Options available for distressed companies: which is the right one for your business
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While the government’s relief measures may help a distressed company to stay afloat for the next six months, they can do little to improve the bottom line if its underlying business is unprofitable.
After the Covid-19 eventually recedes and the support measures elapse, businesses will have to pay back the accumulated amount of deferred rent and loans in an environment of weakened consumer and business sentiments. Many will be in dire straits, especially those already struggling before the current crisis began.
Therefore, the breathing room provided by government support should be used to by directors to assess the financial position of their businesses, see what options are available and develop a strategy for the future.
Evaluate the financial position of the company
The first thing to do if your business faces financial difficulty is to assess whether the company is insolvent, meaning it cannot meet its debt obligations as and when they fall due. Apart from liquid assets, resources available to a company to recapitalise and shore up its financial position will be considered, such as the ability to raise debt or equity capital.
If a company can be reasonably suspected to be insolvent, its directors should seek professional advice and act immediately. Doing so maximises the business’ chance of survival and minimises the consequences of business failure on the directors personally.
The following are the three main mechanisms available to companies in financial trouble.
Informal restructuring under Safe Harbour protection
Restructuring with safe harbour protection is an informal mechanism that enables directors to collaborate with a qualified adviser to improve the company’s financial situation while remaining in control of the company. It has the added benefit of protecting directors from being pursued personally for insolvent trading even if the company ends up in liquidation.
Directors seeking to avail themselves of safe harbour must make sure of the following:
- Maintain proper and adequate financial records;
- Comply with employee entitlements and tax reporting obligations;
- Seek advice from an appropriately qualified adviser; and
- Develop and implement a plan that is reasonably likely to lead to a better outcome for the company and its creditors than an immediate external administration
This mechanism is appropriate for businesses that are viable and possess sufficient assets to sustain the restructuring process. For more details about Safe Harbour provisions and the temporary relief from insolvent trading introduced to encourage businesses to continue trading through Covid-19, see here.
Voluntary Administration followed by a deed of company arrangement
Voluntary administration is a formal insolvency process during which a moratorium on creditor actions against the company is imposed, and an independent administrator is appointed to takes control of the company, conduct investigation into its affairs and advise creditors in determining the company’s future.
To exit an administration, directors may propose a deed of company arrangement (‘DOCA’). DOCA is a flexible instrument that allows a variety of solutions to be considered, for instance it may contemplate a compromise of debts in exchange for having a better dividend than in an immediate liquidation, or to postpone a final decision until a further time (known as a ‘holding DOCA’). Voluntary administrator would then make a reasoned recommendation on whether it is in the creditors’ interests to accept the proposal.
If a majority of creditors vote in favour, the DOCA becomes binding. Subject to the supervision of the deed administrators, the directors would resume control of the company and perform their obligations under the DOCA. If creditors refuse the proposal, the company will usually end up in liquidation.
This is a good option for companies that are, or are likely to become, insolvent, but still have a viable business that could return to profitability if it overcomes the existing debt burden.
Liquidation
If the first two options are unsuitable or unavailable, the only option is to formally wind up the company. In a liquidation, a liquidator is appointed to investigate the company’s affairs, recover and realise assets, and distribute dividend (if any) to creditors.
While liquidation is the last resort for companies that are insolvent and have no viable underlying business, it has the benefit of finality as directors would be assured that it is highly improbable for further liability to arise post liquidation.
Key Takeaway
The Covid-19 outbreak is causing great challenges for many businesses. Apart from seeking available support from the government and lenders, it is imperative for directors of distressed companies to contemplate how restructuring and insolvency mechanisms, such as the ones listed above, may help to alleviate the pressure.
The team at Collins Wentworth is here to assist you through this unprecedented crisis. We are experienced in business financial matters. If you have concerns about the financial position of your business and wish to know more about how we can assist you, contact us today.
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