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Businesses that could be rescued are failing

In the current issue of Business Plus magazine Declan de Lacy argues that many companies going into liquidation could have been rescued, and offers advice on how to restructure. The full text of the article is below.

The owners of many troubled small businesses find they spend as much energy juggling cash to meet essential bills as they do on actually managing their business. These businesses are often quite insolvent, but manage to survive by delaying some payments, making others by instalments, and simply neglecting to pay the rest. This type of management is unsustainable in the long run and eventually the business runs out of cash and fails outright.

Whilst I paint a bleak picture for small troubled businesses, I must add that it is possible to emerge from this situation by implementing a successful restructuring plan. It is disheartening to note that businesses suitable for restructuring fail every week. The loss involved is felt not only by the owners, but also by suppliers, employees, and the exchequer.

What is meant by restructuring?
The form of restructuring required will depend on the particular problems facing a business. In most cases the restructuring will involve implementing a plan to return to profit, agreeing a compromise settlement of creditor balances, and renegotiating property leases. The compromise with creditors will usually involve balances partially written-off or deferred, and the renegotiation with landlords might involve rents being reset to market rates.

What is crucial is that a restructuring proposal is cast so that after being completed the company can pay its’ debts as they fall due. There is no value in a restructuring proposal if after it is completed the company makes further losses and returns to insolvency.

Why do creditors approve proposals?
Directors considering restructuring their company should be mindful that any compromise needs to be approved by the parties whose rights are proposed to be affected.

Most creditors have become accustomed to losing the full amount due to them when debtors go into liquidation. This experience means that creditors are often favourably disposed toward proposals that allow them to recover a part of their debt and keep a customer or tenant.

Notwithstanding their favourable disposition, creditors are unlikely to support a proposal unless they are satisfied that it will result in a better outcome than if the proposal is not approved. Companies proposing a compromise should therefore advise creditors that the company will be wound-up if the proposed compromise is not approved.

A comparison of the outcomes for creditors if the proposed compromise is approved, and on a winding-up, should be set out for creditors so that they can appreciate why the former might be in their interests. I set out below a number of reasons why this would be the case.

  • A proposal might involve directors / banks advancing money to partially pay balances due to creditors. These funds would not be available if the company was liquidated.
  • A proposal might involve an element of deferred repayment from future profits. If the company is liquidated there will be no future profits from which to make deferred repayments.
  • If the company is liquidated then liquidator’s fees, redundancy payments, and certain taxes will all rank ahead of unsecured creditors for payment. This will usually result in no funds being available for unsecured creditors.

Whilst putting a proposal to creditors it would be useful for a company to document (i) the terms proposed, (ii) the amounts each creditor will receive if the proposal is approved and if the company is wound-up, and (iii) the reasons why creditors will receive a better return from the proposal than from winding-up.

Funding a compromise proposal
Compromise proposals often involve balances due to creditors being partly written-off. Creditors agree to the write-off on the basis that the remaining balance will be settled immediately. A scheme is unlikely to be successful unless the company can arrange for a settlement payment to be made.

It is rare for a company being restructured to have sufficient funds to make the settlement payment, which must made from other sources.

Settlement payments are most frequently funded by an injection of capital made by a director or shareholder. A less frequent source, but one more frequently seen in recent times, is a bank with a vested interest in a company’s survival. This typically occurs where the bank has lent funds to finance a property, and the property value will be damaged if the trade ceases.

In cases where a company has a significant book of debtors it may be possible to factor or discount these, and to use the proceeds to make a settlement payment.

Legal form of compromises with creditors
A restructuring transaction can take many forms which range from the very informal through to examinership supervised by the High Court.

In the least complicated circumstances it may be possible for a company to reach a compromise with all of its’ creditors with a minimum of formality. In these cases the compromise might be recorded in a series of simple agreements between the company and its’ creditors. The problem with this approach is that reluctant creditors cannot be compelled to participate on the same terms as more willing creditors, or indeed at all. A minority of creditors can therefore obtain an advantage over other creditors for themselves, or even derail the whole process.

Where a minority of creditors refuse to agree to a proposal it can be made binding on them by relying on the provisions of Section 279 of the Companies Act 1963. This section provides that where three quarters of a company’s creditors are in agreement, a proposal can be made binding on all of the creditors. This section can be relied on without obtaining Court approval. An aggrieved creditor does however have the option to request the court to cancel, amend or vary the proposed agreement. This provision only becomes operable if the agreement is made when a company is “about to be wound-up”, albeit it is not necessary that the company actually be wound-up. Directors considering making a proposal to their creditors should take professional advice to ensure that their company falls within the meaning “about to be wound-up” when the agreement is made.

Companies that have difficulty engaging with their creditors, or that have substantial Revenue or secured debt, are unlikely to obtain the approval of 75% by value of their creditors. In these cases it might be appropriate to avail of the provisions of Section 201 Companies Act 1963. This section provides that a company may request the court to summon meetings of each class of creditor to be affected by a proposal. The proposal can be made binding on the creditors if it is approved by a simple majority in number, and 75% by value, of the creditors in attendance at each meeting.

It should be noted that neither the mechanism in Section 279 nor in Section 201 of the Companies Act 1963 can be used to bind a landlord to a reduced rent. That having been said, when faced with the alternatives of losing a tenant in a winding-up, or keeping a sitting tenant at market rent, most landlords will opt for the latter.

Company directors often fail to recognise and address the signs of insolvency before it is too late to take remedial action. A simple test that directors might consider is whether their company has arrears of taxes, rent or wages. If a company does have such arrears, or if it is reliant on funds being provided by directors to pay these costs, then it is likely to be insolvent. The earlier this problem is recognised and a plan to overcome it implemented, the greater the chances that the company will survive.