Help clients avoid insolvency, and worse, in the covid-19 crisis

Help clients avoid insolvency, and worse, in the covid-19 crisis Credit: shutterstock.com/Freedomz

Covid-19 has left companies in hot water, with many falling behind on credit payments and commercial obligations. Law firms are busy keeping their clients’ businesses in the clear and trying to help them mitigate the financial problems covid-19 might cause.

Mandatory quarantine, self-isolation and social distancing measures. These are all strategies many countries in the world, including in Latin America, are employing to quell the spread of covid-19, protect public health and save lives.

Clients are scrambling for advice from external law firms to help them navigate this new normal. Some are experiencing reduced demand for their products and services due to the mass exodus of customers and consumers from public life, while almost all are having to contend with the strain posed by a workforce working entirely from home and higher numbers of employees off on sick leave. Not everyone can work from home though – in sectors like agribusiness, with employees off sick or self-isolating at home, a reduced workforce means reduced output. With demand high but supplies low, prices will inevitably go up.

It is hard for companies to continue as normal during these extraordinary times, and this can have a serious and damaging impact on their bottom line and, in turn, their ability to fulfil financial obligations. Complying with credit agreements is a major concern for clients. The threat of insolvency – and the dreaded b-word, bankruptcy – looms on the horizon. This is the time for law firms to step up.

When a pandemic hits, the immediate focus for firms tends to be advising companies on their labour and employment-related issues, because the health and safety of employees is a pressing issue. Commercial contracts – for ongoing projects or supply chains, for example – also occupy a lot of partners and associates’ attention.  

But as liquidity reduces – at a rate that depends on the individual company – insolvency-related issues start to surface. “This is likely to ramp up in the coming weeks, and we expect a general default in obligations for many companies,” says BMA - Barbosa, Müssnich, Aragão partner Sergio Savi.

Who is most at risk?

Companies that can’t carry on, business-as-usual, will be those most at risk of defaulting on payments. Industries that are directly impacted by isolation and quarantine measures will be particularly vulnerable. “These kinds of companies will be exposed to an abrupt shrinking demand as a consequence of government measures of self-restrictions to freedom of movement,” says Ferrere (Uruguay)’s Alejandro Pintos. At risk companies include retailers of “non-essential” products, companies in the hospitality industry, airlines, travel agencies and hotels, as well as many others.

Simply put, companies that can’t make money – and that cannot get their hands on liquidity – will struggle to pay their debts (depending on the extent of their reserves).

Some countries have acted fast to provide support for companies. Brazil and Chile have both passed measures to support companies falling behind on payments, such as debt repayments or employee wages. In Argentina, lawyers anticipate the government will enact extraordinary measures in the next few weeks that might include payment reprofiling and stays for foreclosures and interest payments. These are “likely to provide some relief for debtors,” says Beccar Varela partner Martín Gastaldi. “However, they would negatively impact creditors. If such a scenario does occur, we believe the individual and small-sized merchants [banks] will be the most affected.”

How long the pandemic and the disruption it is causing to businesses will last is currently unknown. This makes it difficult for law firms to advise their clients on how to make accurate assessments about future revenue and draw up effective business plans without having to reconsider them week by week, even day by day. Within this context, the hope is that lenders – with or without government support – will be open to finding creative solutions to avoid company defaults. “Banks, lessors, corporate debtors and suppliers must work together in implementing consensual rollovers, typically considering four to six months of grace periods and payment in kind interest structures to get through the more difficult months of the pandemic,” says Ritch, Mueller, Heather y Nicolau, SC partner Thomas Heather. “This leaves time to prepare for thorough restructurings during the last quarter [of 2020], by which time hopefully forecasting may be carried out with greater certainty.”

Bankruptcy isn’t the only end

It is easy for in-house counsel to think of the worst-case scenario when the numbers aren’t adding up. Now more than ever, they are instructing law firms for restructuring advice. Many want to discuss their options for refinancings and other ways of deferring their immediate debt obligations. “Ultimately, all of these enquiries will also involve an advice on bankruptcy proceeding,” Pintos warns.

But there are steps to take before bankruptcy becomes the only option. For countries like Argentina, where extraordinary measures to support companies with debt payments, have not yet been approved, lawyers should advise clients not to do anything too drastic, says Beccar Varela partner Federico Sosa. “For the time being, we understand that a good tool for those who have difficulties in meeting their payments would be to try to negotiate a readjustment of the contractual terms considering the current exceptional scenario.”

It is important that clients follow government recommendations and take economic aid where available. “[This aid] aims to decompress the “bottlenecks” some companies might face at this stage,” says Ferrere’s Pintos. Further down the line, “resisting the use of these aids can be viewed negatively by a bankruptcy judge,” he adds.

Given that judicial courts are temporarily closed in most Latin American jurisdictions, companies having difficulties making payments have some time on their side. “Creditors are not in a position to easily obtain injunctions – for example, attachments – against their debtors, or to initiate proceedings against them,” adds Beccar Varela senior associate Yanina Salemme.

Know the numbers

For clients under financial strain, regularly analysing their cash flows and other financial indicators at their companies, rather than waiting until the situation deteriorates, can alleviate the situation. “Having all accounting documents up-to-date is essential and will also be considered relevant in any bankruptcy scenario,” says Ferrere’s Pintos. There are further contingency steps for lawyers to follow: for those creditors with whom it is possible to negotiate, try to make agreements in writing and, more broadly, “establish guidelines for collaboration so as to avoid precipitated executions that could lead to the company’s bankruptcy,” adds Pintos.

Making and saving money has never been more paramount for businesses, and it is advisable for companies to make critical payments and try to make an action plan to accomplish this, says BMA partner Eduardo G Wanderley. This could include reviewing supply, service and financial agreements, including terms, obligations, guarantees and material adverse change clauses. Reviewing the operational footprint of the business to see which activities can be suspended temporarily – to help save money – is a good idea, too. “Clients know perfectly well what to do: sit on the cash,” says Bomchil partner Tomás Araya. “Payments which are not essential to keep the business operative, should be delayed.”

Companies should reach for revolving credit according to Baker McKenzie’s regional head for banking and finance partner Gabriel Gómez-Giglio. “Given the forecasted reduction in revenue and profits resulting from the government enforced breakdowns in many jurisdictions, drawing on revolving credit facilities is also an alternative to mitigate massive unexpected cash flow deficiencies,” he says. “Prudent liquidity management for companies is key to survive through these challenging times".

There are other options, though these are less pleasant from a labour perspective. “To successfully navigate a crisis period without jeopardising your company, it is essential to do certain critical activities,” says Wanderley. This could include identifying “inefficiencies” that can be immediately adjusted, for example through lay-offs, as well as assessing the risk involved in different restructuring options and choosing the cheapest option.

In-house legal teams recognise the importance of acting sooner rather than later and not scrimping on getting the best counsel for their company. “If the numbers aren’t looking good, the first thing to do is hire a law firm specialised in insolvency; don’t wait to be bankrupt or with real problems – the law firm can help you save a lot of money with just one or two recommendations,” says senior legal counsel of Argentina’s Grupo Ecipsa Tomás Naselo. “As in-house lawyers, we aren’t used to facing these kinds of crises within our companies, but external attorneys do this all the time. Don’t underestimate this whole situation – spending money now by hiring specialised lawyers will save you money – and more – in the future.”

Communication remains key throughout a crisis. Law firms must encourage clients to be honest and face the real problems they might encounter, now or in the future, rather than sit tight and hope they go away. They won’t. They must make sure to communicate clearly outside their company, too. “Clients should maintain a close relationship with suppliers and critical customers, with an open channel of communication to discuss emergency issues,” adds BMA’s Savi.

LACCA and Latin Lawyer’s covid-19 information hub lists up-to-date legislation and official communications from governments issued in response to the pandemic in the main jurisdictions across Latin America.