Financial trends: chapter and verse on resurgent US bankruptcy

US company bosses joke that they simply cannot afford to go bankrupt. Steep legal fees are the issue. A new threshold was crossed in 2022. Filings revealed that Paul, Weiss would charge more than $2,000 an hour for its work for Revlon. The law firm has been representing the cosmetics company in Chapter 11 proceedings.

Perhaps more egregiously, junior legal team members just a couple of years out of law school were expecting to bill more than $1,000 per hour.

Most companies, for now, are choosing to restructure their debt outside of bankruptcy. The preferred method is through so-called distressed exchanges. Here, lenders and bondholders swap old paper for new debt, typically with a lower face value. That allows the company to delever its balance sheet. The lower nominal value is typically balanced by a higher interest rate or other new protections. 

Senior lenders are swallowing discounts in restructurings and bankruptcies that are greater than ever. In recent years, loose credit requirements have allowed opportunistic groups of lenders to seize collateral from “first-lien” debtholders. These transactions are known as “uptiering” or “dropdowns”.

Moody’s notes that recoveries for first-lien debt have historically been around 76 per cent in debt restructurings. The data group predicts the figure will end up lower in this current cycle.

The Revlon bankruptcy is best known for the episode where Citigroup, a loan administrator for the company, mistakenly wired a $900mn repayment to lenders, several of whom did not return the money.

Those recalcitrant lenders were aggrieved enough to keep the cash because of a previous Revlon restructuring. Here, their collateral had been snatched, depressing the value of the loans they held. They reached a settlement with Citi as the working year ground to a close.

Messy disputes between lender groups about priority and collateral claims are best resolved via bankruptcy proceedings. But huge costs then accrue. Higher interest rates, lower growth and resulting financial distress will ensure that Paul, Weiss and its law firm rivals will have a lucrative 2023.