METHODS TO PREVENT THE INSOLVENCY OF COMPANIES Ioana Monica HORJA, Dimitrie Cantemir University, Bodoni Sandor 3-5, Tîrgu Mureş, Mureş, România. Smaranda Vancea, Dimitrie Cantemir University, Bodoni Sandor 3-5, Tîrgu Mureş, Mureş, România. Abstract: The insolvency of companies is a phenomenon more and more common in Romanian economy. A business is insolvent if it doesn t have enough assets to cover its debts, or it is unable to pay its debts as and when they are due. If a company can anticipate the insolvency risk it can avoid insolvency. The aim and the objective of the paper is to highlight the main strategies and methods for preventing insolvency and also their importance for a company. The financial difficulty of a company doesn t have a legal adequate definition, but the accounting information, the evaluation report or audit reports, the banks admonitions can offer important criterions for the appraisal of the venture and can create a reference point for the trigger action of the alertness. A hypothetical line of the companies difficulties would start from the admonitions of the difficulties, would continue with the eventual prevention procedures or measures and procedures of extra judiciary treatment of the financial crisis, and only if these procedures didn t gave result, with the insolvency procedure. The insolvency procedure gave also a chance for a company, the reorganization procedure, but may also lead to bankruptcy. The methods for preventing insolvency can be applies also by profitable companies in order to prevent financial difficulties, and also by companies in difficulties, company which can pass the crises period applying these strategies and methods. Keywords: insolvency, methods of prevention, bankruptcy, corporate governance INTRODUCTION In the Romanian economic environment change has become normality, but the pace of change has accelerated, Romanian entities are faced with a number of increasingly larger competitors, many of them coming from outside the country. To be able to adapt to these permanent changes, Romanian entities must be sufficiently flexible and innovative in order to maintain the products and services, in order to provide maximum quality for the customer and not least in order to meet deadlines and to maintain on the market [1, pag.9]. Gearing a trader in the complex and continuous relations with suppliers and creditors, on a part, and with customers and the other side implies the continuous functioning of cashing and payments mechanism with these. If this mechanism is blocked because of scarcity of liquidities on this circuit s link, the activity of many customers connected by successive operations is threatened. Maintaining on the continuous mechanism of payments in commercial activity is realized sometimes with the price of removing from the circuit of these who, most of increasing the losses, can t continue the payments. Page 59
These customers removing who cannot pay their debts are made by a procedure named bankruptcy, organized and leaded by juridical rules. 1. CAUSE OF INSOLVENCY OF COMPANIES A company can have difficulties because of internal and external causes. Among the external causes can be enumerated: product or market profitability (if case of a new product which cannot reach the target); technical causes (the products of a concurrent company); monetary causes (the inflation ratio, the appreciation or the depreciation); legislative and fiscal causes or even loss of customers. Between the internal causes we can remind defectively management; bad organization of the production or commercial sector or too many outgoings. All these causes can result in a crisis for the company, crisis which can be considered the final stage of an undesirable process in which the company potential of obtaining profit and its liquidity are going to a wrong direction who threatens the company existence and can go into bankruptcy. The emphasize of these lack of poise situations can get to incapacity of pay, which is a situation characterized by changing the liquidity and solvency level. The financial state of a company that is able to pay all debts as they fall due by the assets shows the solvency of a company. The liquidity shows that the company has financial resources to pay its debts as they fall due, so it has solvency. Seeing this crisis on time can get the remediation of the situation by measures of prevention the insolvency. 2. THE IDENTIFICATION OF INSOLVENCY RISK Any economic entity when identifying a potential risk must use a recovery process, possibly through a restructuring process, which is a complex process requiring the completion of some activities targeted and specifically formulated. This process of recovery can be synthesized, schematically, as follows :[1, pag.110]: The manifestation of signs of weakness in the entity activity Strategy of recovery for a long term Making a complete analyse in order to elaborate the recovery strategy Initial diagnose: licquidation or continuing the activity Chances of recovery Recovery through judicial reorganization No changes of recovery Liquidation strategy Reorganization plan Establishong the objectives Chosing the measures and applying the measures Figure 1. The recovery process of companies Page 60
After the identification of risk, after the analyze and the selection of the strategy, these must be applied in the entity, in time, in order to be achieved the expected effects. 3. PROCEDURES TO PREVENT INSOLVENCY Most European laws provide various measures in order to prevent insolvency, which can be applied both as creditors and debtors. Around an entity are multiple economic interests and many people depend greater or less to the survival of the entity, the state can not easily allow the loss of a source of taxes and duties, and also places of work. The insufficiency of funds, the excessive recourse to credits is the origin of almost all bankruptcies. For the entity that is in difficulty, but viable, the use of prevention mechanisms of insolvency is the last useful means to maintain or regain economic and legal independence. The financial crisis, the prior stage to the occurrence of a state of insolvency is a situation which may be presumed by forecasting accountancy information, by evaluation or audit reports, by warnings from the banks, from the state institutions, however as indicators for assessing the risk of the activity, as warning indicators. Warning of crisis may come from external sources such as banks, external auditors or from internal sources such as accounting information or internal auditors. An important fact is that the measures for the prevention of insolvency are options of the debtor and can be applying a crisis management; reorganization of the company through merger or division; negotiate with creditors. Crisis management in companies dependents on its creditors and may be applied by an entity in order to prevent financial difficulties and by an entity already in difficulties. There are several ways to apply crisis management solutions. The corporate governance is one of crisis management solutions because a well governed company takes a longer term view that integrates environmental and social responsibilities in analyzing risk, discovering opportunities and allocating capital in the best interests of shareholders [3, pag.207]. Corporate governance intends to control and limit abuses of managers or controlling shareholders by principles and standards aimed at ordering behavior among others seeking to limit abuse management and streamline business and also can prevent insolvency. The auditors, internal or external, as elements of organizational structure of a company may be useful for prevention of insolvency because they have the power to trigger the alert in case of discovering a dangerous situation for the company's business in the financial statements. The alert procedure may be also triggered by the shareholders. Another method, not very used in Romania is the manager s liability insurance which is a liability insurance payable to the managers of a company, or to the company itself in order to cover damages or defense costs in the event they suffer such losses as a result of wrong acts while acting in their capacity as directors and officers for the organization. This insurance is very important when a company is insolvent because the company can repair the damages produced by a manager and can continue its activity. A forecast accounting can save a company for the insolvency risk. Where once the accounts and financial statements are prepared according to the financial forecast, an early warning of financial difficulties is possible. These financial projections are important for both company management and investors or creditors. On the other side of prevention of insolvency there are the extrajudicial measures of treatment, which can be used to exit from the crisis entity. Page 61
The extrajudicial measures of prevention the insolvency such as mediation or preventive agreement are also used in Romania, after the adoption of the Law of mediation in 2006 or the preventive agreement law in 2010. So, the extra judicial methods of prevention the insolvency are based on agreement between the parties. The mediation procedure involves the intervention of a mediator, the companies tries to resolve their differences amicably and only if failure the company goes to the court. In insolvency, the mediation can be used in order to reach a compromise with creditors, for avoiding the insolvency procedure. In an insolvency procedure value lies in the insolvent undertaking as a going concern. Provided there is buy in to the mediation from the parties then it can be arranged within weeks if not days and at a convenient venue. The arbitration procedure can be used to prevent insolvency through a compromise acceptable by the debtor and creditors in the debtor's business recovery purposes. The preventive agreement provides a business solution for improving the economic entity that is in crisis, but does not coincide with the reorganization court. Preventive arrangement involves a contract and legal mechanism designed to enable a debtor honest in financial difficulty to avoid insolvency [3, pag. 205]. The aim of the law regarding the introduction of preventive agreement and ad-hoc arrangement tries to help the company in difficulty, in order to continue its work, to preserve jobs and to cover claims against the debtor through friendly procedures for renegotiating the debt or the terms of the debt. The company is an organized economic activity taking place constantly and systematically by combining financial, workforce drawn, materials and logistics and information resources, at the entrepreneur s risk in cases and under conditions stipulated by law [2, pag.28]. The ad hoc mandate is a confidential procedure initiated at the request of the debtor, in which an ad-hoc representative, appointed by the court, negotiates with creditors in order to achieve an agreement between one or more of them and the debtor to overcome a state of difficulty the company of the latter is in. Object of the ad hoc mandate will be to achieve, within 90 days, an agreement between a debtor and one or more of its creditors in order to overcome the difficulty the debtor s company is in, to safeguard the company, to preserve the jobs and to recover the claims from the debtor. To achieve the mandate object, ad-hoc representative may propose deletions, rescheduling or partial reduction of debt, continuation or termination of contracts in progress, staff reductions and other necessary measures. Another procedure is the safeguarding procedure, a procedure that can be opened at the request of the Head of the company, without the company being unable to pay, and only by the fact that the known difficulties that may not exceed one, without the justice. The strongest effect of this procedure is the opportunity given to the debtor to preserve liquidity in money, in that they would be used to continue the work, thereby generating revenues needed to cover claims accepted by arrangement. The measures that the debtor proposes for this purpose are: delays or rescheduling the payment of claims against it, deletion in all or part of some claims or only the interest or penalties. According to Art. 22 of Law no. 381/2009 on the introduction of preventive arrangement and ad hoc mandate, the debtor may ask the judge in the supply arrangement with creditors a temporary suspension of forced proceedings [4]. The temporary suspension remains until the publication of preventive arrangement approved or, if necessary, until the rejection of the offer of the debtor by most creditors. Page 62
From the date of the decision of finding the arrangement as precautionary, they shall suspend the individual prosecution of signatories on the debtor's creditors and the flow of the prescription right of enforcement of their claims against the debtor. With approval, the syndic judge may suspend all enforcement procedures. At the conciliator s request, subject to guarantees granted by the debtor's creditors, the syndic judge may impose the non-signatory creditors of preventive arrangement 18 months of deferment of the due them, during which they will not run interest, penalties and any other expenses regarding claims. During the running of approved preventive arrangement the insolvency proceedings against the debtor cannot be opened. In proceedings, the debtor operates within its normal business, under the conditions of preventive arrangement and the supervision of conciliator. CONCLUSIONS A special importance should be given to the methods and procedures to prevent insolvency. Most European laws provide various measures in order to prevent insolvency, which can be applied both as creditors and debtors. The insufficiency of funds, the excessive recourse to credits is the origin of almost all bankruptcies. For the entity that is in difficulty, but viable, the use of prevention mechanisms of insolvency is the last useful means to maintain or regain economic and legal independence. The status of difficulty of the entity may be presumed by forecasting accountancy information, by evaluation or audit reports, by warnings from the banks, from the state institutions, however as indicators for assessing the risk of the activity, as warning indicators. All this should be a warning to managers of the entity concerned. A hypothetical route of the difficulties of company is shown in figure 2: Warning about the difficulties Measures to prevent insolvency Extrajudicial measures of financial crises Insolvency procedure Judicial reorganization Liquidation Financial recovery Figure 2. Hypothetical route of the economic difficulties of an entity It should put more emphasis on how to prevent insolvency, as this would avoid insolvency of the honest debtors, of those who try to save their business and they have been incapable of paying their debts because of objectives connected to an economic - financial crisis or because of bad customers. Page 63
The number of bankruptcies could be reduced by the introduction of protective measures and a greater confidence in the judicial reorganization procedure. The economic entities facing financial difficulties should seek reorganization and only in case of failure to reach a state of bankruptcy. However, this does not occur on the Romanian market due to lack of managerial culture, the heads of economic entities waiting until the last moment, without taking the necessary measures. BIODATA - Ioana Monica HORJA is Associate professor PhD. at Dimitrie Cantemir University, Bodoni Sandor 3-5, Tîrgu Mureş, Mureş, România. - Smaranda VANCEA is Lecturer PhD. at Dimitrie Cantemir University, Bodoni Sandor 3-5, Tîrgu Mureş, Mureş, România. REFERCES 1. Horja, I.M. The Restructuring Operations of Companies, Cluj Napoca, Risoprint, 2010, pp. 274-284. 2. Lupulescu, A.M. Companies Reorganization. Strategies and Judicial Base, Bucharest, Wolters Kluwer, 2008, pp.28 3. Piperea, Gh., Insolvency: Law, Rules and Reality, Bucharest, Wolters Kluwer, 2008, pp.200-230,pp. 203-223 4. Law 381/2009 about the preventive agreement 5. Law 85/2006 about the insolvency procedure Page 64