Reorganization protects entrepreneurs prior to the company turns out to be in utter distress

By: Dr.Mohamed Ibrahim M.Adam.
Dr.Adam & Associates.

May, 2015

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It may be said that successful entrepreneurs have superior opinions of their capabilities to manage dealings. They normally assign constructive results to their aptitude of decision making. Audacity may be the underlying raison d’être that directors slacken in placing a troubled company in bankruptcy even in situations where it is evident that a company’s current liabilities exceeded the fair market value of its current assets. If the rescue attempt is made for a public corporation, the result would definitely affect wide latitude of interests. This is because a public corporation is not only a fortune of privately owned rights, but represents interests of a group of people. This may be verified by considering the interests of employees, creditors, suppliers, shareholders, and the local community in which the firm operates. It is submitted that the shareholders’ interest remain the primary goal of directors. Directors’ are only bound to take reasonable care to ensure the interests of shareholders. They are not legally obliged to serve the interests of non-shareholders. However, it would a helpful attempt if directors initiated a scheme of arrangement before actual insolvency. Directors, accountants and legal advisors may be involved at an early stage instead of concealing or misrepresenting the company’s true statement of insolvency. The act of concealing a company’s low financial standing may extend the life of an insolvent company but would not ultimately avoid its death.

Financial restructuring in a scheme of arrangement is envisaged to address a distribution of economic interests in the company’s assets between creditors and shareholders. The practical question is this: how could a restructuring scheme provide the requisite rescue as would restore the financial position of the company in distress? This requires a constructive business plan which may not be appropriately structured without the debtor’s involvement. One of the main factors behind a company’s fall into financial distress may be attributed to a host of factors, however primary causes may be attributed to incompetent management, shortage of capital structure and corporate governance. In most of the cases corporate governance comes at the forefront which invariably leads to corporate failure. On the other hand, an efficient well conversant board of directors having industry expertise and financial literacy is prone to prevent a company’s fall into liquidation. On account of the above, in some developing and least developed countries craving to attract foreign direct investment, the legal framework in connection with bankruptcy law, requires to be reformed as would ensure a successful emergence from a restructuring process.

Perhaps it is important to indicate that a restructuring process demands the ability to maintain sufficient liquidity during the restructuring process, unadulterated cooperation of major creditors of the company in distress, representing three-fourths in value, the availability of qualified personnel, supporting broad-spectrum economic and business conditions, corporate governance, quality of enforcement procedure and institutional capacity. These may be the underlying reasons why in some jurisdictions companies opt for a restructuring process while in others straight liquidation is always preferable

In addition to that one may reiterate the following points in favor of restructuring reasons. First, the rationale underlying restructuring of a company in distress arises in situations where the assets employed for the business appear to be more valuable than a piecemeal sale; however the return on the assets employed is inadequate to repay the debts of major creditors. It is evident that in such a situation the main problem is a cash flow problem which requires the major creditors to wait for payment of the debt if not prepared to afford fresh infusion of cash. Second, restructuring would be positive if it does appear from the facts that the company in distress would likely be returned to a viable state of affairs. Under the circumstance it would be more efficient to restructure or reorganize whatsoever the terminology employed rather than to liquidate on the ground that restructuring is apt to preserve the assets and the available human force. The whole process entails a fine-tuning exercise between the company in distress and the creditors as would increase the likelihood of a successful restructuring, even though the company in distress would not remain in possession and operate its business during the restructuring process. The restructuring process requires the court to appoint a liquidator as a trustee in the scheme of arrangement proposal. The liquidator would probably advance the interest of the major creditors, in addition to helping the company in distress to organize its financial affairs. The liquidator may utilize the services of accountants, lawyers and financial advisors if he deems fit. In the event the restructuring fails, the liquidator would eventually turn into a receiver for the creditors. Third, cost of liquidation may erode a substantial portion of the assets. Fourth, the going concern of the company in distress appears significantly better than its liquidating value. Fifth, the company in distress could maintain its present customers. Sixth, at the end of the day, it is more in the interest of the company in distress, if the major creditors, agreed to accept a plan for restructuring or rehabilitation or reorganization on the ground that the funds envisaged to be recouped will be much larger than could be obtained if a liquidation procedure is adopted. Seventh, liquidation entails losses. Assets sold by auction would not maintain their obtainable value. Needless to say, considerable related costs such administrative, accounting and legal would be incurred.

In most contemporary legal systems of the world a company can be wound either by the court which is called compulsory winding up or by members or creditors of the company which is called voluntary winding up. In addition to the available winding up modes under the law, a holder of a charge or a debenture created under the law may avail himself of the ordinary remedies available to a creditor by applying to the court for the appointment of a receiver. The powers of the receiver are subject to the rights of every person who has a charge ranking prior or pari passu with the floating charge. Accordingly, a creditor whose debt is in default might present a petition to the court to get a court order to foreclose property as would satisfy the claimed debt.

In all winding up forms including receivership, failure to pay the debt may place the company into liquidation unless a restructuring proposal is planned. Perhaps it is of paramount importance to note that, in some developing and lease developed countries, the debtor could not file a petition for protection, to the effect that the filing would automatically stop all creditors from taking action to attach property until after bankruptcy court hearing determine the best course of action. Concomitant to this, in some jurisdictions, the court has no discretion as regards creditors’ decision to liquidate. In other words, in these jurisdictions the law does not provide for an automatic stay of proceedings on a debtor’s petition. An automatic stay takes place when the court takes an order for winding up the company.

The procedure in connection with restructuring and rehabilitation is something different from the procedure of straight liquidation. The legal mechanism of Composition and scheme of arrangement is a workout option for emergency from bankruptcy. Such an arrangement requires an agreement between a company about to be or in the course of being wound up voluntarily and its creditors. Such an arrangement is binding on both the company and its creditors. However, the arrangement must be sanctioned by an extraordinary resolution of the company and in most jurisdictions the creditors must accede to the arrangement by three-fourths in value of the creditors. Again, in the event of a company is being wound up by the court, the liquidator may with the sanction of an extraordinary resolution of the company, approval of three-fourths in value of the creditors and the sanction of the court make any compromise or arrangement with the creditors.

A restructuring process signifies an informal debt restructuring agreement between the creditors and the company in distress. It involves two major issues. First, an extension of time, that is to say postponement of agreed payment dates and composition which means a reduced cash settlement. It may be said that restructuring is not determined by the court with the object of rescuing a company in distress to the effect of changing its capital structure and management. However, as a matter of fact restructuring in most jurisdictions is prearrangement between the company and its creditors. It would definitely work if the company is not in low financial waters. It would operate as a remedy to address a temporary liquidity problem. Again, it is highly prone to succeed when there are few creditors. It may be in order to indicate that, in most jurisdictions, a creditor without his consent can not be forced to accept equity in a company encountering financial problems or to be required to accept less debt than actually owed to that creditor. The decision of major creditors is crucial for a successful restructuring. On account of this, secured creditors will probably prefer liquidation and may resist a restructuring proposal, particularly if the restructuring proposal is not feasible or realistic. On the other hand, unsecured creditors would probably get nothing or a nominal fraction of their claims. Given the fact that in a restructuring proposal, management would not remain in control, the ultimate decision resides with the liquidator who eventually decides whether the company will continue or be dissolved. It is germane to this point to say that a restructuring proposal is likely to serve creditors’ interests.

Perhaps it is important to indicate that a restructuring process demands the ability to maintain sufficient liquidity during the restructuring process, unadulterated cooperation of major creditors of the company in distress, representing three-fourths in value, the availability of qualified personnel, supporting broad-spectrum economic and business conditions, corporate governance, quality of enforcement procedure and institutional capacity. These may be the underlying reasons why in some jurisdictions companies opt for a restructuring process while in others straight liquidation is always preferable. Managers may be biased towards restructuring; however creditors are biased towards liquidation. Creditors would rather prefer to seize assets and sell them if existing management is inefficient. In such an instance, the creditors would probably decide that the company would pay more without being restructured. Consequently, a company in distress would be liquidated and its property be sold and distributed according to the priority prescribed under the law. Liquidation process involves auction under court supervision. Needless to say, judicial discretion is of prime importance in identifying viable from non-viable firms. In cases where judges’ insightfulness is lacking creditors prefer liquidation. On the other hand, where judges insightfulness increases, good organization of contracts would be improved to the effect of preferring restructuring. In the end, the whole issue requires well structured bankruptcy laws as would provide sufficient creditors’ protection.

In most cases, distress appears to be a temporary cash flow problem rather than deterioration in the value of a company’s assets. An experienced attorney may opt for restructuring or reorganization of a company in distress if the procedure available under the jurisdiction would warrant an automatic stay of proceedings if a mere petition to the court is presented. Again, one may reiterate the following points. First, the rationale underlying restructuring of a company in distress is that assets employed for the business appear to be more valuable than a piecemeal sale; however the return on the assets employed is inadequate to repay the debts of the major creditors. The main problem is a cash flow problem which requires the major creditors to wait for payment of the debt if not prepared to afford fresh infusion of cash. Second, it does not appear from the facts that the company in distress would not be returned to a viable state of affairs. Under the circumstance it would be more efficient to restructure or reorganize whatsoever the terminology employed rather than to liquidate on the ground that restructuring is apt to preserve the assets and the available human force. The whole process entails a fine-tuning exercise between the company in distress and major creditors as would increase the likelihood of a successful restructuring, even though the company in distress would not remain in possession and operate its business during the restructuring process. The restructuring process requires the court to appoint a liquidator as a trustee in the scheme of arrangement proposal. The liquidator would probably advance the interest of major creditors, in addition to helping the company in distress to organize its financial affairs. The liquidator may utilize the services of accountants, lawyers and financial advisors if he deems fit. In the event the restructuring fails, the liquidator would eventually turn into a receiver for the Bizbank and other creditors. Third, cost of liquidation may erode a substantial portion of the assets. Fourth, the going concern of Mirage appears significantly better than its liquidating value. Fifth, Mirage could maintain its present customers. Sixth, at the end of the day, it is more in the interest of Bizbank, as the major creditor, to accept a plan for restructuring or rehabilitation or reorganization because the funds envisaged to be recouped will be much larger than could be obtained if a liquidation procedure is adopted. Seventh, liquidation entails losses. Assets sold by auction would not maintain their obtainable value. Considerable related costs such administrative, accounting and legal would be incurred.

One of the major drawbacks of the present restructuring procedure, under Sudanese law, is the absence of the debtor’s involvement during the restructuring procedure. The liquidator has full control. Financial restructuring in a scheme of arrangement is envisaged to address a distribution of economic interests in the company’s assets between creditors and shareholders. The practical question is this: how could a restructuring scheme provide the requisite rescue as would restore the financial position of the company in distress? This requires a constructive business plan which may not be appropriately structured without the debtor’s involvement. One of the main factors behind a company’s fall into financial distress may be attributed to a host of factors, however primary causes may be attributed to incompetent management, shortage of capital structure and corporate governance. In most of the cases corporate governance comes at the forefront which invariably leads to corporate failure. On the other hand, an efficient well conversant board of directors having industry expertise and financial literacy is prone to prevent a company’s fall into liquidation. On account of the above, the Sudanese present legal framework, in connection with bankruptcy law requires to be reformed as would ensure a successful emergence from a restructuring process. At present there is an attempt underway to reform the Sudanese present Companies Act.

 

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