SECONDWAVE OFINSOLVENCIES EXPECTED

Warning from experts as once-strong businesses falter

TORONTO • As the second wave of the coronavirus pandemic was taking hold in Canada, with Toronto once again prohibiting indoor dining, Peter Tsebelis and his team at King Street Co. Inc. decided they had little choice but to file for creditor protection. It was a stunning reversal of fortune for the network of trendy restaurants including Italian eatery Buca and Jacobs & Co.

Steakhouse. Less than a year ago, plans were under way to open more concepts in and around Canada's largest city.

“Alongside the entire hospitality sector, the COVID-19 pandemic has put us in an extremely difficult situation that was beyond our control,” Tsebelis said in a statement on Nov. 9.

The filing signals an even more unfortunate turn to those who spend their days dealing with restructurings and insolvencies. To them, it means the economic impact has spilled over from the usual suspects in sectors such as retail and cannabis that had problems before the spread of COVID-19 slammed the brakes on normal daily life.

"King Street Company's filing … likely marks the start of a new wave, where previously healthy industries that have been hit hard by the pandemic begin to falter,” said Rob Fedrock, principal at Origin Merchant Partners.

“The restaurant space is a prime example,” he said, adding that with indoor dining restrictions and the end of the patio season, “fine dining restaurants are in for a tough ride.”

And the ripples could keep spreading, insolvency specialists warn.

Linc Rogers, a partner at Blake, Cassels & Graydon LLP, said it's clear to him that there are a number of “zombie” companies staggering on in Canada, appearing nearly normal yet propped up only by government subsidies, wage support, tax remittance deferrals and general government-backed stimulus.

“They are being artificially kept alive,” said Rogers, who specializes in complex restructurings and distressed financings and acquisitions.

He is expecting an explosion of work once those supports dry up.

Combined with a reluctance of bankers to call loans in an environment where asset values could be significantly depressed, the government supports merely “allowed many stressed companies to delay the inevitable,” he said.

“Even though we've only felt the tremors so far, we all believe an earthquake is coming.”

Those tremors include a growing line of filings and restructurings in the retail sector, one that was particularly hard hit by the pandemic but was already struggling.

Lawyers on the insolvency team at law firm Stikeman Elliott LLP in Toronto say year-to-date public filings by retailers for insolvency-related proceedings are already

“more than double what was filed last year.”

The list of more than two dozen companies that have filed for relief under the Companies' Creditor Protection Act includes household names such as Pier 1 Imports Inc. and Davids Tea Inc. and apparel retailers Reitmans Ltd., Aldo, J. Crew Group LLC, Le Chateau Inc., Mendocino Clothing Company Ltd., Groupe Dynamite Inc., and Moores the Suit People Inc.

Rogers said temporary closures and a decline in foot traffic due to the pandemic and measures to control it merely accelerated the effect of earlier miscalculations, such as taking on debt and aggressive expansion. This, in turn, hampered the ability to pivot to online sales.

“The pandemic exposed that latent defect” in the sector, he said.

“The burden of paying interest on the debt means that the enterprise doesn't have enough funds to invest in capital improvements needed to remain competitive.”

Unable to adapt to a more locked-down society impaired the ability to even maintain debt servicing for some, leaving creditor protection the only option, he said.

Shayne Kukulowicz, a partner at Cassels Brock & Blackwell LLP and chair of the firm's restructuring and insolvency group, said some proceeding could cure operational or balance sheet issues and a streamlined business may emerge. But much depends on the trajectory of the spread of COVID-19, rolling lockdowns and the development of a vaccine.

“An insolvency proceeding won't increase the number of customers at a restaurant,” Kukulowicz said.

One thing struggling businesses appear to have in their favour at the moment is a reluctance by bankers to pull the plug on loans in the midst of a global economic and public health crisis.

“Banks may be concerned about the optics of enforcing against companies that are struggling due to external factors,” said Kukulowicz.

In addition, he said, the “practical reality” right now is that it would lead to a distress sale with a dearth of buyers for assets in hard-hit sectors.

Rogers said Canada's large banks are “cognizant of reputational issues,” which may be keeping them from calling loans where businesses are falling behind in payments, or are likely to do so once government support disappears.

“They understand their critical role in supporting Canadian business and the far reaching consequences that would occur should that support waiver,” he said.

But their “measured patience” is also driven by solid business reasons.

“Banks are rational and pragmatic commercial actors and take a long-term strategic view,” he said. “Who wants to sell a distressed airline or hotel in this environment?”

Still, as the winter and holiday season approaches, travel and related businesses from airlines to hotels to car rental agencies — and now restaurants — will be on the watchlists of insolvency and restructuring experts.

These sectors “will remain under stress as customers elect to remain close to home,” said Rogers.

WE ALL BELIEVE AN EARTHQUAKE IS COMING.