Some historians of economics make a shibboleth of not referring to present economic knowledge in studying events of the past. This is clearly a case of playing “hide the ball”, especially when it comes to addressing the issue of corporate bankruptcies.
While there is no doubt that bankruptcies are a part of economic theory, how they arise is critical to addressing different diagnoses as policymakers come to grips with potential solutions. It is obvious that there is a systemic lack of liquidity that permeates the atmosphere (despite the stimulus efforts announced), and the ricochet effects this has on investment behavior suggests that the underlying cause is deeper than previously thought.
We know there is an abundance of liquidity chasing technology deals, and every other sector has been scrambling to dress themselves up to reap the benefits of the torrent of cash investors are all too eager to throw at them. The dearth of liquidity everywhere else implies that as more companies seek bankruptcy protection, the number of skilled professionals required will increase, which will only happen over time.
Slowing it down
Until this occurs, professional fees will rise (which is problematic for the SME sector), but more importantly, the process of asset sales will be delayed. This will delay payments to critical vendors and investors, further disrupting supply chains and destroying value in a vicious downward spiral that will further deteriorate sentiments.
Is this bleak scenario inevitable as we move forward, absent liquidity injections or restructurings from banks, which seem to have slowed down at the present time? Clearly, there is a need for expertise to deal with the bankruptcy “pandemic”. Until this pool of expertise expands, other variables need to be present in the economic system that facilitates private sector re-allocation of capital for troubled assets.
Give process a chance
What we are witnessing instead is fund flows headed towards inflating the tech bubble, partly because there is no clear direction of how investors can deal with companies currently going through the pain. Bankruptcy need not necessarily lead to liquidation, and even when it does, there needs to be a moratorium on liabilities that is covered by the law such that it allows either for swift asset disposal and/or for the business to recover in an expeditious manner.
Paucity of firm action
From the amounts that are chasing “tech deals”, we know that there is no shortage of private sector capital. This implies that the framework for the resuscitation of companies and/or for the disposal of assets is not well equipped with sufficient expertise that allows for this re-allocation. Unfortunately, this means that we go into a spiral where bankruptcies spread throughout the economy, further deteriorating the outlook and sentiment as well as the underlying salvage value of the assets. This loss of confidence (which manifested itself in the real estate sector in 2008-09 in the form of stalled projects) then becomes a pandemic of its own that needs to be dealt with.
Cut down process time
While there are no easy answers, there have to be a few essential steps in place. Firstly, a moratorium assumes that there is the possibility where stakeholders can find common ground fairly quickly. There have to be “haircuts” that all have to take.
But it does not help if spiraling professional costs in the interim period make it virtually impossible for either the business to recover or for the underlying assets to attract private sector capital as these costs and the procedures that come along with it becomes a barrier too high to overcome. Financially distressed companies must have the ability to deal with creditors directly, with minimal court supervision. The same process must be facilitated for private sector investors. Pre-negotiated options must also exist as possibilities that can be explored under this criteria.
It goes without saying that excoriating events such as the Arabtec liquidation must be minimized. For this to happen though, it is imperative that the expertise in the system must be available at rates that are palatable, especially to the SME sector if supply chains are not to be entirely disrupted by the process.
This, along with legal remedies that allow for visibility, expediency and clarity as to what options are available for both the investor as well as the distressed company will pave the way for a re-allocation of capital... and eventually a recovery. None of this is obvious to economic historians and commentators.
However, these are the lessons that must be learnt quickly if further pain minimization is the goal.
- Sameer Lakhani is Managing Director of Global Capital Partners.