The A- Z Guide of Rescue, Restructuring & Insolvency

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1 The A- Z Guide of Rescue, Restructuring & Insolvency

2 Guide to Rescues, Restructuring and Insolvencies INDEX Introduction: TMP meet the team The following Chapters are included in this guide. Please click on the Chapter heading that is most relevant to your situation. Chapter 1. Chapter 2. Chapter 3. Chapter 4. Chapter 5. Chapter 6. I am a Director of a company that is in financial difficulties I am an Individual in personal financial difficulties I am a Partner in a Partnership in financial difficulties I am a Creditor who is owed money I am a Professional Advisor advising generally on insolvency How to contact TMP

3 The following Appendices should be read in conjunction with this guide and are referred to in the relevant chapters. Appendix 1. Appendix 2. Appendix 3. Appendix 4. Appendix 5. Appendix 6. Appendix 7. Restriction on the Re- Use of Company name in liquidation Disclaiming a lease Illustration of IVA procedure The Domino Effect of Partnership Landlords Creditors with Retention of Title Claims Creditors with Liens Disclaimer and release date information

4 TMP TMP specialises in corporate rescue, restructuring and refinance. TMP is the only leading firm of insolvency practitioners that focuses first on avoiding formal insolvency, thereby maximising returns to creditors. Meet the team: Please visit our website for the CVs of our team Doug MacDonald Director Neil Chesterton Director Libby Aird- Brown Insolvency Practitioner BACK

5 Chapter 1 Company Directors: Page 1 of 61 I am a Director of a company that is in financial difficulties The following topics are discussed in this chapter: Company Directors' Decision- Making Strategy Establish if the Company is Insolvent Objectives in Corporate Insolvency Options Available to Insolvent Companies Choosing which Option is Appropriate BACK

6 Chapter 1 Company Directors: Page 2 of 61 Warning!! Important notice Explanation This guide is a tool to allow you as a director of an insolvent or potentially insolvent company to decide what is the best option you can take so as to maximise both the interests of your creditors and the interests of you and your family. It should help you decide what route to take but it is merely an on screen guideline so as a result it is inherently limited. If, after going through the guide, you need to take further action, you should seek professional advice. The guide will have increased your awareness and allowed you to ask the correct questions. Professional Advice When taking professional advice because corporate recovery and insolvency is very specialised you should ensure that you take advice from either: a. An insolvency practitioner or b. A professional advisor who specialises in corporate recovery and insolvency. OK I have understood this let s go to the next page.

7 Chapter 1 Company Directors: Page 3 of 61 Company Directors' Decision- Making Strategy Explanation You are a director of a company which is in financial difficulty. It is very likely that this is the first time that you have been in this situation. It is undoubtedly a stressful time for you and you will be experiencing a significant number of unwelcome pressures. To make matters worse, you need to think very carefully and clearly as the legislation affecting insolvent (and potentially insolvent) companies is vast and extremely complex. As a result, insolvency and corporate recovery is a very specialist area. This guide attempts to simplify and de- mystify it. However, it is vital that you have a clear decision making strategy - so that you find the correct and appropriate solution. Decision making strategy You need to consider the key areas detailed below. If you need further information as to why this is important click onto the "More" box, which will give you more information. 1. Establish if the company is insolvent. It is important to establish if the company is insolvent as it affects: a. The options available. b. The required conduct of the directors.

8 Chapter 1 Company Directors: Page 4 of If the company is insolvent - what should your objectives be? It is important to lay down specific objectives to ensure that the correct option is taken. Therefore, during the planning process, you need to ask - what should you (as a director) be trying to achieve? Later on, suggestions are given as to what your objectives should be. 3. Having established your objectives - what are your options? To find out these options - you need to look at the commercial and legal options available to the company. Each option will have certain advantages and disadvantages. Therefore, it is common in an insolvency crisis for the chosen course of action to be a compromise. Invariably it will be the best option rather than a perfect option. 4. Now you choose the best available options to maximise your objectives. When you have established: 1. That the company is insolvent or likely to become insolvent, 2. Your corporate objectives, 3. The options available to the company, you then choose the option that maximises your (or the company's) objectives - having fully understood the big picture. Once again... remember...it is vital to take professional advice from a specialist in insolvency. Next step How do I establish if the company is insolvent? Let's go to the next page

9 Chapter 1 Company Directors: Page 5 of 61 Establish if the Company is Insolvent How do I know if the company is insolvent? Broadly, a company is insolvent if fails to meet one of the following criteria: 1. Cashflow Test The company is unable to pay its debts as and when they fall due. This means that the company's cash resources are running out. Therefore, the company is not going to be able to pay its creditors on time. The cashflow test is very subjective. Generally, the directors should have a good understanding as to the company's cashflows. Legally, they are required to have such an understanding. If any director is in any doubt as to the cashflows of the business - he should take immediate steps to establish the position. This is discussed in full later on. An example of the cashflow test is illustrated below:

10 Chapter 1 Company Directors: Page 6 of Balance Sheet Test The company's assets are less than its liabilities. The balance sheet test includes contingent and prospective liabilities. This is confusing because if you take this definition in its literal form, there will be few companies - after having taken account of future rents due - that are solvent. However - for simplicity's sake - assume that if the prospective liabilities (say rent) generate positive cashflows (rather than cash outflows) then the prospective liability need not to be taken into consideration. But... if the reverse is true, then you should include the prospective liability. The illustration below demonstrates the "Balance Sheet Test" It should be noted that it is possible for a company to have a strong balance sheet but be unable to fund its cashflows - meaning that it is insolvent.

11 Chapter 1 Company Directors: Page 7 of 61 Additional factors that may be used to prove a company's insolvency In addition, there can be other factors that determine the company's solvency. If either of the two circumstances listed below exists, then this allows a creditor to petition to wind- up the company through the courts: 1. If there is an outstanding statutory demand. Statutory Demand A statutory demand is a legal demand for repayment of a debt - under statute (The Insolvency Act 1986 and The Insolvency Rules 1986). If the outstanding statutory demand is not paid, this is grounds for the issuing creditor to petition to wind up the company. The following must be satisfied: i. The statutory demand must have been outstanding for greater than 21 days, and ii. The debt is for an amount greater than 750. Statutory demands are often a cost effective way of obtaining the grounds to petition for a company's compulsory winding up. 2. If there is an outstanding judgment. Outstanding Judgment If a creditor obtains a legal judgment against a company, this puts the liability beyond dispute. If the judgment debt is not paid then the creditor is entitled to enforce the judgment. One of the methods of enforcement is to petition to wind up the company. Therefore, if a company has an unsatisfied execution on a judgment debt this is deemed to be proof of the company's insolvency and to be grounds for the winding up of the company.

12 Chapter 1 Company Directors: Page 8 of 61 Conclusion You need to decide whether the company is actually insolvent. Remember - if you have any doubts about the solvency of the company - you should take professional advice. Having established the company's solvency - you need to examine what the options available to the company are. Next Step Let's see what those options are on the next page

13 Chapter 1 Company Directors: Page 9 of 61 Directors' Objectives in Corporate Insolvency Explanation As a director of an insolvent company (or potentially insolvent company) you must be very clear in your objectives - so that you choose the correct rescue, restructuring or insolvency option. Every company will have different objectives. However, there are generally common objectives among most companies. The key ones are listed below. Common objectives The implications of the following objectives are discussed in the pages that follow: Maximise the interests of Creditors Keep the business alive Comply with the law Avoid personal liability of the directors Terminate onerous liabilities and contracts Maximise the interest of the employees Minimise personal guarantees

14 Chapter 1 Company Directors: Page 10 of 61 Maximise the interests of Creditors It is of absolute paramount importance that the directors act in such a way so as to maximise the interests of creditors. Failure to do so may result in: a) The directors being made personally liable for the debts of the company. b) The directors being disqualified to act as directors of limited companies. Therefore, if the company is insolvent - or potentially insolvent - the most important objective is to maximise the interests of creditors.

15 Chapter 1 Company Directors: Page 11 of 61 Keep the business alive As a rule of thumb, you should only attempt to keep the business alive if: 1. The problem that caused the insolvency is not likely to recur. 2. You are confident (realistically, rather than optimistically) that the business can generate positive profits and cash flows, post- insolvency - in such a way to ensure that: i. Creditors will not suffer further losses, and ii. The recovered business can provide an adequate return for the shareholders in the business. In other words, there is no point in directors putting another (say) 5 years of their life into a business that can never provide a decent return, and is under constant threat of failure - regardless of how emotionally attached they are to the business. 3. It is possible to save the business, in terms of the insolvency/rescue tools available, and the commercial, financial and legal circumstances permit this to happen. It should be emphasised that a very, very common complaint amongst insolvency practitioners is that directors and their advisors do not contact them early enough. There are many businesses that could be saved if the directors took the correct advice far, far, sooner... So - always take specialist insolvency advice as soon as the problems arise. In this way, the business is far more likely to survive. However, if you do not want to keep the business alive, you should want to minimise the damage, and liquidate the company so as to maximise the interests of creditors. In addition to achieving this it allows the directors and employees to go and do other things with their lives; and importantly be relieved of the stress of a failing business. Therefore, in the appropriate circumstances, there are broadly two ways of keeping the business alive, even if the company is insolvent.

16 Chapter 1 Company Directors: Page 12 of 61 a. Using a corporate recovery technique such as: i. Administrations ii. Company voluntary arrangements iii. Administrative receiverships. (This option is only available where a qualifying floating charge was created prior to 15/09/2003) b. Buying the business - usually in conjunction with a third party from the liquidator, administrator or receiver - however: i. There are important legal requirements for the directors to satisfy before they can do this, and ii. The interests of creditors must be maximised. This is also known as Phoenixism - which is allowable but must comply with the law and "best practice". These issues are very important. The Insolvency Service has recently issued guidelines which an Insolvency Practitioner must comply with when selling a business and assets as part of a pre- packaged Administration, whether to connected parties (e.g. directors) or not. Directors Buying the Business and/or Assets from the Liquidator/Administrator Explanation It is possible for the directors to buy the business and/or assets from the liquidator, administrator or receiver. This is also known as Phoenixism. However it is stressed in the strongest possible terms that any sale to directors should be unimpeachable and that the part played by the insolvency practitioner should have absolutely no suggestion of corruption or favouritism. Pre- pack Administration Under the guidelines issued by the Insolvency Service, the Insolvency Practitioner will disclose the elements of the transaction to creditors at least within 14 days of the appointment as Administrator. The information required to be disclosed includes, inter alia, the identity of the purchaser, whether or not they are connected or have been previously connected to the company, the value of the transaction, the valuations obtained for assets, the level of marketing undertaken, what efforts were made to consult with major creditors and what alternative courses of action were considered.

17 Chapter 1 Company Directors: Page 13 of 61 Ensuring directors and insolvency practitioner are beyond reproach When the directors buy the business and/or assets - the following should apply: 1. The IP should advise the directors as directors of the company rather than as individual buyers. There must be no suggestion that the IP is more interested in the fate of the directors - rather than protecting the general interests of creditors. 2. The IP must ensure there is no conflict of interest. 3. If the directors believe the business is viable then there should be full consideration as to whether a Company Voluntary Arrangement should be proposed. 4. The IP should not advise the directors how to put the bid together. 5. The IP should ensure there is full marketing of the business and assets to attract alternative buyers (if this is appropriate or possible). 6. If the directors restrict the sale to a third party (because they want a cheaper acquisition) then this would amount to a breach of their duty to co- operate. 7. The IP must be prepared to justify the sale if it is ever called into question. 8. A liquidator is required by law to disclose any sale to a connected party (i.e. directors) to the liquidation committee. However, it is best practice that IPs disclose ALL such sales to all known creditors - stating the reasons and advantages to the creditors. It is important to note that there are tough restrictions on directors re- using the business' name if the company has gone into insolvent liquidation. However - there are certain exemptions. This is a complex and very important issue. Please refer to Appendix 1 which discusses the restrictions relating to directors re- using the business name in an insolvent liquidation.

18 Chapter 1 Company Directors: Page 14 of 61 Comply with the Law It is very important that the directors comply with both the company and insolvency legislation. This requires specialist advice in order to ensure compliance. Failure to do so may result in: a) The directors being made personally liable for the debts of the company. b) The directors being disqualified from acting as directors of limited companies. Avoid the personal liability of the directors By conducting yourself correctly as a director you can avoid personal liability. It is only when directors act in a way that does not comply their obligations under the companies legislation and with the principles of reasonable business conduct or in a way that prejudices the interests of creditors that the directors can be held to be personally liable. The types of problem areas are discussed later on. The Insolvency Act 1986 has a vast array of armoury to attack misconduct. It is often useful to apply simple concepts of reasonableness. Therefore, a director (who is not a specialist in insolvency) should ask if his conduct or the company's transactions are fair and reasonable and do not prejudice the interests of creditors. Broadly speaking, if they do, the conduct or the transactions can generally be attacked.

19 Chapter 1 Company Directors: Page 15 of 61 Therefore, it is strongly recommended that you: a. Act quickly if there is the possibility of a problem b. Take immediate advice from a specialist in insolvency c. Do nothing that prejudices the interests of creditors - and take advice if you have any concerns. Terminate onerous liabilities and contracts One of the common problems facing businesses is that at some stage the business has entered into an onerous contract, which adds considerable cashflow burdens to the company - without the corresponding benefits. Often, these onerous liabilities and contracts can make a solvent company very insolvent. It is possible to use insolvency techniques to terminate onerous contracts or liabilities. A common example of an onerous contract is leasehold rent. In liquidations (only) - a liquidator can disclaim the lease, so that all rights (of occupation) and liabilities are disclaimed. Please refer to Appendix 2 for an explanation of Lease Disclaimers in Liquidations and Bankruptcies. Landlord rights are also discussed. Maximise the interests of Employees Employees are (usually) creditors of the business as a result of their contracts of employment. Therefore, directors are also (usually) creditors of the company. Therefore, it is essential that the directors act in such a way as to maximise the interests of the employees - as creditors. More information on how the employees' interests can be maximised as follows: General Approach The employees' interests (as creditors) can be maximised, by one of, or a combination, of the following:

20 Chapter 1 Company Directors: Page 16 of Minimising the actual loss to employees - by ensuring that the business does not trade without prospect of paying the employees. 2. Arranging for a purchase of the business (in or out of an insolvency procedure) in which the employment contracts are transferred to new purchaser. This means that all liabilities on employment contracts (such as arrears of pay, holiday pay, etc) are transferred to the new employer. This means that the company's employees do not suffer any financial loss from the insolvency. 3. Alternatively, it is not possible to sell the business and transfer the employment contracts, the employees' rights are protected as follows: i. The employees will receive a minimum statutory payment from the Redundancy Payments Office. These payments are known as EPA claims (EPA is short for Employment Protection (Consolidation) Act 1978). These claims are processed by the insolvency practitioner and are paid regardless of the amounts realised in the insolvency. Directors with written (valid) employment contracts are entitled to this EPA claim. ii. The employees can also claim, as an unsecured creditor, for any amounts in addition to the EPA claim. Some of this claim may be preferential ie it is paid before any distribution to other unsecured creditors. It should be noted that the employee cannot claim twice for these two claims ([i] and [ii]). Therefore, if an employee gets paid part of his claim as a creditor by the Redundancy Payment Office, he can claim the unpaid balance against the company. The position regarding employees is complex - and specialist advice should be taken. However, the key issue is to maximise the employees' interests, as creditors.

21 Chapter 1 Company Directors: Page 17 of 61 Minimise Personal Guarantees Principle Directors often give personal guarantees for financial and commercial transactions. Effectively, the guarantee provides security for the creditor. So directors' personal guarantees are a very common issue in insolvency. Examples of the common guarantees as follows: Common Examples of Directors' Personal Guarantees Common examples of directors' personal guarantees usually arise from: 1. Guarantees on bank loans and overdrafts. 2. Guarantees on leasehold property (ie rent guarantees). 3. Guarantees on leases of office equipment, plant and machinery and motor vehicles. 4. Guarantees on certain types of corporate credit cards. Caution - when considering directors' guarantees It is important that the director does not act in such a way that is prejudicial to the general body of creditors, when attempting to minimise the guarantees. For example - if the guarantor of a bank overdraft which is repaid shortly before the company enters liquidation and he/she did so with the desire to eliminate a personal guarantee, then this is deemed to be a preference. In other words, the director intended to put himself in a preferential position over and above other creditors. In this case and other similar situations this transaction could be set aside. This would mean that the preferential benefit the director received would have to be repaid. Very importantly, the creation of a preference would be grounds for the directors' disqualification (to act as a director). Minimising personal guarantees Guarantees can legitimately be minimised in a number of ways (but to re- emphasise - please note the comments above).

22 Chapter 1 Company Directors: Page 18 of 61 Legitimate Ways to Minimise Directors' Personal Guarantees Common examples of the legitimate ways to minimise directors' personal guarantees are as follows: 1. Ensuring that the losses suffered by all creditors (and not just the guarantee creditors) are minimised, and/or 2. Using insolvency techniques such as: i. Disclaimer of onerous contracts (only available in liquidation) - for example leases. In certain cases the disclaimer minimises (rather than eliminates) the guarantee. ii. Binding the future obligation (such as rent) into a company voluntary arrangement. This can crystallise the liability and minimise the actual guarantee. This is complex so professional advice is required. iii. Using an insolvency restructuring (such as a company voluntary arrangement) to keep the company using property that creates the guaranteed liability (such as office machinery; rent on office premises etc.). This means that the company pays the liability as a normal business expense - meaning that the guarantee does not crystallise. iv. Considering proposing an individual voluntary arrangement if the guarantees make you personally insolvent. (Please refer to Insolvency of an individual) Additional objectives Please note that these objectives are merely the common objectives in a financial crisis. You may need to consider additional objectives that are unique to the company's type of business or financial situation. Next Step Let's see what options are available to insolvent companies on the following pages

23 Chapter 1 Company Directors: Page 19 of 61 Options Available to Insolvent Companies Decision making Now that you have established: (1) That the company is insolvent (or potentially insolvent), and (2) What your objectives are, it is important to consider the options available to you. Options available The various options that are available to you are listed below. The relative advantages and disadvantages of each are then discussed including when the option is an appropriate procedure. Trading On Informal work- outs Refinancing & Restructuring Company Voluntary Arrangements Administrations Fixed Charge Receiverships Creditors Voluntary Liquidations (insolvent) Members Voluntary Liquidations (solvent) Compulsory Liquidations Voluntary Dissolutions Administrative Receiverships

24 Chapter 1 Company Directors: Page 20 of 61 Trading On Trading on means that the company continues to trade on - to trade through its financial difficulties, and to pay back its creditors out of cash generated from operations. Advantages of Trading On The advantages of trading on are that it: a) Avoids potentially expensive insolvency and legal costs. b) Avoids unnecessary disruption to business. c) Maintains goodwill in the business. However, it is essential to add that trading on is only an option if the circumstances are appropriate. Disadvantages of Trading On When considering whether or not to trade on, in a situation where the company is facing actual or possible insolvency, it is vital to consider the disadvantages of trading on: a) Trading on is not appropriate if the business is not viable. b) Trading on may result in the company generating further losses and incurring more debt. This could result in the directors wrongfully trading and therefore being personally liable for the debts of the company. c) Trading on may depend on the support of ongoing trade creditors. d) It may be impossible to finance the cash requirements of "trading on", even though the company can generate future profits. e) There may be more appropriate formal insolvency procedures. Circumstances where Trading On is Appropriate Trading on is genuinely only appropriate if the company is in financial difficulties rather than being technically insolvent. Importantly: a) The company can pay its debts as and when they fall due, or b) There is unequivocal support from certain key creditors who are willing to defer, secure or compromise their debts.

25 Chapter 1 Company Directors: Page 21 of 61 Examples are directors' loans, holding company loans, or major trade creditors. In addition, trading on requires: a) The ability to finance trading on, without incurring any new creditors that cannot be paid on time. b) Stable and appropriately qualified and experienced management team (which is a basic requirement for all companies - but is especially important in a financial crisis). c) Continued support of trade creditors and suppliers. d) No pressing creditor who is going to enforce its security unexpectedly - for example: i) A debenture holder (normally a bank) considering appointing an administrator or an administrative receiver (where applicable). ii) A landlord distraining for unpaid rent. Therefore, all creditors generally need to be paid on time. So trading on is appropriate for companies that are not insolvent. Caution should be exercised if there is any doubt, and advice should be sought immediately.

26 Chapter 1 Company Directors: Page 22 of 61 Informal work- outs An informal work out is where: a) The company makes an informal arrangement to pay back creditors over a period of time. Invariably, an informal work out involves one creditor or a small group of key creditors - and the non- participating creditors are paid on a normal basis. b) It is "informal" as it does not involve the "formal" procedures available under The Insolvency Act Advantages of Informal Work Outs The advantages of informal work outs are as follows: a) There is no need for formal insolvency procedures. b) It can be considerably cheaper than formal insolvency procedures (although this is not always the case). c) It is possible to arrange different work out deals with different creditors. d) It can avoid negative publicity. Disadvantages of Informal Work Outs The disadvantages of informal work outs stem principally from applying informal work outs in inappropriate circumstances. a) Informal work outs can often be difficult (or impossible) to implement. For example, there may be too many creditors to get "informal agreements" in place. b) Any dissenting creditor can commence enforcement proceedings - for example, to wind up the company. Therefore, control is limited. c) If the company does not comply with the work out deal, this can result in a lack of trust - meaning that alternative rescue and restructuring procedures (available under The Insolvency Act 1986) are subsequently impossible (or very difficult) to implement. d) Trying to implement informal work outs may involve endless management time. e) Informal work outs need bilateral concurrence - i.e. all the individual creditors (party to the informal work out) must agree to the deal(s). f) Informal work outs may merely prolong the ultimate insolvency of the company if the fundamentals of the company are inappropriate.

27 Chapter 1 Company Directors: Page 23 of 61 Circumstances where Informal Work Outs are Appropriate Informal work outs can be appropriate in many circumstances, and commercial and professional judgment should be exercised. However, generally: a) The proposed work out deal should not be speculative. So, the deal should be based on known recurring cash flows, which can realistically sustain the work out arrangement. b) Stable, experienced and suitably qualified management should be in place. c) The problem that caused the financial difficulties should not be likely to recur, and should have been eliminated. d) It may be appropriate to arrange a work out deal with only one major creditor - who is known to be supportive - whilst paying all other creditors on normal credit terms. This can make a work out much simpler to implement.

28 Chapter 1 Company Directors: Page 24 of 61 Refinancing & Restructuring It may be possible to refinance and restructure the business so as to avoid formal insolvency proceedings. Examples include: a) Increasing long- term borrowings. b) Introducing new equity capital. c) Being bought out by a trade buyer. d) Discontinuing loss- making activities in an area of overall business activity (or, for example, liquidating a loss- making [and cash- draining] subsidiary). Advantages of Refinancing and Restructuring The advantages of refinancing and restructuring are: a) It avoids formal insolvency procedures. b) It can avoid major disruption to business: - no effect on employees - no effect on creditors. c) It maintains goodwill in the business. d) There is no negative publicity. Disadvantages of Refinancing and Restructuring The disadvantages of refinancing and restructuring are: (1) Refinancing can often take a very long time to complete. For example, a "quick" refinancing would take as long as three months in most (positive as opposed to crisis) circumstances. Therefore, the time required to re- finance often prohibits this option, given the pressing cashflow needs of the business.

29 Chapter 1 Company Directors: Page 25 of 61 (2) Financiers are often unwilling to consider recovery situations - consequently, it may prove impossible to refinance the business in a crisis. Therefore, the effort is totally wasted. It is very common for directors and their advisors to waste time trying to refinance a business that is "unfundable", when they should have been concentrating on the rescue alternatives available under The Insolvency Act (3) The directors may become personally liable for wrongful trading if they "rashly" pursue unrealistic refinancing alternatives, and at the same time, incur new liabilities. Caution should be exercised when refinancing; professional advice should always be taken. Circumstances where Refinancing & Restructuring are Appropriate Caution should be exercised when refinancing and professional advice should be taken. However, the following are examples (from a potentially endless list of possibilities) of where refinancing and restructuring are appropriate: a) Established banking relationships allow an existing bank to extend funds. This will only apply if there is a solid relationship with existing bankers. It is extremely rare that a "new" bank will lend in a crisis situation. b) Equity capital can be introduced by venture capitalists, who have faith in the long- term prospects of the business. Therefore, to consider venture capital, the business must be able to generate significant returns in a relatively short period of time. It should be noted that in a crisis it is often more effective to allow the company to be restructured using insolvency procedures - and then to introduce new finance into a "clean" balance sheet. c) Facilitate a trade buyer of the business. This can often be a very appropriate recovery solution as a trade buyer can often move quickly because a trade buyer can: i) Quickly understand the business, and ii) Efficiently "bolt on" additional turnover to an existing business. d) Discontinuing an activity (to minimise cash outflows of a loss- making activity) and at the same time refinancing the core business, which is sound. e) Liquidating a subsidiary to prevent a loss- making part of a group from draining the whole group.

30 Chapter 1 Company Directors: Page 26 of 61 Refinancing and restructuring creates many potential pitfalls and problems - it can be very technical - so professional advice should be taken. Technical Pitfalls in Refinancing and Restructuring during a Financial Crisis Refinancing and restructuring creates many potential pitfalls and problems. It can be very technical, so professional advice should be taken. Consideration should (for example) be given to: a) Transactions at an undervalue b) Preferences c) Wrongful Trading d) Re- use of restricted business names e) Transactions defrauding creditors

31 Chapter 1 Company Directors: Page 27 of 61 Company Voluntary Arrangements Company Voluntary Arrangements (CVAs) are best summarised as: (1) An arrangement (or a deal) between an insolvent company and its creditors, (2) Which is supervised by a licensed insolvency practitioner, and (3) Is formally governed by the Insolvency Act An appropriate CVA will improve the returns to creditors than would have been the case if the company went into liquidation / administration or receivership. CVAs can be a very cost- effective recovery tool, in the appropriate circumstances.

32 Chapter 1 Company Directors: Page 28 of 61 Illustration of CVA Procedure Advantages of Company Voluntary Arrangements The principal advantages of CVAs for the relevant parties, in the appropriate circumstances, are split into 3 categories. (A) ADVANTAGES FOR CREDITORS The specific advantages of CVAs for creditors are as follows (in the appropriate circumstances): (1) An optional moratorium, preventing creditors taking any action, can be obtained. (2) Generates the highest and quickest return to creditors (if the circumstances are appropriate).

33 Chapter 1 Company Directors: Page 29 of 61 (3) Creditors can vote whether to accept, reject or modify the CVA proposal. A 75% majority of the creditors voting is required to approve a CVA. Therefore, as creditors "effectively" control the nature of the proposal, they can ensure that it maximises their interests. (4) The CVA is essentially a contract that is "supervised" by a supervisor who is a licensed insolvency practitioner. If the directors of the company fail to comply with the CVA terms, the supervisor will (generally) be empowered to liquidate the company. (5) There may be material commercial benefits for keeping the company alive. For example: (a) Trade creditors can continue making profitable supplies to the company. If the on- going supplies are not paid on the due dates, this will (usually) result in the default of the CVA. (b) (c) Employees - who are also creditors - keep their jobs. Landlords continue to receive rents (if the occupation continues at the premises). (6) CVAs are often very cost- effective recovery tools. (B) ADVANTAGES FOR DIRECTORS The specific advantages of CVAs for the company's directors are as follows (in the appropriate circumstances): (1) Keeps the company alive. (2) No risk of wrongful trading. (3) An optional moratorium, preventing creditors taking any action, can be obtained. (4) Maximises interests of creditors - including employees. (5) CVAs are often very cost- effective recovery tools.

34 Chapter 1 Company Directors: Page 30 of 61 (6) Minimal publicity - only those creditors notified of the CVA proposal are aware of the CVA. Notice of the CVA approval is filed at Companies House. However, when compared to other procedures, the publicity is minimal. (7) Directors remain in control of the company. The supervisor "supervises" the company's compliance with the terms and conditions of the approved CVA - and is not (unless the terms require) involved in the management of the company's affairs. (8) Business conduct is unaffected. The directors carry out all normal functions including incurring credit and borrowing (if appropriate). (C) ADVANTAGES FOR SHAREHOLDERS The specific advantages of CVAs for the company's shareholders are as follows (in the appropriate circumstances): (1) Keeps the company alive, and therefore the opportunity for future returns. (2) Shareholders also vote to approve the CVA - a 50% majority is required. Therefore, shareholders have significant say in the nature, terms and conditions of the CVA. (3) Maximises interests of creditors - including employees. (4) CVAs are often very cost- effective recovery tools. (5) Minimal publicity - only those creditors notified of the CVA proposal - are aware of the CVA. Notice of the CVA approval is filed at Companies House. However, when compared to other procedures, the publicity is minimal. (6) Directors remain in control of the company. The supervisor "supervises" the company's compliance with the terms and conditions of the approved CVA - and is not (unless the terms require) involved in the management of the company's affairs. (7) Business conduct is unaffected. The directors carry out all normal functions including incurring credit and borrowing (if appropriate).

35 Chapter 1 Company Directors: Page 31 of 61 Disadvantages of Company Voluntary Arrangements The disadvantages of CVAs are often symptoms of attempting to implement a CVA in inappropriate circumstances, or attempting to implement the "wrong" deal. The principal disadvantages of CVAs for the relevant parties are split into 2 categories. (A) DISADVANTAGES FOR CREDITORS The disadvantages for creditors are as follows: (1) There is no punishment for the directors - aggrieved creditors often feel that the directors are "let off the hook". (2) The directors, who often arguably cause the failure, still remain in control of the company. (3) A CVA can often merely postpone the inevitable - which is the ultimate liquidation of the company. (B) DISADVANTAGES FOR DIRECTORS The disadvantages for directors (and also the company) are as follows: (1) It can be a very demanding and sometimes harrowing experience getting a CVA proposal approved by creditors. Ironically, it can sometimes be "easier" on the directors to merely liquidate the company - even though the creditors' returns are usually far, far better in a CVA than in liquidation. (2) Inappropriate CVAs can merely postpone the inevitable failure of the company. (3) It may be more expedient to liquidate the company - and start again in another more profitable business. (4) If the company fails to comply with the CVA terms, the supervisor will wind up the company.

36 Chapter 1 Company Directors: Page 32 of 61 Circumstances where CVAs are Appropriate (1) The CVA must maximise the financial return for creditors. Therefore, to support the CVA the creditors must perceive that the CVA will yield a higher return than any other alternative they have available to them. Best practice requires that voluntary arrangements will always have a comparison of outcome - which shows each class of creditor what their expected return is. Please note in addition: a) Creditors should always consider their risk of supporting the CVA as opposed to not supporting it, in conjunction with the estimated return in either option. CVAs usually have a minimal risk as there is a chance of an upside - whereas often (say) in liquidation there is no chance of any return for unsecured creditors. Therefore, the risk in CVAs is often far less than risking an alternative insolvency procedure. b) Because of the inherent uncertainties - the estimated outcomes in the proposals are merely the best available estimates. (2) The company must be genuinely insolvent - or likely to become insolvent. (3) The management of the company must be of a reasonably high quality. If there are any weaknesses in the company's management, these weaknesses need to be resolved prior to or as part of the CVA proposal. In particular, quality financial management is of critical importance. (4) There must be known recurring cash inflows - so that the nature of the proposal is not excessively speculative and based on wishful thinking. The business should be fundamentally profitable - and the restructuring should restore the business to profitability. (5) Creditors must be supportive of the directors and the company. Creditors generally reject CVA proposals if:

37 Chapter 1 Company Directors: Page 33 of 61 (a) (b) They do not trust the directors or have no confidence in the company's management. The return is inadequate. (6) There must not have been an abuse of Crown creditors (VAT and PAYE). This may result in HM Revenue and Customs rejecting the proposal (if they control the voting). Crown creditors often have non- financial criteria that determine their willingness to support voluntary arrangements. A history of non- cooperation will often be recorded on (say) the HM Revenue and Custom's files, and this, understandably, affects their confidence. Creditors (including the Crown) generally reject CVA proposals if: (a) They do not trust the directors or have no confidence in the company's management. (b) The return is inadequate. (7) The business must be able to finance its activities, or as part of the CVA, new finance is introduced. The directors must ensure that the business can finance itself: (a) During the hiatus period when the CVA proposal is being drafted, proposed and considered, and (b) During the implementation of the CVA. Generally, significant consideration must be given to the future cash flows when the CVA proposal is being drafted. Normally finance will come from either: (a) (b) (c) Cash generated from trading Cash generated from opening debtors' receipts - which are used to finance future working capital, as opposed to paying off historic liabilities New finance being introduced on the condition of the CVA being approved. If a small company moratorium is applied for to protect the company from creditor action, one of the obligations placed on the nominee (Insolvency Practioner) during the hiatus period is to ensure that the company has sufficient working capital. If he

38 Chapter 1 Company Directors: Page 34 of 61 forms the opinion that the company has insufficient working capital he must withdraw from acting. This will bring about an end to the CVA process. Whatever the route taken, the company must ensure that it has adequate liquidity during the early stages of the CVA. This is essential. (8) The business must be able to obtain ongoing supplies, once the CVA has been approved. This can be problematic as trade creditors are often willing to support the CVA but unwilling to extend ongoing supplies on credit terms. This problem can be overcome by: 1. Negotiating with key suppliers in advance. 2. Making it a condition (of the CVA) that if future debts are not paid on time this will be a default meaning that the supervisor will wind up the company. This is normally a standard condition in most CVAs. This fact can be used to comfort creditors bound by the CVA that their risk is minimised (although never eliminated). 3. Ensuring that there are alternative suppliers. (9) The company's finance agreements can be kept in place. If the company has any finance agreements - such as normal secured bank loans/overdrafts and leases - these are unaffected by the CVA, as secured creditors' rights are not affected by a CVA. Because secured creditors' rights are not affected by a CVA, the secured creditor can still enforce his security even though the CVA has been approved. So, it is important to: 1. Always consider the position of the secured creditors in advance, and 2. Where appropriate negotiate with the secured creditor to ensure that these are kept in place or alternatively replaced. Generally, secured creditors will be willing to support a voluntary arrangement if: 1. The payment obligations (that existed previously) are not affected or changed.

39 Chapter 1 Company Directors: Page 35 of The security is unaffected and more importantly, the rights of enforcement are unaffected. A voluntary arrangement cannot affect these rights without approval from the creditor involved. Understandably, this rarely happens. (10) There are no transactions or misconduct that could be attacked under administration or liquidation. In administration and liquidation, it is possible for the respective administrator or liquidator to attack certain "voidable transactions" or misconduct. The objective would be both: 1. To increase the assets available and therefore to increase the return to creditors, and 2. Prevent the directors from repeating the misconduct. This is delivered by disqualifying them from acting as directors. Therefore, if there have (for example) been previously voidable transactions that can provide material returns for the creditors, it is unlikely that the creditors will support the voluntary arrangement.

40 Chapter 1 Company Directors: Page 36 of 61 Administrations "Administration" must not be confused with Administrative Receiverships. In simple terms, the administration procedure is summarised as follows: (1) The directors, company's creditors, or the holder of a qualifying floating charge can appoint an administrator. (2) The company s creditors can only appoint an administrator by petitioning to the court. (3) A qualifying floating charge holder can appoint an administrator out of court. However, if there is a winding up petition against the company, then the qualifying floating chargeholder must appoint an administrator by petitioning to the court. (4) The directors can appoint an administrator out of court but the form appointing the administrator must then be filed in court to make the appointment effective. (If there is a qualifying floating charge at least 5 days notice of the intention to appoint must be given to the charge holder by the directors). (5) The company enters administration when the appointment of the administrator becomes effective. (6) An administrator can only be appointed if he is a licensed insolvency practitioner. (7) A company cannot enter administration when there is a resolution for a voluntary winding up or a winding up order in existence unless the holder of a qualifying floating charge petitions to the court. (8) When the company enters administration there is a complete moratorium over creditors' actions (subject to minor exceptions). (9) To accept an appointment as administrator the insolvency practitioner must be satisfied that he can achieve the purpose of administration and must perform his functions with the objective of: - (a) rescuing the company as going concern, or (b) (c) achieving a better result for the company s creditors as whole than would be likely if the company were wound up (without first being in administration), or realising property in order to make a distribution to one or more secured or preferential creditors. (10) Within 8 weeks of his appointment the administrator must make a statement setting out his proposal for achieving the purpose of administration. (This can include a company voluntary arrangement).

41 Chapter 1 Company Directors: Page 37 of 61 (11) The administrator s statement and proposals must include a notice for a meeting of creditors which must be held within 10 weeks of his appointment. Advantages of Administrations The principle advantages of administrations are as follows. (A) Advantages Generally (1) Administrations allow protection (or a moratorium) while the rescue plan (such as the sale of the business or a company voluntary arrangement) is being approved. This can often be essential if hostile creditors are enforcing their claims. (2) Administrations put an "independent" licensed insolvency practitioner in control - rather than leaving the directors in control. This is often seen as beneficial to creditors, as the directors (arguably) may have caused the failure. (3) The administrator has a reasonable time period in which to create sound proposals. (4) It is possible to set aside certain prior transactions that are voidable. This can increase returns to creditors. (B) Advantages for Preferential and Unsecured Creditors The principal additional advantages to preferential and unsecured creditors are as follows: (1) It may - in appropriate circumstances - lead to highest and quickest return for creditors. (2) It prevents one creditor "leap- frogging" their claim over and above other creditors. (3) Directors are controlled by the administrator. (4) The floating charge holder (i.e. the bank who holds a debenture) has at least five days notice of the intention to appoint an administrator. In that period he could appoint his own administrator (This is unlikely, however as the objectives of the administrator would be the same). However, because of this it is generally essential to fully consult banks prior to appointing an administrator.

42 Chapter 1 Company Directors: Page 38 of 61 (C) Advantages for Directors The principal additional advantages for directors are as follows: (1) Creates moratorium and immediately protects the company. (2) No risk of wrongful trading. (3) May maximise interests of creditors - in appropriate circumstances. (4) May lead to survival of the business - in appropriate circumstances. Disadvantages of Administrations The principal disadvantages of administration orders are as follows. (A) Disadvantages - Generally The general disadvantages of administrations are: (1) Cost. Administrations can be a very costly exercise due to: (a) (b) (c) The obligations placed on the insolvency practitioner during the process. The significant responsibilities of the administrator once appointed. Carrying out these responsibilities requires a considerable amount of expensive time. Therefore, the cost of administrations can often be: (i) Prohibitive to smaller companies. (ii) In excess of the benefits achieved by the administration. As a result, the costs/benefits of administrations should be carefully considered in advance. (2) Time. Although a company can be placed into administration rapidly, there is still a considerable amount of time- consuming work required to be undertaken by the administrator once appointed.