Shaping global finance throughout history.
Economic crisis looms and political populism is amplifying global instability.
Freshfields overcomes the odds in high-profile international litigation to secure an unlikely win for one of the world’s biggest businesses. The year is 1772.
For more than 200 years, Freshfields has been at the centre of the biggest international crises. Many at the firm can still remember the tense atmosphere on the eve of financial meltdown in 2007, when Freshfields mobilised to offer triage advice, drafting over a single weekend the Financial Market Stabilisation Act, then undertaking a wide range of restructuring work.
Yet our advice on such unprecedented crisis restructuring and insolvency matters started much, much earlier.
1772 – international credit crisis
In the 18th century the increasingly internationally connected economy lacked the oversight needed to prevent a series of crashes, the most serious of which was the credit crisis of 1772.
Manufacturing, mining and agriculture expanded rapidly through the 1760s and early 1770s on the back of a credit boom. Critically, the trade between Britain and its colonies in America and the Caribbean was heavily reliant on credit, with substantial debt raised to invest in sugar and tobacco plantations. The so-called ‘Ceded Islands’ (Grenada, Tobago, St. Vincent and Dominica) absorbed a disproportionate amount of capital. Sugar production increased more than fourfold in Grenada between 1762 and 1772, for example. A bubble was rapidly inflating.
On 8 June 1772, Alexander Fordyce, a bullish banker (and former hosier), fled his creditors to France, stirring panic in London. Paralysis of the credit system ensued, angry crowds waited at banks to call in debts or withdraw deposits. Twenty important banks went under.
As the Gentleman’s Magazine commented,
No event for 50 years past has been remembered to have given so fatal a blow both to trade and public credit.
The deeply encumbered Ceded Islands, where credit had been stretched to breaking point, were “distressed… beyond conception,” wrote Governor Leybourne of Grenada in June 1773.
Where does Freshfields (or rather Winter & Kaye, the precursor firm) fit in? Our biggest client, the Bank of England, had loaned the Edinburgh house of William Alexander and Sons a large sum of money against two large sugar estates in Grenada– Riviere du Chemin and Bacolet. But the now bankrupt Alexanders fled to France to claim French citizenship and their properties. We were tasked with foreclosing upon and disposing of the estates.
The international situation can hardly have been less conducive. The outbreak of the American War of Independence was followed by the French capture of Grenada. Undaunted, Freshfields engaged in protracted litigation and negotiations with the French, while hostilities were still in progress. The Bank was able to sell the estates in 1790 and recover much of its money. The Bank paid our partners £4,000, a considerable sum for the time.
1850 – off the rails
Undoubtedly one of the greatest innovations of the 19th century, railways soon began to cut journey times from days to hours. But railways were uniquely complex – not just for the engineers but lawyers too.
Solicitors were intimately involved in railway projects in everything from parliamentary legislation, to the acquisition of land and raising the massive amounts of capital needed.
Still, convinced of the transformative potential of the technology, investors rushed in. By 1850, about 36 per cent of Britain’s GDP had been poured into railway development.
But costs of construction and operation outstripped expectations, while demand was lower than expected. Poor (and sometimes fraudulent) financial reporting, as well as overly optimistic perceptions, concealed the grim reality from investors.
Railway share prices peaked in 1845, the dismal truth emerging just as the potato crop in Ireland failed in 1845 and 1846, followed by a poor harvest both in Britain and in Continental Europe.
The interest rate was raised and panic set in. The Bank leapt into action to stave off financial meltdown – there were ‘no weekends’ for the directors, according to Bank records. The Bank’s response was sophisticated: substantial capital injections kept key financial and trading establishments afloat. As the Bank’s legal advisers, the workload James [II] and Henry Freshfield was heavy.
Still, the consequences of the crisis were widespread. Bankruptcies included three firms in which directors of the Bank of England, including the Governor, were partners. Future prime minister W. E. Gladstone (then an opposition MP and to become a longstanding client of the firm) was also affected.
By 1850 railway share values had plummeted by more than half, and dividends had dropped from more than 7 per cent to 2 per cent.
Back on track
With Britain left reeling from the crisis, the Mercantile Laws Commission of 1854 investigated its causes and possible solutions. James Freshfield give evidence as an expert, helping cut the chances of similar speculative crises, and contributing to the adoption of limited liability as a standard feature of English-law-incorporated companies.
Generally, Freshfield said, trade and corporations should not mix in case of “speculation and gambling” causing “loss and ruin” to “persons ignorant of business”. Yet, always the pragmatist, Freshfield admitted that “the construction of railroads requires the establishment of corporations”, although the “evil” of recklessness meant the “unnecessary extension of the principle” must be avoided. Corporations were necessary, Freshfield claimed, to finance insurance, docks, canals, railways and steam boats, but not to finance banks.
1890 – the Baring crisis
Singling out banks’ risk taking proved prescient. In arguably the most serious global crisis yet, the collapse of entire private banking system of London loomed in 1890, raising the spectre of global economic catastrophe. Like subsequent banking crises, the contagion spread from one large player, the world’s largest merchant bank, Baring Brothers & Co., which had ill-advisedly become deeply exposed to Argentine securities.
Barings’ liquidity crisis came from an overconfident capital issue the house had undertaken for the Buenos Aires Water Supply and Drainage Company in 1888. Barings began to sell blocks of securities, raising tensions in the City.
Again, the Bank of England’s confident response is impressive. Apparently having learned from the railway crisis, instead of waiting for the panic to break, the Bank organised a pre-emptive ‘lifeboat operation’, again drawing on Freshfields’ expertise.
Acting before the markets knew anything of the parlous state of Barings’ balance sheet, the Bank and Freshfields coordinated a rescue package from a syndicate of private banks, backstopped by the promise of Government support.
With the Bank left as Barings’ dominant creditor, Freshfields helped pioneer a very modern solution, splitting Barings into a ‘good bank’ (mercantile) and a ‘bad bank’ (investment).
After a liquidation of the ‘bad bank’ lasting four years, the new Baring Brothers & Co., Ltd. approached Freshfields with proposals for a final settlement. Freshfields had again played crucial part in averting what the Stock Exchange later suggested would have been a panic of unparalleled dimensions.
1930s Credit Anstalt and the Depression
The Great Depression is still familiar today but its causes are less well understood. The US stock market crash of 1929 was certainly a primary contributor but the Credit Anstalt debacle of 1931 is generally seen as triggering the most serious period of the Depression.
Through the 1920s, the Bank of England had become heavily involved in post-war international financial reconstruction. Their global role in dealing with the next crisis would also expand Freshfields’ horizons.
In May 1931, a Viennese bank named Credit-Anstalt failed. Founded by the famous Rothschild banking family in 1855, Credit-Anstalt was one of the most important financial institutions of the Austro-Hungarian Empire.
But the contagion spread. Danatbank, then the second biggest bank in Germany, went bust two months later. A wave of bank runs ensued in Germany banks. Soon, banks across Europe were closed. The repercussions were felt as far away as the US.
As the chill spread through the world’s financial capitals, a Committee of experts was formed, as the Times of 1931 explained, that “represents important interested parties and will keep in close touch with the Credit-Anstalt, and deal particularly with the policy to be adopted in near future”.
An International Committee with expanded scope was soon meeting regularly to deal with the fallout of Credit Anstalt’s collapse and liquidation. Vivian Smith of Freshfields was heavily involved: as the Rothschild archive notes, on 12 June 1931 he went to Vienna to negotiate the first Creditanstalt agreement. A draft had been drawn up in London.
By the end of 1936, less than five years after the crisis, the claims of the foreign creditors had been satisfied, partly by a small payment in cash, representing about 15 per cent of the total claim, and partly by a variety of securities, Gesco bonds and shares, Creditanstalt Preferred Ordinary Shares and Austrian Government Annuities.
2007 – ‘the busiest year’
With the August 2007 depositor’s run on Northern Rock, the scale of the crisis became apparent.
“We then had to deal with the situation of the first full-scale panic bank run of a UK for, I think, 100 years,” said Partner Alan Newton.
By October, German banks were facing their own liquidity crisis. Partners in Frankfurt and Berlin were asked by the German Government to draft over a single weekend unprecedented legislation providing crucial assistance to the banking and insurance sectors.
“The pace of the project was just extraordinary, the dedication of everyone was very, very high, also the collaboration with the people at the Ministry of Finance was extremely good, extremely collegiate and very focused. It was an extraordinary and very interesting experience,” recalled Partner Gunnar Schuster.
Freshfields had only a small team of restructuring and insolvency lawyers but the volume of distressed work rocketed, as well as advising governments in the UK, Germany, France, Italy, Spain, the Netherlands and Switzerland. "We developed this idea that we had to find the talent in the network; find people who didn’t realise that they were restructuring lawyers,” said Partner Ken Baird.
“As I recall, ‘08–‘09 was probably the busiest year the firm had ever had in terms of the flow of mandates and the sheer number of hours we put in,” said Partner Will Lawes. “I attribute that the fact that we are seen as the firm to go to in a crisis.”