2023 Insights Five Critical Areas for the Year Ahead - Skadden, Arps, Slate, Meagher & Flom LLP
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2023 Insights Five Critical Areas for the Year Ahead
Editorial Board Victor Hollender Editorial Board Chairman Boris Bershteyn Adrian J. S. Deitz Maya P. Florence George Knighton Bruce Macaulay Alexandra J. McCormack Edward B. Micheletti Amy Van Gelder Jenna Cho Marketing and Communications This collection of commentaries provided by Skadden, Arps, Slate, Meagher & Flom LLP and its affiliates is for educational and informational purposes only and is not intended and should not be construed as legal advice. These commentaries are considered advertising under applicable state laws.
Contents
01 A Possible 29 New Regulatory 55 Litigation
Recession Challenges Developments
03 US M&A Levels Remain
Healthy, but Due Diligence 31 Disparate US, EU and
UK Sanctions Rules 57 Supreme Court Term
May Upend Precedent,
and Deal Protections Will Complicate Multinationals’ Push Back Regulation
Become Even More Critical Exits From Russia
60 Trends in Forum Selection
05 The Widely Forecast
Recession in the UK 35 Why Directors and
Executives Need To Pay
Provisions, Merger Objection
Class Actions and SPACs
Will Likely Reshape M&A Attention to Sanctions, Continue To Shape Securities
Money Laundering and Litigation
Export Rules
08 Focus of China Cross-Border
M&A Turns to Government-
62 Rise in Crypto Securities
Favored Sectors and Away
From West 38 This SEC Press Release
Is a Compliance Checklist
Filings Could Persist
for Corporations and Their
Boards 65 The Evolving Climates
10 A Playbook for Borrowers
Facing Economic and Debt
in the US and UK for
Environmental Damage
Market Pressures
42 New Corporate Minimum
Tax and Stock Repurchase
Claims
Tax Will Take Effect in 2023,
14 UK-Listed Issuers Under
Financial Stress Gain
but Questions Remain 67 A Divided Congress
Will Have an Active
Latitude in Secondary Investigations Agenda
Capital Raisings
44 Tax Enforcement:
A Spotlight on Complex
Over the Next Two Years
Partnership Structures
16 HKEX Initiatives Present
Opportunities Even in a
Down Market 69 Pressure for
47 More Intense ESG Policies
18 Reductions in Force:
Legal Do’s and Don’ts
Merger Reviews
70 ESG Momentum Remains
Strong but May Face
21 How Directors Can 48 US and EU Regulators
Increase Scrutiny of Vertical
Headwinds in 2023
Manage the UK Supreme
Mergers
Court’s ‘Balancing Exercise’
in Difficult Times
52 Demystifying China’s
Merger Review Process
23 Enforcement Priorities
Could Shift in a Downturn
26 Convertible Notes,
Accelerated Share
Repurchases and Other
Equity-Linked Instruments:
Challenges and
Opportunities in 2023A Possible Recession
03 US M&A Levels Remain Healthy, but Due Diligence
and Deal Protections Will Become Even More Critical
05 The Widely Forecast Recession in the UK
Will Likely Reshape M&A
08 Focus of China Cross-Border M&A Turns to
Government-Favored Sectors and Away From West
10 A Playbook for Borrowers Facing Economic
and Debt Market Pressures
14 UK-Listed Issuers Under Financial Stress
Gain Latitude in Secondary Capital Raisings
16 HKEX Initiatives Present Opportunities
Even in a Down Market
18 Reductions in Force: Legal Do’s and Don’ts
21 How Directors Can Manage the UK Supreme Court’s
‘Balancing Exercise’ in Difficult Times
23 Enforcement Priorities Could Shift in a Downturn
26 Convertible Notes, Accelerated Share Repurchases and Other
Equity-Linked Instruments: Challenges and Opportunities in 20232023 Insights / A Possible Recession
US M&A Levels Key Points
– Volatile global financial markets and recessionary fears have led to
Remain Healthy, but declining boardroom confidence and a decrease in deal activity from
2021’s record levels but are still healthy by historical standards.
Due Diligence and – Strategic drivers of M&A activity are in place, and high levels of corporate
Deal Protections and financial sponsor dry powder are available to support deal activity.
– Economic stresses, uncertain financing markets and heightened regulatory
Will Become Even scrutiny make it crucial for parties to conduct robust due diligence and
More Critical –
negotiate deal terms to address downside and termination risks.
In a down market, buyers may find opportunities to acquire
appealing targets that were previously out of reach.
Contributing Partner
Maxim Mayer-Cesiano / New York
Acquisition market participants in the in 2019 and 2020, at roughly the 2018
U.S. approached dealmaking with greater level, according to investment data
Associate caution in 2022 than they did in 2021. company Preqin.
Steadily rising interest rates and financing
Jonathan E. Berger / New York costs, persistent inflation, geopolitical
uncertainty, heightened global regulatory M&A has proven to be
scrutiny and a general decline in board- a permanent fixture of
room and investor confidence have all
companies’ capital allocation
contributed to this change. Unpredictable
toolkits, and M&A engagement
market dynamics have made sellers wary
of overly opportunistic buyers, while continues even as general
buyers have been cautious of overpaying market sentiment shifts.
in what they may see as a new normal.
It has become more difficult to reach agree-
ment than it was during the booming M&A As markets remain volatile in a
market of 2021. low-growth or recessionary economy,
the M&A environment will likely be
However, M&A has proven to be a challenging, so mitigating deal risks
permanent fixture of companies’ capital effectively will be a critical priority. For
allocation toolkits, and M&A engage- those who can navigate these challenges,
ment continues even as general market successfully assessing and minimizing
sentiment shifts. Factors that have driven risks, there may be opportunities for
M&A over the years are as present today substantial rewards.
as ever, including strong corporate earn-
ings; the sentiment that a “buy” strategy Efficient Capital Deployment
can prevail over a “build” strategy in and Financing
adapting to meet changing customer Investors and lenders are becoming
needs quickly and well; and the desire to increasingly selective with their capital
manage corporate portfolios to align with allocation given the meaningful rise in
goals announced to investors. interest rates and cost of capital. Buyers
who require third-party acquisition
Despite the more cautious approach in financing face more reluctant lenders
2022, deal volume globally remained on and higher borrowing costs. As acquirers
par with 2018, 2019 and 2020, and aggre- turn more regularly to private lenders
gate deal value was higher in 2022 than
32023 Insights / A Possible Recession
and other sources of capital (as opposed robust due diligence. They should seize Conversely, being forced to consummate
to syndicated or traditional credit lines or the opportunity to do so, to mitigate an unfavorable or unaffordable transac-
bank loans), they may have to shoulder the risks of an unpredictable market in tion in a down market can also be costly
increased risks or other tighter terms that which company values may be declining. and complicated.
de-risk the loans for the lenders. (See “A Disciplined diligence can help expose
Playbook for Borrowers Facing Economic deficiencies in a target, including legal Well-considered deal terms can provide
and Debt Market Pressures.”) The specter and business liabilities and other vulner- flexibility and additional risk mitigation
of further market pullback adds to the abilities that are material to its valuation for buyers and sellers. They include:
uncertainty about financing and could and the ultimate decision of whether or – covenants and conditions that take into
limit market engagement. not to proceed with an acquisition. account volatile market conditions;
Declining markets do not always provide – the duration of the contract term
the luxury of extended due diligence, and outside date;
For those who can navigate
though. There may even be greater – the scope of the material adverse effect
these challenges, successfully urgency from investors to deploy capital
assessing and minimizing risks, (MAE) clause and its exceptions;
quickly, exploit narrow windows of
there may be opportunities for opportunity and produce returns (to avoid – the size of any termination fee and
substantial rewards. having unutilized cash, particularly in regulatory “ticking fees” to compensate
this inflationary environment). for delays; and
– termination triggers.
Still, both strategic buyers and private We expect participants who are able to
equity funds have dry powder. While strike a balance and conduct meticulous (For perspective on the U.K. market and
down from the record levels in 2020 yet efficient due diligence to be rewarded due diligence and deal terms there, see
and 2021, dry powder in private equity by the market. “The Widely Forecast Recession in the
funds remained at $1.2 trillion as of UK Will Likely Reshape M&A.”)
the third quarter of 2022, according to Downside Protection
the PitchBook Global Private Market and Termination Innovative Opportunities
Fundraising Report. And U.S. corpo- In the current environment, both sides In a down market, we expect dealmakers
rations’ cash on hand in U.S. banks need to consider what could go wrong. to hunt for targets that were previously
remained higher as of mid-2022 than at too expensive. For instance, the falling
any point prior to 2020, according to the That includes understanding the path valuations and performance headwinds
U.S. Census Bureau. While financing to regulatory approval. Competition in the technology sector present opportu-
may limit the number of buyouts at the regulators around the world are adopting nity for incumbent businesses to acquire
largest valuations, private equity will new approaches to assessing mergers and previously unattainable disruptors, likely
likely find opportunity in carve-outs as are scrutinizing transactions that they for far less than it would cost to build
corporations dispose of assets to stream- would have waved through in the past. In their own modernizing technology.
line and focus their businesses. addition, sanctions directed at Russia and
newly imposed national security reviews Sound acquisition strategies among
Together, these forces make it likely that and trade regulations can complicate and participants who can remain nimble
there will continue to be engagement delay some transactions. Further regula- should yield opportunities to unlock
in the market, even if overall economic tory clearances are sometimes required value through acquisitions that would not
performance lags. Those with consider- under those regimes. (See “Disparate US, have been possible in a more expensive
able cash reserves and the willingness to EU and UK Sanctions Rules Complicate marketplace.
transact with less leverage will likely see Multinationals’ Exits From Russia.”)
ample opportunities to buy at potentially (For perspective on China M&A, see
significant discounts. Strategic acquirers Termination and deal withdrawal consid- “Focus of China Cross-Border M&A
and investors with longer-term investment erations tend to become more central in Turns to Government-Favored Sectors
horizons will also have an advantage. negotiations during a lagging market. A and Away From West.”)
terminated or withdrawn transaction may
Disciplined Approach result in costly termination fees, litiga-
to Due Diligence tion and other undesirable consequences,
As a buyer’s market begins to emerge, particularly for public companies that
acquirers will find it easier to insist on may be sensitive to market perception.
42023 Insights / A Possible Recession
The Widely Key Points
– Economic strain in the U.K. is expected to lead to the sale of more
Forecast Recession stressed and distressed businesses. Some are likely to be more attractive
to U.S. buyers because of the decline of the pound against the dollar.
in the UK Will Likely – Challenges in obtaining acquisition financing on acceptable terms seem
Reshape M&A likely to persist and continue to put a strain on the M&A market.
– Market uncertainties will focus buyers on thorough due diligence, although
distressed sales sometimes take place on accelerated timetables.
Contributing Partner
– Deferred and contingent payment terms are likely to be used more
Ani Kusheva / London frequently to bridge gaps in the parties’ estimates of value and to
address economic unknowns, even though they can be contentious
European Counsel
to negotiate. These terms will allow deals to continue to flow.
Natalie Eliades / London
In the U.K., looming economic uncertain- streams but whose values in dollar terms
Associate ties are expected to play a significant role have been depressed by sterling’s fall
in M&A activity at almost all stages of against the dollar.
Sophie Lundsberg / London the acquisition life cycle, from sourcing
deals to financing, due diligence, negotia- Financing Challenges
tion and execution. As a result of higher interest rates, existing
financing will become more burdensome
Sourcing Deals and expensive, decreasing available cash
With the Bank of England predicting that reserves and therefore possibly deterring
the contraction of the U.K. economy that companies from exploring acquisitions. If
began in 2022 will continue into 2024, a company has identified a target, it may
the M&A market is likely to see a decline also find that the financing available is not
in the pipeline of large strategic acqui- viable due to the cost and/or a tightening
sitions, most likely because companies of the covenants required by lenders.
are focusing on their internal challenges
rather than exploring acquisitive growth In addition, for public companies, share-
opportunities. Companies face increased holders may question the rationale, or at
finance costs due to rising interest rates, least the timing, of a deal in the current
supply chain challenges, inflationary environment, which could make equity
pressures, employment-related issues financing difficult.
(filling job vacancies and an upward push
in remuneration) and currency fluctua-
tions. Many companies are also preparing As a result of higher interest
for the downturn and looking to cut costs rates, existing financing will
where possible to protect profit margins. become more burdensome and
expensive, decreasing available
While this is a trying period in the U.K.,
it may create opportunities for U.S. cash reserves and therefore
investors to acquire U.K. businesses, possibly deterring companies
particularly those that have dollar revenue from exploring acquisitions.
52023 Insights / A Possible Recession
A further challenge on the buy side is available should be used to examine driver in forcing the sale. Where a busi-
is the increasing scrutiny by financial fundamental areas of the business, key ness is stressed or distressed, it becomes
sponsor investment committees, where regulatory risks and tax exposure. imperative to understand where the
the merits and financing of deals are “value breaks” — that is, which creditors,
questioned. That scrutiny is also leading Negotiation Dynamics and possibly shareholders, will receive
to more involved due diligence processes A buyer’s market. During negotiations, a payout. The value of the business will
(discussed in greater detail below). Some we are starting to see a shift in the balance typically break in the debt, leaving the
financial sponsors do believe, however, of the bargaining position from the seller shareholders out of the money. The cred-
that financing acquisitions will become to the buyer, in particular where: (i) the itor where the value breaks (also known
easier in the next year or so as public and seller is in a stressed or distressed posi- as the “fulcrum creditor”) will usually be
private credit markets begin to adjust to tion, or is keen to divest assets in order to the one driving the sale process. This can
the economic environment. As in the U.S., re-focus its business; or (ii) the buyer finds create competing interests on the sell side
nontraditional financing sources may help it necessary to require deferred or contin- as to how the sale process should be run,
alleviate the problem and provide solu- gent consideration to allow post-closing who is running it and who is perceived as
tions for some deals. adjustments to the purchase price based the preferred bidder.
on valuation or market uncertainty.
Due Diligence Getting the Deal Done
Stress-testing a target’s financials. Pricing adjustments. Deferred and Allocation of risk is the essence of the
During the legal and financial diligence contingent consideration mechanics are legal process for any M&A deal. In the
phase of acquisitions, there is an increased most typically used to incentivize sellers current economic climate, the parties are
focus on stress testing the target’s finan- post-sale. However, now they are increas- likely to be more risk averse. Buyers are
cials as well as its revenue and contracting ingly employed to deal with uncertainties likely to place more emphasis on deal
model to ensure the economics of the and valuation gaps in the current envi- protections such as:
business are sustainable, and that the ronment (i.e., caused by country, sector,
inflationary or operating cost risks). – break fees and cost coverage
target’s customer and supplier bases are arrangements;
robust and diversified. In addition, buyers Such mechanics can often be sources of
will want to understand a target’s supply contention during negotiations, as buyer – escrow mechanics to ring-fence a
chain exposure. For all of these reasons, and seller will have very different views portion of the purchase price to cover
we expect to see a greater focus on under- on the adjustments, typically resulting in any breaches of the warranty and
taking a vigorous diligence exercise on prolonged discussions. (Where the target indemnity (W&I) insurnce package;
customer relationships and contracts. has entered a formal insolvency proce- and/or
dure, these mechanics are not relevant.) – holdbacks for post-close price
Timing considerations. In a stressed or
We also expect to see negotiations over adjustments.
distressed M&A process, timing is of the
essence, especially as the value of the transaction documentation stretch out We expect to continue to see the trend
business may continue to decrease over where parties are sensitive to tailoring the toward the use of buy-side W&I insur-
time. Notwithstanding that distressed deal to cover a wide range of uncertain- ance where it can be obtained, giving the
M&A is typically a buyer’s market, the ties. Parties will be alert to business risks buyer a direct claim against the insurer
buyer will come under pressure to make between signing and completion, and rather than taking the risk of exposure to
decisions quickly, and there may not be we expect negotiations around conduct- the seller. In a distressed M&A situation,
time to conduct in-depth due diligence. of-business provisions (which can, for warranty packages may be limited, and
There may also be more limited sell-side instance, restrict certain activity or levels indemnity and other forms of clawback
marketing information. If, however, the of indebtedness) to become critical. are rarely available. We expect W&I
company is at the less distressed end of insurance solutions to be available on
the spectrum and not subject to imminent Understanding where the value breaks.
In the context of a distressed M&A these types of transactions, but with more
insolvency, the sale can be conducted more limited coverage than in a typical buyout
like a traditional auction/private bilateral situation, the list of potential buyers may
be more limited, and the seller’s need for deal and with higher premiums. This will
process where more time is afforded for place more emphasis on the alternative
due diligence. In any event, the time that liquidity is likely to be the paramount
62023 Insights / A Possible Recession
solutions available, including holdbacks (For perspective on the U.S. market and cash crunch could be forced to sell in a
and escrows. All these options will need due diligence and deal terms there, see bid to protect the future of the business.
to be considered and balanced against the “US M&A Levels Remain Healthy, but Overall, the private M&A market may
overall competitiveness of the deal. Due Diligence and Deal Protections Will suffer less in a downturn than public
Become Even More Critical.”) M&A, given that private companies are
We expect parties to run health checks less exposed than public companies to
on deal terms already negotiated for In Sum retail investor market skepticism and have
ongoing deals. Revised modeling for greater access to quick and nontraditional
Notwithstanding these obstacles, trans-
valuation purposes could trigger renego- financing. While transaction terms are
actions will continue to get done. In
tiation of the price or require revisions likely to become more complex, deals
particular, due to the economic downturn,
to add more aggressive price adjustment will continue to flow.
many companies will be conducting
mechanics. Other deal protection tactics
strategic reviews, potentially leading to
may be introduced in light of increased (For perspective on China M&A, see
divestments and carve-outs that could
market uncertainty, while some deals may “Focus of China Cross-Border M&A
be snapped up by financial sponsors.
be put on hold and others taken off the Turns to Government-Favored Sectors
Meanwhile, start-ups that are feeling the
table entirely. and Away From West.”)
72023 Insights / A Possible Recession
Focus of China Key Points
– Buyers are fine-tuning their strategies to focus on sectors perceived
Cross-Border to be favored by Chinese government policy, such as industrials,
technology and health care.
M&A Turns to – Chinese buyers have begun to turn their attention away from Western
Government- companies toward those in Asia and the Middle East, partly due to
an increasingly unfriendly regulatory environment in the West.
Favored Sectors – Chinese competition law and new data privacy protections are
and Away –
complicating deals and might deter some.
As in Europe and North America, financial buyers are sitting on large
From West sums of dry powder, which may find its way into transactions.
Contributing Partners
China’s cross-border M&A market regulatory environment in the West. For
Peter X. Huang / Beijing continued to face strong headwinds in example, Canadian and British govern-
2022, with a slowing economy and new ments recently ordered several Chinese
Haiping Li / Shanghai COVID-19 restrictions weighing on the firms to exit their investments in lithium
market. There have been fewer outbound mining and microchip companies, citing
Asia Pacific Counsel and inbound transactions, with total deal national security concerns.
value at a multiyear low, and financial
buyers accounting for a sizable portion Investing in Favored Sectors
Layton Z. Niu / Hong Kong
of that value. And volatile public equity A prominent theme for market partici-
prices and increasing regulatory scrutiny pants is investment decisions informed
Registered Foreign Lawyer of sectors such as technology, internet, by the Chinese government’s policy
critical resources, gaming and education initiatives. With an economic downcycle
Emma Xu / Hong Kong have led to fewer megadeals. looming, buyers are fine-tuning their
acquisition strategies toward sectors such
Buyers have also become more selective,
as industrials, technology and health care.
gravitating toward acquisitions in the
Financial buyers under pressure to deploy
energy, technology, health care, industrial
capital may capture buying opportunities
and consumer sectors. Notable mega-
within these favored sectors and take
deals, such as the $15.5 billion acquisition
advantage of beneficial government poli-
of Aramco Gas Pipelines Company by
cies as well as softening valuation.
an investor group that included China
Merchants Capital and the Silk Road Fund,
demonstrate the state-owned enterprises’
emphasis on strategically important sectors. Buyers have become
more selective, gravitating
Furthermore, while the U.S. and other toward acquisitions in
Western countries generally remain the energy, technology,
attractive destinations for certain health care, industrial and
outbound investments, Chinese buyers consumer sectors.
have been pivoting more resources and
attention toward Asia and the Middle
East, especially ASEAN (Association U.S.-listed SPACs have been active in
of Southeast Asian Nations) countries, acquiring China-based targets in the tech-
partly due to an increasingly unfriendly nology, clean energy vehicle and digital
82023 Insights / A Possible Recession
health care sectors. The large number enter sectors heavily scrutinized by the New opportunities may also arise as the
of SPACs still searching for acquisition anti-monopoly regime, such as through Chinese government continues to institute
targets suggests that this source of M&A early stage investments in targets. (See market-stimulating policies in certain
deal activity could continue, at least until “Demystifying China’s Merger Review sectors. In addition, some multinational
existing SPACs reach the end of their Process.”) companies reassessing their existing pres-
life cycles. ence in China may pursue divestment,
National security reviews. In addition, spin-off or joint venture opportunities.
Regulatory Trends Affecting opaque and unpredictable national secu-
China M&A rity review processes under both Chinese A contentious global geopolitical
and U.S. law have made cross-border landscape characterized by competition
Myriad merger-related regulations, includ-
M&A transactions in strategically critical between the U.S. and China will continue
ing those on data privacy, competition and
sectors difficult. to influence M&A deal flow. For example,
national security, bring both challenges
the latest U.S. export controls on semi-
and opportunities to M&A in China. In light of pre-closing regulatory filings conductors to China cast further doubt
and reviews, parties in inbound and on the political and economic viability of
Data privacy. Critical legal frameworks
outbound M&A transactions need to private sector collaboration between the
on cross-border data protection, such as
plan for longer deal timelines. two countries. This does not, however,
the recently implemented Cybersecurity
Law, Data Security Law and Personal necessarily imply depressed cross-border
Information Protection Law, regulate External Factors and Outlook M&A activity overall.
how companies collect and transfer data China’s forceful measures to combat
Buyers and targets from China shunning
across borders. As a result, data compli- the COVID-19 pandemic and the coun-
U.S.-connected deals will prioritize M&A
ance by target enterprises is becoming a try’s economic slowdown due in part to
opportunities in Asia, and alternatives to
prominent factor affecting a transaction’s those measures will continue to affect
change-of-control transactions — such as
valuation, deal structure and certainty. market sentiment for cross-border M&A.
minority investments and joint ventures
As future COVID-19 quarantine policies
Competition. China’s Anti-Monopoly that attract less regulatory scrutiny —
and travel restrictions have not been
Law, meanwhile, has forestalled large may provide strategic alternatives.
clearly declared, market uncertainty will
companies from pursuing acquisition remain high, hindering M&A deal activ- (For perspective on the U.S. and U.K.
opportunities and dampened strategic ity. Nonetheless, pressure to deploy the markets, see “US M&A Levels Remain
M&A in the technology sector. This has record level of dry powder held by finan- Healthy, but Due Diligence and Deal
opened the door for private equity firms cial sponsors will likely support M&A Protections Will Become Even More
and venture capital funds to approach dealmaking, especially if asset valuations Critical” and “The Widely Forecast
technology targets. Strategic buyers continue to soften. Recession in the UK Will Likely Reshape
are also seeking alternative ways to
M&A,” respectively.)
92023 Insights / A Possible Recession
A Playbook for Key Points
– Common borrower-friendly terms in loans and bond indentures can
Borrowers Facing provide struggling companies with a number of options to extend their
runway in a distressed environment.
Economic and Debt – Options include swapping existing debt for new loans or bonds with
Market Pressures higher payments or lien priorities, transferring assets to subsidiaries that
can borrow freely, and buying existing debt at a discount to reduce a
company’s leverage and interest cost.
Contributing Partners – Winning support from creditors can be difficult, and holdouts can
complicate the process.
Shana A. Elberg / New York
Michael J. Hong / New York
Danielle Li / New York
The U.S. capital markets have experienced Liquidity and Business
James J. Mazza, Jr. / Chicago significant volatility since the arrival of Plan Scenarios
Ron E. Meisler / Chicago COVID-19. After lockdowns resulted in a
Having access to sufficient cash reserves
short recession in early 2020, the markets
Michael J. Zeidel / New York expands a company’s ability to weather
reopened in booming fashion, with M&A,
recessionary pressures and preserves
equity and debt issuances reaching record
optionality for restructuring or acquisition
Associates levels from mid-2020 through 2021. The
transactions. Before the onset of a potential
pace then abruptly slowed in 2022, with
economic downturn, companies should
Jackie Dakin / Wilmington high inflation and rising interest rates.
examine their business plans and potential
New debt issuances fell and IPO markets
Robert E. Fitzgerald / Chicago sources of capital to maximize liquidity
ground to a virtual halt.
and anticipate legal issues they may face
While nontraditional sources of capital if economic headwinds persist. Planning
are expected to fill a portion of the well in advance (i.e., several months
lending gap (private credit funds are esti- before a debt becomes due for repayment)
mated to have $150 billion in dry powder), is important so that companies can avoid
capital costs are likely to continue to losing out on certain options, as each takes
climb, and debt terms are expected to time to implement.
become less borrower-friendly.
Representation and Warranty
If this trend continues and the economy ‘Bringdowns’
transitions into a recession, borrowers In tightening credit markets, borrowers
will need to maximize optionality by should evaluate their ability to access
accessing additional funding and address- undrawn credit lines. Lenders that
ing obstacles such as shrinking profits previously were accommodating may
and impending maturities. Lenders and resist a draw request if they perceive that
bondholders, meanwhile, will try to assert the borrower is headed toward a default.
themselves to ensure repayment, to the Revolving credit facilities typically include
extent that they have rights under cove- a “bringdown” condition to borrowing,
nant-lite and permissive debt documents requiring the borrower to reaffirm all the
that impose few restrictions on borrowers. representations and warranties it made
when the loan was extended, in addition to
Below, we outline key items and issues there being no default. For borrowers in a
for companies and their boards and distressed or deteriorating financial situa-
management to consider in the event the tion, lenders may cite the solvency and no
economic environment gets worse before “material adverse change” representations
it improves. as reasons to resist funding the revolver
102023 Insights / A Possible Recession
draw. For the solvency representation, the agreements and cash positions to take impending maturities. These transactions
borrower typically represents that it and its maximum advantage of these favorable can also be attractive to participating
subsidiaries are solvent on a consolidated provisions if they appear in their agreements lenders, as they usually offer improved
basis. For the no “material adverse change” when calculating their leverage ratios. terms for lenders, enhanced priority and
representation, the borrower typically sometimes premiums on the debt being
represents that there has been no material exchanged.
adverse change in its business, assets, Having access to sufficient
operations or condition — financial or Companies may also look to their subsid-
cash reserves expands a
otherwise — since a certain date (usually iaries that are not subject to covenants
company’s ability to weather under the loan documents. In recent years,
the most recent fiscal year end date prior to
recessionary pressures and for example, some borrowers have taken
the effectiveness of the credit agreement).
preserves optionality for advantage of standard credit document
Borrowers weighing a drawdown of their restructuring or acquisition “baskets” to transfer assets to unrestricted
credit line should closely examine the transactions. subsidiaries, increasing the amount of debt
representations and warranties in their those entities can support. Other borrow-
credit agreements and make sure those ers have designated existing asset-owning
continue to remain accurate. While debt-related covenants for bonds subsidiaries as unrestricted pursuant to
are typically measured only at the time the the applicable credit documents.
Financial Covenant Compliance company seeks to take on new debt and do
and EBITDA Add-Backs not require maintenance of specified ratios These types of transactions can lead to
or the bringdown of representations and litigation, however. Lenders may allege
Before accessing additional debt, borrow-
warranties over the lifetime of the bond, that an asset transfer was actually or
ers need to assess whether they are in
issuers should carefully assess any bond constructively fraudulent, or did not
compliance with any required financial
terms that could affect debt exchanges comply with the applicable credit docu-
maintenance covenants (which may
or buybacks, such as debt incurrence or ments. In response to several high-profile
include maximum leverage, minimum
restricted payment covenants. Often the cases involving the use of unrestricted
coverage and liquidity). Leverage-based
timing and structure of such transactions subsidiaries, including a transaction by
covenants are the most common and
is impacted by the release of the issuer’s the retailer J. Crew, some recent credit
are generally tested at the end of each
financial statements, which may deter- agreements and indentures limit a borrow-
fiscal quarter to the extent there are any
mine whether such covenants are satisfied. er’s ability to transfer material assets
revolving loans outstanding or, in some
outside of the credit group covered in the
cases, when a certain percentage of Liability Management and Other loan documents. Similarly, as a result
revolving commitments has been utilized. Liquidity-Enhancing Techniques of the Serta transaction in 2020, where
Borrowers will need to make sure that
In addition to maintaining ample cash, the company repurchased existing debt
they have a sufficient cushion to satisfy
companies with leveraged balance sheets for new superpriority loans, some recent
the covenants, taking into account both
may find opportunities to explore holistic credit agreements now require unanimous
changes in EBITDA (earnings before
capital structure solutions during a down- lender consent with respect to any subor-
interest, taxes, depreciation and amor-
turn. They may have multiple means to dination of existing debt or any changes
tization) and the debt component of the
deal with looming maturities and to right- in waterfall provisions. However, such
leverage calculation.
size their capital structures. provisions are not yet widespread, and
Many credit agreements allow myriad most earlier agreements do not include
borrower-friendly “add-backs” that can Uptier Exchanges and Unrestricted such restrictions and protections.
result in a higher EBITDA for covenant Subsidiary Transactions
The consent needed to amend a credit
purposes than would be calculated using Borrowers may consider a so-called agreement (unanimous versus majority)
GAAP (generally accepted accounting “uptier” exchange, in which a portion can have a significant impact on the
principles) measures alone. In addition, of existing secured or unsecured debt is ability to complete an uptier exchange or
leverage ratios are often calculated on exchanged for new “superpriority” debt. an unrestricted subsidiary transaction.
a “net” basis, allowing all or a portion Uptier transactions allow borrowers to For example, while a borrower typically
of a borrower’s unrestricted cash to be issue new debt or exchange existing debt only needs “required lender” consent
subtracted from the amount of debt. to access additional liquidity or address (i.e., consent of lenders holding more
Borrowers should review their credit
112023 Insights / A Possible Recession
than 50% of commitments and loans) to tender offers. Borrowers should also be risk that debt will become more expensive
amend existing loan documents, certain aware that the meanings of “open market and that lenders and bond investors will
changes — such as modification of purchase” and “Dutch auction” have been push for lender-friendly credit terms,
principal and interest rates, extensions the subject of recent litigation. They also especially in exchange transactions. It
of maturity and amendments to pro will need to weigh the risk of a ratings is therefore important for borrowers to
rata sharing provisions — are typically downgrade if the repurchase price is so establish competitive processes to obtain
treated as “sacred rights” requiring low that it is considered a “distressed the best possible terms.
unanimous lender consent. As a result of exchange.” Repurchases below par may
companies using the flexibility in their also result in the company realizing taxable Know your creditors. Another important
agreements to do uptier transactions with cancellation-of-indebtedness income. consideration when structuring strategic
only required lender consent, certain transactions is the identity of the creditor
recent credit agreements now limit Legal Considerations base, and any institutional or contractual
the ability of borrowers to undertake limitations. Some financing vehicles such
Minority lenders and bondholders who
such uptier transactions by requiring as collateralized loan obligations (CLOs)
opt not to participate in the liability
unanimous consent, and borrowers need may be prohibited by their terms from
management transactions described above
to be cognizant of the consent thresholds receiving certain types of debt or equity
increasingly resort to litigation against
required in their specific agreement. instruments. Other institutions may not
borrowers and participating creditors.
be strictly barred from receiving certain
(This has given rise to the term “lender-
consideration, but they may have a strong
on-lender violence.”) In several cases in
preference for either cash, debt or equity.
Uptier transactions allow recent years, nonparticipating creditors
Understanding these dynamics enables
borrowers to issue new debt challenged uptier transactions, alleging
borrowers and issuers to maximize
or exchange existing debt to that they constituted breaches of contract
negotiating potential.
access additional liquidity or and violations of the implied covenant of
address impending maturities. good faith and fair dealing. A number of Strong nondisclosure agreements with
those suits survived motions to dismiss, potential transaction partners are also
creating the prospect of protracted important because, if news of a prospec-
In bond transactions, exchanges are often litigation that effectively ensured the tive transaction leaks, some lenders might
structured as exchange offers to comply plaintiffs a seat at the table. seek to block it. Borrowers should also be
with securities laws and are coupled aware that cooperation agreements among
Given these dynamics, borrowers consid-
with an “exit consent” that allows partic- lenders are becoming more prevalent.
ering these types of transactions should
ipating bondholders to simultaneously They can establish required lender blocks
combine a transactional legal review
provide a consent to amendments to the to protect lenders from transactions that
with a litigation strategy. Having a strong
existing bond documents that would bind freeze some of them out.
record demonstrating why a particular
any nonparticipating bondholders, further
transaction complies with applicable Addressing Bond Maturities
incentivizing participation. Like credit
credit documents can help lessen the
agreements, however, certain “sacred Companies with outstanding bond debt
likelihood of litigation and increase the
rights” require unanimous bondholder face an additional layer of complexity
chances of winning dismissal should a
consent. because, in many cases, they must negoti-
complaint be filed.
ate refinancings or exchange transactions
Debt Repurchases/Buybacks Practical Considerations with a highly dispersed creditor base,
Companies with sufficient liquidity may particularly if there are retail holders.
In addition to potential legal hurdles,
consider repurchasing debt to reduce Seeking consents in such cases can be
there are important practical factors
leverage and interest expense, and poten- extremely burdensome and costly as
to consider in evaluating a strategic
tially to capture discounts in debt trading well as time-consuming, and issuers are
transaction.
prices. Many credit agreements permit frequently forced to negotiate with holders
borrowers to repurchase debt through Debt terms are expected to become of relatively small positions — often
open market purchases or a Dutch auction, more lender-friendly. It is important for distressed debt investors who purchase
but open market purchases of bonds may borrowers to evaluate potential changes to bonds at heavily discounted prices with a
be limited by securities laws regulating debt market dynamics — in particular, the view toward short-term gains.
122023 Insights / A Possible Recession
Exchanges. Traditional tools such as in the transaction simply to try to extract In Sum
bond tenders and exchanges generally additional value from the issuer. In these
Years of generous credit terms have left
are available to issuers facing maturities. instances, issuers might consider the
many companies with flexibility to adjust
However, these transactions may “staple Chapter 11 pre-pack” — a consent
their debt structures should they find them-
take substantial time to negotiate and solicitation distributed to bondholders
selves under financial stress. However,
document, and many tender offers for along with a pre-packaged Chapter 11
creditors may resort to litigation if they
bonds must remain open for at least 20 bankruptcy plan. Holders that participate
believe a borrower is sidestepping minority
business days. Additionally, bondholders in the exchange also vote in favor of the
creditors’ legal protections and jeopardiz-
may face restrictions on trading for a pre-packaged plan.
ing those creditors’ security or priority.
lengthy period during the negotiation,
If acceptances exceed a specified thresh- Borrowers also need to consider that, in
and it is imperative to properly time the
old (usually above 90% of outstanding a tightening credit market, lenders and
request for restriction to avoid the need
bonds), the borrower closes the exchange, bondholders may insist on greater protec-
for public disclosures before a transaction
and the Chapter 11 plan is disregarded. If tions in any new debt that is extended or
can be announced.
the issuer fails to reach its threshold but when asked to consent to amendments or
In light of these constraints, some issuers receives the participation of over 67% of refinancing of existing debt.
have turned to private transactions to the issuance, it can opt for an expeditious
(See also “UK-Listed Issuers Under
address pending maturities. But these pre-packaged bankruptcy, using the votes
Financial Stress Gain Latitude in Secondary
require a careful review of the indenture’s of the participating holders to bind hold-
Capital Raisings” and “HKEX Initiatives
consent provisions and applicable securi- outs. Often the staple pre-pack, and the
Present Opportunities Even in a Down
ties laws. pre-negotiated support of over 67% of the
Market.”)
holders, is enough to dissuade them. And
Staple Chapter 11 pre-packs. Even in if not, the Chapter 11 case can still be
exchange transactions that enjoy strong completed within a short period of time
support from the holder base, some bond- (one to 60 days, depending on the facts
holders may hold out and not participate and circumstances).
132023 Insights / A Possible Recession
UK-Listed Key Points
– Updated guidelines allow London-listed issuers to raise up to 20% new
Issuers Under capital on a non-preemptive basis, which may be used to strengthen their
working capital position.
Financial Stress – Issuers nonetheless need to approach non-preemptive offerings
Gain Latitude with sensitivity, given the dilutive effect for existing shareholders.
– Close attention must be given to the substance and timing of disclosures
in Secondary to the market, particularly when an issuer is in financial difficulty.
Capital Raisings
As the U.K. faces what the Bank of Insights article “Wide-Ranging Reforms
Contributing Partner England recently described as “very of UK Capital Markets: A Watershed
challenging” times, with the possibility Moment?”) In line with the latitude the
Danny Tricot / London of the U.K.’s “longest recession since Pre-Emption Group offered at the height
records began,” issuers listed on the of the COVID-19 pandemic, the revised
London Stock Exchange should pay close recommendations generally allow for
Counsel attention to updated guidance on second- the annual disapplication of preemption
ary capital raisings as well as disclosure rights up to a limit of 20% of a company’s
Adam M. Howard / London and governance considerations. issued share capital (double the previous
10% threshold), consisting of: (i) 10%
Capital Raisings of the company’s issued share capital on
Associate
In the aftermath of the 2007-09 global an unrestricted basis, and (ii) 10% for an
Rosy L. Worsfold / London financial crisis and during the COVID- acquisition or specified capital investment.
19 pandemic, many listed issuers sought
The Pre-Emption Group suggests a
to shore up their balance sheets through
number of actions an issuer should
secondary capital raisings. As we confront
consider taking as part of a non-preemp-
a possible economic downturn in 2023,
tive offer, including making the issue on a
issuers considering raising funds to meet
“soft preemptive” basis. Soft preemption
their working capital needs through the
(in the context of a placing of shares) is
secondary capital markets should carefully
where the bookrunner allocates shares to
consider new rules related to the U.K.
investors in accordance with a policy that
preemption rights regime.
seeks to preserve the principle of preemp-
What are preemption rights? Preemption tion so far as is practical, to replicate the
rights give existing shareholders the right of existing shareholder base (recognizing
first refusal on the issuance of new shares. that not all shareholders will be able to
This is considered an important safeguard participate).
to protect existing shareholders against
dilution. The U.K.’s Pre-Emption Group,
representing a range of listed issuers, The revised recommendations
investors and intermediaries, is responsible generally allow for the annual
for setting recommendations. While not disapplication of preemption
legally binding, the recommendations are rights up to a limit of 20%
generally followed by the market. of a company’s issued share
Revised guidance. The recommendations capital.
were updated in November 2022 follow-
ing the U.K. Treasury’s UK Secondary
For each 10% limb, companies can seek
Capital Raising Review, which was
authority to disapply preemption rights
published in July 2022. (See our 2022
for up to an additional 2% of a company’s
142023 Insights / A Possible Recession
issued share capital as a “follow-on offer” and do not omit anything likely to affect – information about its financial condi-
to retail shareholders and other investors the import of the information. With an tion on the basis that its position in
who were not allocated shares in the soft uncertain economic outlook, disclosures subsequent negotiations to deal with
preemptive issue. This should meet the to the market (whether periodic or ad hoc) the situation (such as in respect of a
objective of encouraging retail participa- must reflect a true picture of an issuer’s rescue refinancing) will be jeopardized.
tion in non-preemptive offers and further trading position (i.e., its financial and
guard against the dilutive effect and price operational status). Companies experiencing financial
impact of a discounted offer. difficulties that are uncertain about what
It is imperative that an issuer’s personnel information to disclose or when should
(For perspective on secondary capital avoid adopting aggressive accounting poli- consult their professional advisers.
offerings in the Hong Kong market, see cies to overstate the company’s financial Companies should avoid adopting a wait-
“HKEX Initiatives Present Opportunities performance. Warning signs from internal and-see approach, hoping for a recovery
Even in a Down Market.”) financial reports highlighting dispari- in financial performance or other offset-
ties between actual revenues and those ting news before updating the market.
Disclosure of Information reflected in budgeted forecasts or reports
of material financial risks and exposures (For a discussion of directors’ duties
Disclosures become a particular focus
should be escalated to the board and audit when a company is in financial difficulty,
of regulators and investors during periods
committee. Boards and senior manage- see “How Directors Can Manage the UK
of economic stress. On an ongoing basis,
ment should challenge forecasts and ensure Supreme Court’s ‘Balancing Exercise’ in
listed issuers must pay particular attention
that market expectations are managed in Difficult Times.”)
to making timely and accurate disclosures.
Under the U.K. Listing Rules, an issuer light of pressures on profit margins caused
by higher costs in supply chains. In Sum
is required to take reasonable steps to
establish and maintain adequate proce- The board of directors and senior manage-
Disclosures of inside information must ment team have primary responsibility for
dures, systems and controls to enable it
be made as soon as possible, unless safeguarding the company’s assets for and
to comply with its continuing obligations,
there are recognized grounds for delay, on behalf of shareholders. Non-executive
which includes its disclosure requirements
which can include a delay to protect the directors have a particular role in the
and corporate governance infrastructure.
legitimate interests of the issuer. The U.K. oversight of the executive management
In addition, the Listing Rules require a
Financial Conduct Authority has stated team, being one step removed from the
premium listed issuer (which meets the
that a company should not delay disclo- operations of the business.
exchange’s most stringent standards) to act
sure of:
with integrity toward its shareholders and
prospective shareholders. – the fact that it is in financial difficulty or (See also “A Playbook for Borrowers
of its deteriorating financial condition (a Facing Economic and Debt Market
A true picture of an issuer’s position. permitted delay would only relate to the Pressures.”)
An issuer must take reasonable care fact or substance of the negotiations to
to ensure that disclosures to the market deal with such a situation); or
are not misleading, false or deceptive
152023 Insights / A Possible Recession
HKEX Initiatives Key Points
– HKEX has modified its rules to make it easier for companies
Present to have dual primary and secondary listings.
Opportunities – SPAC listings have been allowed for the first time, with rigorous
requirements, and start-ups pursuing specified “specialist technologies”
Even in a will be able to list even if they have little or no revenue.
– Listed companies seeking new capital can issue up to 20% new stock
Down Market without offering preemptive rights, while companies are allowed to
repurchase up to 10% of their outstanding stock — an option for those
with solid balance sheets.
Contributing Partner
– Rules put in place after the 2008 financial crisis place limits
Paloma Wang / Hong Kong on highly dilutive and deeply discounted capital raisings.
Like other global financial centers, Hong main business, operations, assets and/or
Kong has seen falling IPO volumes and place of central management and control
volatile markets in 2022 in the face of in Greater China — were required to
challenging macroeconomic conditions make Hong Kong their primary listing
and rising geopolitical tensions, including venue.) In addition, companies that are
between China and the U.S. But several either non-Greater China companies, or
new initiatives by the Hong Kong stock Greater China companies listed on the
exchange (HKEX) intend to make it more New York or London stock exchanges
attractive and competitive for issuers. prior to December 2017, may apply for a
The exchange also allows capital manage- dual primary listing in Hong Kong even
ment strategies such as secondary capital where their dual-class share structure or
raisings and share repurchases — options variable interest entity arrangements do
companies may want to consider, depend- not comply with HKEX requirements.
ing on their financial circumstances.
SPACs. Following similar initiatives
More Options for Listing in a number of other global markets,
in Hong Kong including HKEX’s traditional regional
rival Singapore, HKEX in 2022 intro-
In the face of increasing competition
duced a new regime permitting SPAC
from other regional exchanges, HKEX
listings and setting out requirements for
has introduced a number of measures over
de-SPAC transactions (mergers of SPACs
the past year to attract more listings.
with operating companies). The rules
These initiatives have included rule set a high bar, including a “professional
changes to facilitate the following: investors only” requirement, rigorous
eligibility criteria for SPAC promoters and
Secondary and dual primary listings a requirement to ring-fence 100% of IPO
by Greater China and overseas issuers. proceeds with full pro rata redemption
HKEX has amended its listing rules to rights offered to investors if no de-SPAC
permit any overseas company, including transaction is completed, or for investors
a Greater China issuer, to undertake a wishing to redeem rather than participate
secondary listing on HKEX, subject in the de-SPAC transaction. HKEX treats
to meeting certain minimum market de-SPAC transactions as new listing
capitalization requirements. (Previously, applications, with the same procedural
to be accepted for listing, Greater China and documentary requirements as a
issuers — broadly, companies with their regular IPO, and it requires a substantial
162023 Insights / A Possible Recession
PIPE (private investment in public equity) balance sheets through capital raisings by Share repurchases. While some
deal to be undertaken simultaneous way of rights issuances to existing share- companies may seek to raise new capital,
with the de-SPAC transaction. To date, holders or through private placements to with pressure on valuations, many
four SPACs have successfully listed on institutional investors, they will need to HKEX-listed companies are seeing an
HKEX, though none have announced a bear in mind HKEX rules that restrict opportunity to expend capital to repur-
de-SPAC transaction. highly dilutive and deeply discounted chase their own shares. In addition to
capital raisings. These rules were intro- being a means for companies to return
duced recently and were not in place value to shareholders, on-market repur-
HKEX in 2022 introduced during the 2008 financial crisis and its chases help support a share price that
a new regime permitting aftermath, when many companies raised management believes does not reflect the
new capital in the secondary market. true underlying value of the company.
SPAC listings and setting out
requirements for de-SPAC While deeply discounted issues can be a HKEX rules permit on-market repur-
transactions. legitimate means for companies to raise chases of up to 10% of existing issued
capital, HKEX had observed some compa- share capital, provided a company
nies taking advantage of this tool at the has obtained a “repurchase mandate”
Listing of “specialist technology expense of excessive dilution to minority from shareholders at its annual general
companies,” including pre-commercial shareholders. As a result, HKEX now meeting. Repurchases must be made
companies. In its latest initiative, prohibits any capital raising — including at prices not more than 5% above the
HKEX proposes to permit the listing of by way of rights to existing sharehold- average closing price for the five preced-
companies engaged in certain specified ers — at a discount, on a fully diluted ing trading days. No new issues of
“specialist technology” sectors, including post-issuance basis, of 25% or more to shares are permitted within 30 days of
next-generation information technology, the market price. Companies in genuine any repurchase. By contrast, off-market
advanced hardware, advanced materials, financial distress may apply for a waiver purchases in Hong Kong require prior
new energy and environmental protec- from this rule. approval of shareholders.
tion, and new food and agriculture
technologies. HKEX proposes to allow HKEX rules also permit companies In Sum
listings by both (i) companies that have to issue up to 20% of new stock on a
While the current economic climate
already reached commercialization with non-preemptive basis at a discount of
poses challenges, Hong Kong — as the
recorded revenue and (ii) pre-revenue, not more than 20% to the market price,
premier international financial market for
pre-commercial companies, subject to provided the board has obtained a
the Greater China region — continues
a number of requirements, including “general mandate” from shareholders at
to present attractive opportunities for
minimum market capitalization and the most recent annual general meeting
companies and investors. HKEX and Hong
pre-IPO investments from sophisticated to make such issuances. (Meanwhile, in
Kong’s regulators have also implemented
investors. This initiative is currently the U.K., updated guidelines also allow
policies to ensure those opportunities
undergoing market consultation, with issuers listed there to raise up to 20% new
continue through the market cycle.
the new rules expected to be finalized in capital on a non-preemptive basis. For
early 2023. a discussion of secondary equity offer- (See also “A Playbook for Borrowers
ings in the U.K., see “UK-Listed Issuers Facing Economic and Debt Market
Capital Management Under Financial Stress Gain Latitude in Pressures.”)
Capital raisings. Should economic pres- Secondary Capital Raisings.”)
sures prompt companies to shore up their
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