texas – Delaware continued to see the most large Chapter 11 filings, with a little over 15 per cent. However, among the three venues, the Southern District of Texas had the largest share of cases with over US$1 billion in liabilities, with approximately 35 per cent of such cases, consistent with increases in large filings in that district over the past several years.

The results show that the pressures affecting most industries in 2020 remained the same in 2021, but with much less impact, and the booming economic outlook during the year allowed many distressed companies to avoid bankruptcy and restructure out of court, as many lenders were willing to forbear and extend maturities on loans, there was increased access to the capital markets, and third-party financing or direct government support was often readily available.14 Low interest rates also contributed to a favourable borrowing environment. The Fed essentially slashed interest rates to near zero, with a 0.25 per cent fund rate from March 2020 through December 2021.15 But this has changed: according to the central bank's minutes, the Fed is expected to consistently increase rates to cool the effect of inflation on the economy16 and, as noted above, has already increased interest rates by half a percentage point in 2022.

The slowdown in business filings has largely continued in the first few months of 2022, with total commercial Chapter 11 filings coming in at 720, compared with 1,272 during the same period in 2021, a 43 per cent decrease.17 Despite these trends, however, an increase in business filings is widely anticipated in 2022, largely due to forecasted increases in default rates, borrowing costs and federal interest rates, and the effects of the sustained increases in inflation over the course of the past year.18

Recent legal developments

Continued activity in mass tort cases occupied the legal landscape over the past year. Courts addressed new considerations for debtors in seeking approval of non-consensual third-party releases and the application of a state law divisional merger doctrine known as the Texas two-step in the mass torts context.

i Non-consensual third-party releases: the Purdue Pharma case

Although subject to some dispute, many courts have generally held that the Bankruptcy Code authorises bankruptcy courts, in exceptional circumstances, to grant non-consensual third-party releases (i.e., a release of creditors' claims against a non-debtor without the creditors' consent). Non-consensual third-party releases are often employed to achieve a global settlement in mass tort bankruptcy cases or other cases in which a debtor's related parties are defending claims that arise out of their relationship with the debtor and those third parties provide a 'substantial contribution' essential to a debtor's plan of reorganisation.

In particular, courts allowing for non-consensual third-party releases have held that these releases of claims may be justified when a third party makes a substantial contribution to the debtor's bankruptcy estate, when enjoined claims would impact a debtor's estate by virtue of indemnity or contribution, when such claims are paid in full under a plan, when the plan is overwhelmingly accepted by affected creditor classes or when such claims are channelled to a settlement fund rather than extinguished.45 Courts closely scrutinise non-consensual releases to ensure that they are justified based on extraordinary facts and circumstances.

Such scrutiny was on display in the Purdue Pharma case. Purdue filed for Chapter 11 bankruptcy in September 2019 after facing mounting lawsuits against it and its owners, the Sackler family, relating to their alleged role in marketing the opioid OxyContin. In its Chapter 11 case, Purdue and the Sacklers agreed to settlements with federal, state and local governments pursuant to which the Sacklers funded multibillion-dollar abatement trusts for the benefit of opioid plaintiffs. In exchange, the Sacklers would receive releases from certain of Purdue's creditors from certain Purdue-related claims. After a lengthy trial, the bankruptcy court confirmed the proposed plan in September 2021, and several dissenting states and the US Trustee appealed.

On appeal, the district court reversed the bankruptcy court, vacating the confirmation order. The district court found that the Bankruptcy Code does not authorise non-consensual third-party releases, arguing that no explicit statutory or equitable authority exists for the bankruptcy court to approve such releases. Thus, the district court vacated the bankruptcy court's confirmation of Purdue's Chapter 11 plan, upending the global settlement. The parties have further appealed the district court's decision and, at the time of writing, it is under consideration by the United States Court of Appeals for the Second Circuit.46

In the Ascena Retail Group Chapter 11 cases, the US District Court for the Eastern District of Virginia invalidated the plan's third-party releases on appeal just weeks after the district court's decision in the Purdue case. The parties had argued that the releases were consensual because they included an option for creditors to opt out. The court disagreed, finding that the releases were non-consensual,47 and ultimately held that the bankruptcy court exceeded its authority by extinguishing a wide swathe of claims in approving the third-party releases without first determining whether it had jurisdiction to do so and without conducting the analysis required for such releases.48

Notably, Congress has similarly been evaluating the propriety of third-party releases in bankruptcy. Specifically, in July 2021, Senators Elizabeth Warren (D-Mass.), Dick Durbin (D-Ill.) and Richard Blumenthal (D-Conn.), and Representatives Jerrold Nadler (D-N.Y.) and Carolyn B Maloney (D-N.Y.) introduced legislation that would prohibit the use of non-consensual, non-debtor third-party releases.49 The legislation is still pending and its prospects are uncertain.

ii Texas two-step in the mass tort context

The past year saw implementation of the state law divisional merger doctrine known as the Texas two-step in the mass tort context. In a Texas two-step, a distressed entity converts to an entity organised under Texas law. Thereafter, that entity avails itself of the Texas divisional merger statute,50 which allows a single entity to divide into two entities – one entity holding assets (an AssetCo) and the other entity holding liabilities (a LiabilityCo). Thereafter, the LiabilityCo files a Chapter 11 bankruptcy case, employing the Bankruptcy Code to restructure its tort liabilities. The AssetCo (and potentially one or more of its affiliates) agrees to fund LiabilityCo in an amount capped at AssetCo's value. The assets and operating business remain outside of Chapter 11.

In a recent challenge to the filing of an entity created by a Texas two-step, a bankruptcy court noted that the use of the bankruptcy system 'with the expressed aim of addressing present and future liabilities associated with global personal injury claims to preserve corporate value is unquestionably a proper purpose under the Bankruptcy Code'.51

Significant transactions, key developments and most active industries

Section I above provides a broad perspective on bankruptcy trends from the past year. As discussed above, industries that saw particular distress in 2021 relative to other years included real estate and utilities. The largest Chapter 11 filings in 2021 by asset size included the following, with between US$1 billion and US$8 billion in assets:52

  1. industrials: Nordic Aviation Capital (aircraft leasing) (the largest case of the year, with US$8 billion in assets), Philippine Airlines (airline), Carlson Wagonlit Travel (travel management) and Katerra (construction);
  2. utilities: Brazos Electric Power Cooperative, Alto Maipo, Stoneway Capital and Frontera Generation;
  3. real estate: Washington Prime Group, PWM Property Management, All Year Holdings, Hospitality Investors Trust and Knotel; and
  4. other: Seadrill Limited (offshore drilling), GTT Communications (information technology), Belk (department stores), Riverbed Technology (information technology), Corp Group Banking (financials) and GBG USA (footwear and apparel).

Although the number of bankruptcy filings continues to remain low, some significant Chapter 11 cases have been filed in 2022 to date, including GWG Holdings (financials) and Talen Energy Supply (utilities).