Today's read (8 minutes):
- Is the UK Economy in Recession?
- Is now the time for Distressed-Debt Investors?
- UK Top 50 Law Firms achieve strong revenue rise
- Case: AIG and Lloyd defend $3.5BN insurance claim
- Deal: Cleary Gottlieb advised on the first ever ESG bonds for Saint Gobain
plus answers to your questions!
Is the UK Economy in Recession?
Yesterday we got some fresh data from the Office for National Statistics (ONS) which didn’t quite match expectations.
The UK economy stagnated in the three months to July as the cost of living crisis hit household budgets and business activity. The growth rate lost momentum as rising costs hit consumers and businesses. UK inflation hit a 40-year high of 10.1% in July, eroding the money people have available to spend on goods and services.
The size of the economy in July was no larger than six months earlier and the monthly rise in gross domestic product of 0.2% fell short of the 0.4% forecast. Problem here is that economists had expected more of a bounce back from the 0.6% fall in GDP recorded in June, which reflected the loss of two working days linked to Queen Elizabeth II’s platinum jubilee celebrations.
💡A recession is a significant, widespread, and prolonged downturn in economic activity. Because recessions often last six months or more, one popular rule is that two consecutive quarters of decline in a country's Gross Domestic Product (GDP) constitute a recession.
How does this impact law firms' clients?
- The ONS statistics show us which sectors (and clients) are struggling the most.
The ONS statistics are helpful in showing which sectors are holding up best. The GDP data showed services expanding 0.4% and leading growth. On the flip side, production, including manufacturing, fell 0.3% after a decrease of 0.9% the previous month. Construction also registered two consecutive sharp contractions. The decrease in activity in these sectors will result in a slowdown in demand for legal work, as clients re-evaluate their costs and reduce their growth opportunities.
Another key point to discuss is whether the freeze in average annual household energy bills at £2,500 over the next two years, announced last week by new prime minister Liz Truss, will help support demand in the economy during the coming months. Despite this many households and businesses will continue to struggle to keep up with energy payments.
Overall, the data tells us that we can expect the economy to continue in a sort of stagnant phase, as businesses juggle growing costs and a slowdown in economic activity.
How does this impact law firms?
- Slowdown in legal work could be countered by boom in demand for restructuring and insolvency work.
- Top Departments: Restructuring and Insolvency
A slowdown in overall economic activity is not great news for law firms, as it means that less clients will be looking to invest in growth opportunities thus reducing the demand for legal work. On the flip side, restructuring and insolvency departments can expect a boost in demand as some of the most struggling businesses enter insolvency procedures after their survival sustained by COVID-related measures in the past few years.
Aside from the points mentioned above, we also have the prospect of higher interest rates playing a role in these forecasts. Economists expect the Bank of England to raise interest rates for the seventh consecutive time at its Monetary Policy Committee’s next meeting on September 22. This will be a rise between 0.5% and 0.75% in interest rates.
Higher borrowing costs are likely to cause a further slowdown in household demand, with consumer confidence in August having dropped to the lowest level since records began almost 50 years ago. Higher interest rates make it more expensive for people to borrow money and they also encourage people to save – meaning there is a reduction in economic activity.
Law firms with offices in Germany may pick out an opportunity from recent data. By contrast to the UK, German data has seen upward revisions over the past three months so the country’s economic performance has now reached the pre-pandemic peak and appears better than Britain’s. This means that international firms could counter a UK slowdown, with a boost in German activity.
Lastly, by the end of September, the ONS will publish new figures for 2021 and 2022. The ONS has indicated that as the costs of the pandemic fall away, the health sector is likely to register faster growth rates, although the statistical agency has not said how large these will be.
Distressed-debt investors are preparing to pounce
With the prospect of rescissions on the horizon, many are expecting a powerful return of distressed-debt investors.
These are parties like private equity firms, or hedge funds may decide to invest in distressed debt purchase the bonds of firms that have filed for bankruptcy or are likely to do so in the near future. They purchase these bonds at a steep discount of their face value in the anticipation that the company will successfully emerge from bankruptcy as a viable enterprise. If the failing company turns its fortunes around, the value of its bonds will increase, giving the hedge fund an opportunity to reap substantial profits.
This is a strategy that became popular during the global financial crisis of 2007-09, when the face value of distressed and defaulted debt reached $3.6trn. Since 2011, funds have raised around $500bn in anticipation of more distress, but have had few opportunities to spend it.
This was mainly due to a decade of low interest rates which made borrowing easy and distress rare. Even the covid-19 pandemic turned out to be a false dawn, since the door to liquidity was held open by massive central-bank stimulus.
A similar situation in shaping up now with many global economy facing the prospect of a recession, and businesses struggling to hold on.
How does this impact law firms' clients?
- Private Equity firms and hedge funds could see current economic climate as an opportunity to invest in struggling businesses.
Despite the economic situation not looking great, distressed-debt investors may not be as successful as during 2007-09. Lending to risky companies in the past decade has been not only vast, but loose. Maintenance covenants, financial commitments which lenders can use as a “stick” to force a restructuring, have all but disappeared.
This means that clients such as private equity firms, or hedge funds may find it harder to get struggling businesses at the negotiating table. Even if they do it is quite common for leveraged-loan documentation to include blacklists to prevent specialist funds from buying in. This is another point which clients will need assistance with, to ensure they do not breach any previous contractual terms that limit their ability to buy up distressed-debt.
Many businesses will still be struggling at the moment, and the growing rate of insolvencies in the UK exemplifies this. They will be looking for legal advice on their options including popular pre-pack sales, administrations, or outright liquidation. Within all these they will also be considering the possibility of discussing options with distressed debt investors to get some cash flow in, and survive for some more time.
How does this impact law firms?
- Law firms can expect an increase in demand for restructuring and insolvency work as insolvencies rise. Other opportunities may arise depending on the solutions pursued by struggling businesses.
- Top Departments: Commercial, IP, Capital Markets, Corporate, Restructuring and Insolvency.
Whenever we speak of troubling economic situation, we have to mention a potential boom in demand for restructuring and insolvency lawyers. These departments have been (surprisingly) relatively quiet over the past few years, partly due to the vast number of COVID related support measures which have been launched by governments worldwide.
Other streams of work for both restructuring lawyers, and other departments such as Commercial, Corporate and Intellectual Property can come from the struggling businesses. A new trend in particular involve subordinating secured lenders. A common example of this in the US is where the borrowing company transfers collateral backing its existing loans to a subsidiary free from creditors’ rights. This allows the company to re-use the collateral to raise new debt, in effect shoving the original lenders down the pecking order if it comes to divvying up assets. American clothing brand J.Crew became the key example of this after shifting around valuable intellectual property in this fashion (similar things then happened at Revlon, a beauty brand, Golden Nugget, a chain of hotels and casinos, and Travelport, a tourism firm).
If the distressed-debt negotiations go well, struggling businesses will also need law firms assistance in drafting the required investment documentation, managing their assets, and liaising with creditors to update them on these arrangements. Contracts may also be drafted to include specific provisions about what happens if the company manages a turn around e.g. the investor could take a bigger stake in the surviving company, or be able to re-sell it at a pre-determined valuation.
Something that caught my eye...
The U.K.’s largest law firms managed their strongest average revenue rise since before the financial crisis, according to this year’s Top 50 rankings.
The firms grew their fee income by 10.9% on average in the last financial year, a noticeable improvement on the previous year, when the average rise was 5.9%. It was the largest average rise in revenue since the 2007-08 financial year, when turnover rose 12.5%.
Out of this list, 19 firms posted double digit revenue increases, compared with 11 in the previous year. Only four firms posted a fall in revenue, compared with 10 in the previous year.
However the U.K. firms’ growth lags that of their U.S. counterparts, with the US Law 100 recording a collective revenue growth of 14.8% for 2021, led by Kirkland & Ellis and Latham & Watkins.
Top Court Case:
AIG and Lloyd's Insurance argued that they do not have to pay AerCap Ireland, the world's largest aircraft lessor, $3.5 billion over 41 aircraft and 29 engines leased to Russian airlines that are now stuck in Russia amid international sanctions over the invasion of Ukraine. Russia responded to sanctions imposed by the EU, US and the UK by passing laws to keep foreign-leased aircraft in the country, with an estimated $13 billion worth of aircraft now stranded. The crisis is causing headaches for insurers, which are likely to be locked in legal disputes for years over liability claims. AIG denied liability to indemnify AerCap under the $3.5 billion all-risk policy, because the engines and airplanes have not gone completely lost, as required by the policy (AIG believes the planes might still be recovered).
AerCap is represented by Mark Howard KC of Brick Court Chambers, instructed by Herbert Smith Freehills.AIG is represented by Gavin Kealey KC of 7KBW, instructed by HFW.
Cleary Gottlieb advised on the first ever ESG bonds for Saint Gobain. It is a EUR 1.5bn issue, including EUR 500mn in sustainability-linked bonds. This deal is the latest in the burgeoning global market for ESG-related corporate financing.
Compagnie de Saint-Gobain is a leading player in the design, manufacturing, and distribution of materials and services for the construction and industrial markets, and specialises in light and sustainable construction.
Cleary Gottlieb was the sole counsel on the deal, advising Societe Generale as the sole structuring advisor and global coordinators, as well as joint active bookrunners.
The sustainability linked bonds will bear a fixed rate of 2.625%. If Compagnie de Saint-Gobain does not meet the objectives set for the key performance indicators under the conditions described in the terms and conditions of these bonds, the interest rate of the sustainability-linked bonds will be increased by 0.375% or 0.75%. This is in line with the sustainability performance target date in 2030 and the sustainability-linked bond principles established by ICMA.
Reporting by our deal specialist Mia Taylor.
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