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Restructuring Opportunities and Challenges in Central and Eastern Europe

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In the United States, the aim of chapter 11 is to give the debtor company a chance to emerge as a restructured corporate entity, and the role of Chief Restructuring Officer (CRO) within that process is well-established. In Europe, tradition and insolvency law have supported the development of a "creditor-in-possession" culture, which can deprive companies of rescue funding, strip directors of their powers and hamper corporate rescues.

This has also influenced the role of the European restructuring adviser, where the adviser has often been limited to an accounting firm preparing a report for a bank group. The problem with this is that after four to six weeks, nothing much has changed; valuable time has been lost, and the company has another significant demand on its cash flow as a result of the report. Management grumbles, and other creditors feel shut out and get nervous while shareholders start to fear the worst: insolvency. In the United Kingdom, the management team may even see the situation as an opportunity to bid for the trade and assets of the company from the inside.

In Central and Eastern Europe (C&EE), insolvency law tends to be even more focused on the insolvency process itself and less focused on the rehabilitation of the company as a going-concern. The shortcomings in local restructuring laws mean that the banks are very keen to avoid insolvency at all costs.

Providers of debtor-in-possession (DIP) funding are few and far between, and the survival of distressed corporate entities is rare. Few, if any, businesses enter into insolvency in Europe and emerge intact. Most end up being liquidated and their assets sold at liquidation values. Worse still, because of these deficiencies and the lack of rehabilitation processes, companies often trade well beyond the point of no return.

A further challenge in European restructuring is the number of jurisdictions often involved even for mid-market companies with cross-border operations. Despite the growing trend toward harmonization of European legislation, each country has so far retained its own insolvency law, requiring familiarization with a number of different sets of rules. This is in addition to the various different cultural attitudes toward change that is normally engendered by restructurings.

Role of the European Restructuring Officer

It is only in recent times that company-side advisors have become an acceptable face of restructuring. Historically, even large companies would enter a restructuring or insolvency process guided by the banks' own advisors only. This may be a laughable thought to someone familiar with the American approach, where the company drives the restructuring and the creditors take advice from their own counsel.

The rise of the European CRO has been fueled by the need to avoid bankruptcy, which might sound strange to a U.S. bankruptcy advisor. European CROs tend to work on informal restructurings and are therefore focused on operational improvement and out-of-court financial restructurings, such as debt-to-equity swaps. If a court process is required, it tends to be used to confirm the restructuring agreements rather than to control creditors.

Opportunities in C&EE

There are currently some attractive opportunities for CROs in Europe generally. While costs of production are still lower in C&EE than in the United Kingdom and America, rapidly escalating wages and energy costs mean that the recent European Union (EU) entrants' competitive edge is vanishing. The other problem in low-cost countries is that companies tend to employ more people. So although the latest accession countries are benefiting from certain aspects of their membership, such as major investment in infrastructure, social costs are rising as an inevitable consequence of the harmonization process.

Indeed, the pattern of consumption in these new EU countries is no different from their more-established neighbors. Take an evening promenade along the high street of any mid-sized city in the region and you notice that the brand names in the shop windows are no different from those in any high street of America or Western Europe. With wages and salaries growing disproportionately to sale prices, many companies are struggling to rationalize their cost base and improve efficiency.

In addition, many of the new EU entrants have been hit with exchange rates moving against them. Many of those trading within the EU have seen their currencies strengthen against the Euro, and those trading with the United States have also suffered from the strength of the Euro against the dollar. Many Euro-based currencies such as the Hungarian forint have appreciated by more than 50 percent in relation to the U.S. dollar in the last two to three years. This has had a devastating effect on earnings for these export economies with companies exporting to the United States. Costs are inevitably Euro-based while incomes are dollar-based, and no amount of hedging offsets the uncertainty that this brings to investment decisions.

The Future of Restructuring in Europe

The outlook for 2006 and beyond will see the demand for restructuring services accelerate in C&EE as the region comes to terms with a reducing competitive advantage. The rapid rise of low-cost manufacturing capability in China and the liberalization of the Ukrainian and Romanian economies are only exacerbating the problem. The whole of Europe is set for a further shift of production eastward.

This will prove challenging for the economies of C&EE, which were until relatively recently subject to central planning. The concept of outsourcing production, for example, is new to many of their companies. However, it is undoubtedly one of the next steps for these markets to fully catch up with their more mature Western couterparts that have already been through the process. As a result, part of the CROs' role in CEE in the years to come will be to educate their clients on issues that are now taken for granted in Western Europe and America.

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Friday, September 1, 2006

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