COVID-19 Restructuring your business – what you need to know
This article was first published in The Edge Markets on 16 April 2020 –
Covid-19 has created unprecedented business liquidity issues. For businesses, foremost among them is its business viability in the long term. In the short term, it is managing the cash flow crisis for some enterprises. Some companies will be compelled into re-organising themselves and may have to undergo a restructuring.
This article considers what businesses should know if they intend to restructure, assuming that they have a “business case” for restructuring.
B. Types of Restructuring
Restructuring can take the form of operational restructuring or debt restructuring. There are also other forms of restructuring, but those forms are not within the scope of this article. This article focuses on debt restructuring, that is when there is an inability to pay its debts as and when they fall due.
C. Do you have a business case for restructuring?
What does “a business case” mean? A short response to that would be that the business is still viable – that is the business has the prospect of operating as a going concern after restructuring.
In a debt restructuring, a restructuring specialist will typically look at what is called the EBITDA (earnings before interest, tax, depreciation and amortisation). In short, it entails looking at whether the business generates a positive cash flow, assuming that it does not carry any debt or borrowings in its books. EBITDA may not equate to the net cash received from the business operations available for debt servicing, as some of the cash received may have been used to build up assets such as inventories or receivables.
The fact that a company is EBITDA positive does not in itself mean that the company is viable. It can carry too much debt or borrowings, such that the positive cash flow from the business operation is not sufficient to pay its debts. Hence, without restructuring its debts, the company will suffer from cash flow insolvency and will not be a viable going concern.
Furthermore, a company may owe a substantial sum of money to its trade creditors. While a trade creditor may allow a credit period to pay, it will over time suspend or cease to trade with the company if the old debts have not been paid. This too will impact on business viability.
A key step in debt restructuring is therefore establishing how much a company can afford to pay its creditors. A restructuring specialist, after establishing the level of EBITDA (for current and future years), would then make adjustments of the following items to arrive at CFADS (cash flow available for debt servicing):
- Add cash from asset sales (if any)
- Less overdue liabilities (for example, stressed creditors or overdue taxes)
- Less non-discretionary capital expenditure (for example, upgrading of its plant and machinery)
- Add new money from the shareholders or borrowings
Not only must a restructuring specialist work out the financials for EBITDA and CFADS for prospective years, he must also work out the timing of incoming and outgoing cash flow. He must develop a set of realistic or robust cash flow projections, taking into account the timing of cash inflows and outflows. With the robust cash flow projections, the restructuring specialist would be ready to formulate a restructuring proposal to be considered by the lenders and creditors.
The process of arriving at a restructuring proposal often involves multiple discussions with creditors and stakeholders. There is sometimes a white-knight involved, who will typically have conditions that must be fulfilled before he puts in the money. The discussions with the stakeholders can be bi-lateral or multi-lateral. These discussions are often protracted as each stakeholder would be pushing to protect its own interest. As an example, a fully secured creditor may not want a restructuring as he would rather force-sell the collateral for an early recovery. On the other hand, other creditors or shareholders may want to keep the business alive, so that they can get a better recovery compared to a liquidation scenario. Managing stakeholders is one of the key challenges in restructuring.
D. Sources of money for restructuring
In short, debts can be paid by (a) income from the business operations (b) funds from the balance sheet – there could be surplus assets available for sale, for example, land, investment in a subsidiary or inventories or (c) new money. New money can be from new borrowings, whether it is from lenders or white knights or new capital from the shareholders.
E. Options for restructuring available under the Companies Act 2016
As Restructuring can be done via (a) a Scheme of Arrangement, (b) Company Voluntary Arrangement or (c) Judicial Management. All the options aim to achieve the same result, that is, to provide a framework for a company to carry out restructuring.
The provisions for the three different modes of restructuring under the Companies Act 2016 are as follows:
- Arrangements and Reconstructions, Division 7, Subdivision 2;
- Corporate Voluntary Arrangement, Division 8, Subdivision 1; and
- Judicial Management, Division 8, Subdivision 2.
F. Scheme of Arrangement
While this mode can also be used for solvent companies, the focus of this article is on insolvent companies.
When the company is not able to pay its debts, the company can resort to this mode of restructuring. The management of the company continues to rest with the board of directors. The board of directors has to call for a meeting of creditors, convened pursuant to a court order, to propose and agree on the restructuring scheme. It requires a vote of 75% of the creditors (or class of creditors) in value present and voting to agree to the scheme.
When applying to the court to convene a creditors’ meeting, the company often resorts to applying for an order restraining further proceedings in any action or proceeding for a period of 3 months provided there is no winding up order or resolution to wind up the company. This period of 3 months can be extended for up to 9 months. This provision does not apply to actions or proceedings by the Registrar of Companies or the Securities Commission. In order for the court to grant the restraining order, the applicant (the company) must meet stringent criteria. If the company is not able to meet these criteria, the meeting of creditors may still proceed but without the restraining order (Section 368 of the Companies Act 2016).
If the creditors vote in favour of the proposed scheme with the required 75% majority in value of creditors or class of creditors, it binds all creditors or class of creditors as applicable.
G. Corporate Voluntary Arrangement
This mode of restructuring is similar to a Scheme of Arrangement in that the management of the company continues to be in the hands of the board of directors. The key difference is that the restructuring scheme may be proposed and accepted by the creditors without the need to apply to the court to convene a creditors’ meeting. A Corporate Voluntary Arrangement is not applicable where a company has a secured creditor(s) or in other cases set out in section 395 of the Companies Act 2016.
The process requires the company to appoint an insolvency practitioner (referred to as ‘nominee’ in the Companies Act 2016) to provide an opinion, amongst others, as to whether the proposed scheme is viable and whether it is likely to be accepted by the creditors. If the nominee is of the view that the scheme should be tabled for consideration by the creditors, the nominee would provide a written opinion on it and file, amongst others, the documents setting out the terms of the proposed voluntary arrangement, a statement of assets and liabilities and a statement that the company is eligible for a moratorium. While the papers relating to the voluntary arrangement are filed in court, the court acts as a “depository” of documents, there is no court hearing before the voluntary arrangement can take effect.
Upon filing the requisite papers in court, an automatic moratorium of 28 days sets in. A meeting of creditors shall be called within this moratorium period to consider whether to accept or reject the proposal by the company. If the proposal is voted in favour by 75% in value of the creditors present or voting by proxy, it binds all parties (unsecured creditors).
H. Judicial Management
This mode of restructuring involves the court process and an insolvency practitioner taking control of the management of the company. While the insolvency practitioner manages the affairs of the company, his duties include preparing the restructuring proposal for consideration by creditors, both secured and unsecured. This mode of restructuring is not available for certain types of companies as listed in section 403 of the Companies Act 2016.
While a creditor may apply to place the company in judicial management, it is usually the company which applies to the court to place the company in judicial management. The typical reason is the inability to pay debts. The company would resort to the moratorium provided under judicial management for a period of time, while the judicial manager works out a restructuring scheme.
Upon application to the court to place a company in judicial management, a moratorium sets in immediately. This means that all legal proceedings against the company cannot continue. If the court decides to appoint a judicial manager, the company enjoys a 6-month moratorium from the date of the appointment. This can be extended for another 6-month period. During this period, it gives the company ’breathing space’ to manage its affairs and restructure its debts while litigation is kept in abeyance. While it may be possible for a creditor to continue with its legal action against the company, leave of court must first be obtained.
An application for the appointment of a judicial manager will be dismissed if a secured creditor objects to it.
If the proposal is accepted by 75% of the majority of creditors in value whose claims have been accepted by the judicial manager, it binds all parties. Where the purpose of the judicial management order has been achieved or it cannot be achieved, the judicial manager will apply to the court to be discharged.
I. Concluding remarks
Whilst these three modes of restructuring a company are available, there are restrictions on the application of these modes which are not particularly “restructuring friendly”. There have been continuing discussions to make changes to these restrictions. However, it is not within the scope of this article to discuss them.
If you have a ‘business case’ and are facing a liquidity crisis, especially in these uncertain times, you should seek early help from restructuring specialists to protect and preserve the business value. The restructuring specialist will work through the business and legal issues with relevant professionals.
The appointment of an independent third party is likely to have a great impact on the success of the restructuring. Trust is often an issue. The stakeholders or creditors expect an independent third party to “endorse” the cash flow projections and the reasonableness of the scheme. There are also nuances to the restructuring process and technicalities of legal provisions that only a restructuring specialist would be familiar with.
This material is for general information only and is not intended to provide legal advice. If you have any queries regarding the above, please feel free to contact us at firstname.lastname@example.org.