2023 restructuring trends: déjà vu all over again

 
That does not mean there wasn’t significant activity in some quarters, but it was driven by older high-end files and mid-market work (or small business matters that don’t qualify as mid-market). Files that commenced in 2021 like Bridging Finance, Just Energy, and Laurentian University continued to dominate activity levels. Even U.S. Steel (Stelco)—a 2014 CCAA filing—continued to be highly active in 2022 as the pension plans near full wind up and the sale of excess lands formerly owned by U.S. Steel continued. But where was all the new activity?

I am not saying that we didn’t have any new CCAA filings in 2022. Canada Sheep and Lamb Farms Ltd. commenced CCAA proceedings in Alberta in 2022; Groupe Sélection filed in Québec; and Canada Fluorspar filed in Newfoundland and Labrador. And there were unquestionably a lot of relatively small new filings in 2022 that originated in the cannabis space, such as CCAA filings for the Choom group, Cannapiece, Flowr Corporation, Speakeasy Cannabis Club, Mjardin Group, Zenabis, the Eve & Co group, Sproutly and Lightbox Enterprises / Dutch Love Cannabis. Without cannabis work, what little new commercial insolvency work there was in 2021 would have been truly anemic. But where were the big files? The Nortels and the Sears and big tobacco? Files that drive change through significant developments and case law that shape this field? Even reliable staples of the insolvency world disappeared in 2022. I cannot remember the last time we did not see at least a few larger retail insolvencies in a calendar year. But in 2022—crickets.

We have all grown rather weary of prognostications of impending economic doom and increased activity levels in the distressed space. We have been living that Groundhog Day since the financial crisis of 2007-08, with a steady succession of predictions each year that an economic correction is inevitable and only just over the horizon. That chorus built to a crescendo with the arrival of the pandemic in early 2020. Only, the influx of new insolvency mandates has not materialized. It should have, but it did not—due in large measure to over a decade of government fiscal, monetary and other macroeconomic policies intended to prevent a correction from occurring. 

Here we sit looking forward at 2023 and once again the loud voices are crying wolf. One cannot help but be reminded of Yogi Berra’s famous quote that it is déjà vu all over again. Only, people in this practice area really—REALLY—believe it this time. And it is not just the lawyers and the accountants. The banks believe it, the bondholders believe it. Economists and politicians, they believe it. And many companies and their C-suite are very worried about it and preparing as best they can for it. It’s no longer about whether or even when—the question to ask is: how deep?

What’s ahead for 2023

I would offer several observations and predictions for 2023, in no particular order:

• Expect less-patient lenders. Through the pandemic, the lending community has been remarkably supportive of troubled business. Amendments, forbearance, waivers of defaults, and out-of-court workouts have been pervasive. That patience was admirable but is waning. Working out a distressed situation out-of-court is often more demanding for lenders than court-supervised insolvency proceedings, whether receivership or debtor-in-possession proceedings. As work-out groups get busy and at risk of being spread thin in 2023, they will have less time and resources to devote to out-of-court hand-holding and high-maintenance borrowers.
• 2023 will see increased focus on company borrowings that were incurred during the pandemic in order to survive the challenges of that period. Many of those COVID-19-era loans will start to come due in 2023 or otherwise be looming going into 2024. Debt maturity walls can be resolved with repayment or refinancing, but that may be easier said than done. The pattern of “extend and pretend” financing that’s been pervasive for years is widely believed to have run its course in the current economic climate. I’m as skeptical as the next person when I hear about tighter lending, but it’s seemingly already happening. Higher interest rates and stressed business models will make refinancing a challenge for weaker companies.
• Increased insolvency activity in 2023 will not be confined to a specific sector. In the past, we have often seen periods of distress centered on certain economic sectors: a real estate collapse, a tech sector collapse, a financial institutions collapse. But the factors driving current distress—interest rates, energy prices, inflation, labour market disruptions, supply chain challenges, wavering consumer spending, geopolitical factors—are not relegated to one industry and instead threaten companies in all areas of the economy.
• Canadian personal and corporate debt levels are staggering. In this environment, companies whose businesses depend on discretionary spending—especially discretionary consumer spending—are more likely to bear the brunt of a downturn. Food prices have increased by double digits (and the magnitude of those increases is expected to continue in 2023), mortgages are more expensive and continuing to trend upward. Granted, consumers can modify their diet and downsize their homes to a point, but food on the table and a roof over one’s head remain obvious necessities. As consumers tighten their belts and spend relatively more of their income on necessities, the trade-off will largely be directed elsewhere (i.e., discretionary spending).
• The increased insolvency activity won’t be evenly distributed geographically. Insolvency work will pick-up more strongly in Ontario and Québec than in Alberta. The energy sector should cool off in 2023—but it should not be front and centre in the insolvency world, except insofar as energy prices remain a frequently-cited cause of other companies’ distress. We have seen record price increases and sustained profitability of late in the energy sector, but that is leveling off and, in some cases, modest pricing declines in Canada are expected. Even so, most energy companies are in a good position in the short to medium-term. And I’m mindful that we lost so many small Canadian E&P companies in the last oil and gas bust a few years ago, that it sometimes seems we’re mostly left with sizable players that have deep pockets and scale.
• Travel and hospitality remain sectors to watch. Expect to see continued volatility in business and consumer dining, entertainment, travel, and vacations. These challenges will be further exacerbated by higher interest rates, inflation, energy costs, and pressure on consumer spending. The airline industry may attract scrutiny, as there was extensive borrowing in this industry through the pandemic. For example, government loans through the Large Employer Emergency Financing Facility (LEEFF) program during the pandemic were heavily focused on the airline industry. While these industries have seen some recovery in 2022 due in large part to the lifting of COVID-19 restrictions and some semblance of business and consumer normalcy returning, there are still challenging headwinds ahead in 2023.
• Retail insolvencies will pick up again. Tenants have had an unexpectedly strong run of late, in part because consumer spending has been sustained through the first two years of the pandemic and in part because retailers’ two largest fixed costs—rent and employee wages—have been heavily subsidized for two years. But that won’t continue, and there will be some fallout for business models that aren’t viable. Inflation, rising interest rates, falling house prices—all of that impacts consumer confidence and consumer spending. Compound that with labour and supply chain challenges, and some retailers will inevitably need to restructure or liquidate. Expect the most severe challenges to be side-stepped by retailers targeting high end customers and by discount retailers—the greater pressure remains on retailers in the mid-market.
• Expect continued activity in cannabis. The sector is maturing and consolidating, but still has a long way to go before the sector stabilizes. More casualties along the way are a certainty.
• Other sectors of note. Other sectors that have been relatively busy in the past few years—including mining and pharmaceuticals / health care—are likely to continue to provide a steady stream of restructurings and distressed M&A transactions. And we may see more activity in relatively new sectors like cryptocurrencies and related platforms, which are suffering through a significant loss of public confidence and value.

An economic correction is not all bad. There are seemingly too many so-called “zombie companies” afloat and arguably too many economic resources consumed by non-viable or laggard businesses. A thinning of the herd may be painful, but it ultimately is healthy, even necessary. And a correction inevitably brings potential upside for those companies that are well-positioned to capitalize on opportunities.

You have likely heard for some time that an economic correction was coming, and you may have become jaundiced to these warnings. As you’re inundated with the now customary annual warnings and assurances that an economic correction lies ahead, you may well wonder: is this indeed déjà vu all over again? Perhaps. But it is an easy prediction to make. With so little activity in 2022—and with no large-scale corporate insolvency filings with national scope—the reality is, it can only get busier.