Options to address creditors during corporate rescue
Introduction
Corporate rescue is also known by other terms such as business rescue or judicial management. According to Section 121 of the Insolvency Act (Chapter 6:07), hereinafter (the Act) of 2018 corporate rescue means the proceedings to facilitate the rehabilitation of a company that is financially distressed.
It involves providing for:
Temporary supervision of the company and of the management of its affairs, business and property, and Temporary moratorium (relief) on the rights of claimants against the company or in respect of property in its possession, and The development and presentation, if approved, of a plan to rescue the company by restructuring its affairs, business, property, debt and other liabilities and equity.
According to section 124(1) unless a company has adopted a resolution contemplated in section 122 an affected person may apply to a court at any time for an order placing the company under supervision and commencing corporate rescue proceedings.
A creditor is included in the definition of an affected person.
In terms of section 124(4) a court may make an order placing the company under supervision and corporate proceedings if it is satisfied that the company is financially distressed. During corporate rescue a practitioner’s principal responsibility is around two areas, namely:
Paying off creditors
To improve the company’s operations including its financial situation.
Addressing creditors or debt
In this article I will share with you some of the options available to deal with creditors or debt during corporate rescue.
Staggered or phased payments to creditors
A corporate rescue practitioner (CRP or practitioner) may agree with a company’s creditors to spread the payment of debts using cashflows from the company’s trading operations.
This option works if the company is still trading. At times companies are placed under corporate rescue proceedings when they are no longer operating. In that case the entity will in fact be in need of a financial injection to resume operations.
Disposal of redundant or non-core assets
It happens a lot that a financially distressed company that cannot finance its operations has redundant or non-core assets. These assets are usually in the form of property, plant and equipment. It is worthwhile to consider selling those assets and apply the proceeds towards creditors and financing the business, even in part.
Issue of new shares to existing shareholders
Funding for the business can be raised through an issue of the company’s new shares to its existing shareholders. This can be done in the form of a rights issue whereby existing shareholders subscribe for shares according to their current proportionate or percentage shareholding.
They may also agree otherwise whereby existing shareholders who cannot follow their rights to the new shares lose them.
Issue of new shares for capital injection works to the extent that the existing shareholders are willing and able to inject fresh capital into the business. The option is usually fast and avoids fights by existing shareholders who will be resisting dilution.
Issue of new shares to new shareholders or third parties
It is quiet common to find a practitioner issuing shares to third parties or new shareholders if existing shareholders are unable or unwilling to take up new shares and inject capital into the company.
It is important to comply with the relevant provisions of the Companies and Other Business Entities Act (Chapter 24:31), Insolvency Act and the company’s Articles of Association.
When new shares are issued funds flow or go into the company. Existing shareholders’ current shareholding will be diluted. This option usually attracts resistance or even litigation by existing shareholders and has the unfortunate effect of stalling the turnaround of the distressed company.
Often times, the new shareholders also acquire shares from the existing shareholders.
This will enable the new shareholders to have better control of the company.
Please note that if the new shareholder acquires shares from existing shareholders the funds or proceeds go to the existing shareholders and not the company. In other words funds go to the person selling the shares.
Shareholder loans
Shareholders who are willing and able may inject funding into the company in the form of shareholder loans. In simple terms this can be viewed as debt substitution.
Shareholder loans enable the existing shareholders to fund the company, retain their existing shareholding and the company to pay off its creditors.
The shareholder loans may then be repaid when the company recovers usually through trade.
Compromise with creditors
A company and its creditors may agree on a compromise in terms of section 147 of the Insolvency Act. For example creditors may agree to be paid a portion of their debt in full and final settlement.
Available resources can then be used to pay off the creditors. During inflationary times it may be advisable to consider a compromise if the percentage reduction or compromise will be lower than the anticipated rate of inflation to the point the creditors are paid.
For example it may be worthwhile to accept a 20 percent haircut if projected inflation is say 50 percent between now and when creditors are to be paid if there is no compromise.
Conversion of debt into equity
A CRP may agree with the company’s creditors to convert their debt or balances into equity. In other words the creditors become shareholders in the company.
The creditor can keep the shares for some time and then dispose of them when they are more valuable. The effect of this option is to dilute existing shareholders and eliminate future loan repayments and interest expense.
Some of the shares may be redeemable in that the company may buy them back, subject to legal requirements or a shareholder may simply sell to another person.
Disclaimer
This simplified article is for general information purposes only and does not constitute the writer’s professional advice.
Godknows Hofisi is a legal practitioner, chartered accountant, corporate rescue practitioner, and consultant in deal structuring and tax. He writes in his personal capacity. He can be contacted on +263 772 246 900 or ohofisi@gmail.com -The Herald
