When a company gets into financial difficulty the directors have the opportunity to enter into a formal scheme of arrangement with its creditors by either utilising the procedure set out in section 201 of the 1963 Companies Act or availing of the Examinership legislation under the 1990 Companies Act. However, these formal procedures incur significant legal expenses, and are therefore generally not suitable for the small/medium sized company.
Situations Suitable for Informal Schemes
Informal schemes are done outside the ambit of the courts and are particularly suitable for situations where there are a handful of large creditors. Dealing with a large number of smaller creditors would be time consuming and the risk of news of the company’s difficulties reaching the market place is increased.
Effective communication is paramount for the creditors to understand how the company got into financial difficulties and for them to support any future recover plan.
Once the directors become aware of the company’s financial difficulties, they need to take steps to protect their personal position in respect of any subsequent claims for wrongful and reckless trading. Accordingly, no new supplies should be ordered by the company unless the directors believe that they have a reasonable expectation of paying for them.
First Meeting of Creditors
Once the directors have decided to try and work out an informal scheme of arrangement with their creditors, they should arrange for the preparation of a report which should be distributed to the major creditors. This report should contain the following:
- Reasons for the company’s current financial difficulties.
- Management accounts prepared up to a recent date.
- A listing of creditors.
In some circumstances it may be appropriate for the company to obtain signed confidentiality agreements from the creditors prior to distribution of the report.
At the meeting of creditors a recovery plan should be presented for the creditors agreement. The recovery plan should clearly show that the underlying business is still viable, or can be made viable if certain steps are taken. The recovery plan may call for changes to the management team, the financial controls, products/market reorientation , pricing, and cost reduction. The plan will generally call for creditors to write off a portion of their debts. Apart from creditors being asked to write off a portion of their debt, they may also be asked to extend support to the company by reducing their prices for a period, providing advertising support and/or extending credit terms.
At the creditors meeting it should be made clear that the continued operation of the company will be dependent upon all major creditors accepting the recovery plan. The recovery plan should clearly show how creditors will benefit by supporting it. This can be illustrated by demonstrating the return which creditors would receive under a liquidation scenario versus the return they would receive from supporting the recovery plan.
A major disadvantage of attempting to implement an informal schemes of arrangement is that the company does not have court protection . Accordingly, if a large creditor decides not to support the recovery plan, then he can take legal action, such as a winding up petition or enforcement of a judgment debt. However, provided the company can establish trust with their creditors and the creditors act commercially, then such legal action should not occur.
If creditors are being asked to write off a significant proportion of their debts, then in order to encourage the creditors to support any recovery plan it may be necessary to arrange for the provision of "new monies". These new monies my come from the directors themselves or from a new investor and may be used to invest directly in the business or to enable an initial dividend to be paid to the large creditors.
Not all trade creditors may be in a similar position. Some creditors may have valid reservation of title clauses in their standard terms and conditions, or personal guarantees which would enable them to partially recover some of their debt. The value of such terms need to be established and to be incorporated into any dividend scheme for the creditors.
The Revenue Commissioners
Invariably speaking, the Revenue will need to be consulted as part of any recovery plan. While the Revenue are prohibited by law from writing off taxes due, they are prepared to enter into deferred installment arrangements in certain situations for the settlement of past liabilities provided interest is paid on the instalments.
The bank will also need to be consulted as part of any recovery plan. Whether the bank will be prepared to write off a portion of their debt will depend on the value of the security they hold.
The implementation of an approved plan should be monitored, at least on a quarterly basis, and creditors should be kept informed of progress made.
Informal schemes of arrangement can enable a company which encounters financial difficulties to remain in business and pay a higher dividend to unsecured creditors then what they would receive in a liquidation.
© Copyright Friel Stafford
For further information, contact Jim Stafford or Jonathan Foley of Friel Stafford, 44 Fitzwilliam Place, Dublin 2. Tel: 01 661 4066. Fax: 01 661 4145