Restructuring Troubled SME’s

All accountants have clients whose businesses have recently failed, but might have survived if they were restructured before their problems became insurmountable. These business failures often result from losses incurred whilst adjusting to the present environment, or from excessive rents and other commitments made in better times. Many of these businesses could have avoided failure by availing of the restructuring procedures provided by the Companies Acts.

There is a popular misconception that formal restructuring is only available to companies of sufficient scale to justify examinership. This misconception should be dispelled. The restructuring procedure provided by Section 201 Companies Act 1963 is affordable for SME’s, and can produce many of the same results as examinership.

Section 201 sets out a procedure whereby a company can make a compromise proposal to its creditors, or classes of them. The proposal is considered by the creditors at a meeting summoned by the High Court. The Court can make the proposal binding on all creditors if it is approved by a majority in number and at least 75% in value of the creditors who attend and vote at the meeting.

The Court can also suspend legal proceedings against the company to allow time for the proposal to be considered.

It is notable that the procedure in Section 201 has never been widely employed to restructure insolvent companies, nor has it been employed more frequently in recent years. This suggests that company directors and their advisors may not appreciate the value of Section 201 as a restructuring tool, or do not appreciate how accessible it is to SME’s.

Form of restructuring
Whilst every compromise proposal is unique, they all feature either a full or partial compromise of some or all creditors’ rights. The form of compromise might be a write-down of balances, a deferral of repayment, or repayment being made contingent on future profits.

It is not necessary for a proposal to treat all creditors equally. The proposal might, for example, provide for preferential creditors being paid in full by instalments, and for unsecured trade creditors to be written down.

There is no procedure in Section 201 for disclaiming onerous contracts. Notwithstanding this, companies might anticipate greater success in renegotiating onerous contracts (eg leases) in the context of a Section 201 proposal. The mere fact of the Section 201 procedure being initiated should prompt counterparties (eg landlords) to consider whether the proposed compromise offers a better outcome than winding-up, and to act accordingly.

Procedure to be followed

The steps involved in proposing a compromise pursuant to Section 201 are as follows.

  1. Prepare the compromise proposal;
  2. Identify the classes of creditors affected;
  3. Apply to the High Court for an order summoning meetings of creditors;
  4. Give creditors notice of the meetings by post, and by advertisement if required by Court;
  5. Hold meetings of each class of creditors;
  6. Apply to the Court to sanction the proposal if approved by the creditors.

Information to be supplied to creditors
The company must send notice of the meetings to each creditor. The notice must explain the effect of the proposal, and describe the directors’ interests in the company and how they will be affected by the proposal.

In many cases the compromise proposed will include an element of deferred repayment, or future repayment contingent on future profits. In these cases it would be wise to give creditors comfort regarding the company’s future repayment capacity. This comfort should be provided by including some or all of the information described below.

  • A statement of affairs showing the company’s assets at book and realisable value;
  • A description of the measures that have, or will be, implemented to return the company to profitability and solvency;
  • An indication of the company’s working capital requirements and how they will be met if the proposal is approved;
  • Recent management accounts for the company, distinguishing between activities that are proposed to be continued and discontinued after the restructuring;
  • A forecast of the company’s future cashflows and results;
  • A description of any measures to ringfence future profits for repayment of pre-compromise debts.

Identifying classes of creditors
The company must identify the relevant classes of creditors, and hold separate meetings of each. Each class of creditors must be confined to creditors whose rights are not so dissimilar as to make it impossible for them to consult with a view to their common interest. The Court will decline to sanction a compromise if it is not satisfied that the classes of creditors were properly identified.

The obvious classes of creditors might include secured creditors, preferential creditors, and unsecured creditors.

It might be appropriate to add a class of unsecured creditors who are also shareholders. These creditors are distinguished from other unsecured creditors by having an interest in the company’s survival so as to realise future value from their shareholding.

Reasons why creditors approve proposals
Informal restructuring proposals are often rebuffed by creditors and landlords because they suspect they are being misled about a company’s circumstances, or that other creditors are being treated more favourably. These suspicions are less likely to arise when the proposal is presented at a meeting summoned by the Court, and where the terms being offered to each class of creditors is fully disclosed.

Creditors are unlikely to support a proposal to compromise their rights unless it results in a better outcome than a winding-up. The information provided to creditors should therefore include an estimate of the amounts likely to be available for each class of creditors on a winding-up, and a comparison with the amount forecast to be available if the proposal is approved.

In this regard it should be borne in mind that significant costs including liquidators fees and redundancy payments arise in a winding-up, but are avoided if the proposal is approved. Both liquidators fees and redundancy amounts will rank ahead of unsecured creditors in a winding-up, and usually result in funds not being available for unsecured creditors.

It should also be borne in mind that a greater contribution towards creditor balances might arise from working a company’s assets than would arise on a liquidation sale.

Many compromise proposals involve directors / shareholders contributing funds to facilitate a partial reduction of creditor balances. In circumstances where this is proposed it should be made clear to creditors that these funds will only be available of the proposal is approved, and not if the company is wound-up.

 

If the company will not survive unless the proposal is approved then an EGM to wind-up, and a creditors meeting, should be called for immediately after the meetings of creditors. The fact of the company’s imminent winding-up will impress the need for compromise on creditors and other counterparties.

 

Special position of the Revenue Commissioners
The Revenue Commissioners adopt a position that they cannot vote in favour of a proposal that involves a tax liability being written-down.

Any VAT, PAYE or RCT debts outstanding for less than one year will rank as a preferential debt, as will assessed taxes for one year to be nominated by the Revenue Commissioners. Revenue will be included amongst a class of preferential creditors in respect of these debts. In most cases the preferential debt due to Revenue will exceed 25% of the company’s preferential debts. It is therefore unlikely that a write-down of any preferential liabilities will be possible. It should be noted that Revenue have a practice of agreeing instalment plans, and a credible proposal providing for preferential debts being repaid over a term is likely to be approved.

A company may have tax liabilities that do not rank for priority in repayment. This would occur if a company had long outstanding arrears, or had agreed an instalment arrangement with a term longer than twelve months. Revenue might be included amongst a class of unsecured creditors in respect of liabilities not ranking as a priority. If the requisite majority of the creditors present and voting at a meeting of that class approve then the amount due to them may be written-down.

If tax liabilities represent more than 25% of the amounts due to unsecured creditors then these amounts can only be written-down if Revenue abstain from voting at the meeting of that class. In circumstances where by so abstaining a greater recovery will arise to Revenue then it would be in their interest to do so.

Consequences of a proposal being rejected
A company’s position is not altered if the creditors do not approve a compromise proposal. That is to say that a company will not automatically proceed into winding-up if a proposal is not approved.

Conclusion
Readers may be surprised that the provisions of Section 201 are not more frequently employed. This may be because directors of SME’s are often more reluctant to propose a restructuring proposal, than creditors are to approve one.

In most cases this reluctance stems from directors identifying too closely with their companies, and being prevented by pride from admitting to their difficulties. Their reluctance often prevents them from seeking help until recovery is no longer possible

It seems incumbent upon Chartered Accountants to volunteer advice on restructuring to the directors of troubled companies. This advice should be given at the earliest opportunity to maximise the company’s prospects for survival.

This article by Declan de Lacy, a director in our Advisory & Insolvency Department, was originally published in the October 2012 edition of Accountancy Ireland the journal of the Institute of Chartered Accountants in Ireland.