This is my article on my column Raising the Bar published on 4 August 2016 in The Malaysian Reserve (in association with the International New York Times).
The Companies Bill 2015 will introduce two corporate rescue mechanisms: corporate voluntary arrangement and judicial management. These mechanisms will allow financially distressed companies to restructure its debts and to continue with its business.
Under present laws, there are limited options to allow the rehabilitation of companies. Once a company has entered financial distress, the most common event is liquidation.
I explain more about this upcoming era of corporate rescue. In some cases, it may be a real lifeline to ailing companies. But I hear that borrower companies may not gain much benefit and lenders may face some pain under these new laws.
CORPORATE VOLUNTARY ARRANGEMENT (CVA)
The CVA provisions are modeled after the corresponding UK provisions. As an example of a successful CVA in the UK, Fitness First UK successfully carried out a CVA with its landlords. The arrangement allowed for a reduction of the rental rates for some of their branches by more than half.
CVA is a procedure to allow a company to put up a proposal to its unsecured creditors for a voluntary arrangement. The key advantage of the CVA is that there is minimal court intervention and therefore the costs should be low and it is a speedy process.
I explain briefly the four stages of a CVA.
Firstly, an independent insolvency practitioner must provide his positive statement that the intended CVA has a reasonable prospect of being approved.
Secondly, the company files the necessary court papers. This triggers an automatic 28-day moratorium. A moratorium is a period in which no legal proceedings can be taken against the company. It is meant to give some breathing room for the company from creditors’ legal proceedings.
Thirdly, meetings of the company’s shareholders and creditors must be held within this 28-day period. Approval of a simple majority of the shareholders and 75% of the total value of the creditors must be obtained.
Finally, with such approval, the CVA takes effect and is binding on all creditors. The aim of the CVA is that it should only extend to restructuring the unsecured debts of the company. It cannot affect the right of a secured creditor to enforce its security.
Key Weakness of the CVA: Company with a charge is shut out
However, the CVA mechanism cannot be utilised by several categories of companies.
Firstly, public companies are excluded so only private limited companies can apply for a CVA. Secondly, and this is a key weakness, a company which has a charge over its property is excluded from the CVA.
Many companies in distress would have loans and with the bank having a charge over the company’s property. These companies would be shut out from the CVA mechanism and may largely limit the wider use of CVAs.
The new judicial management mechanism is modelled after the Singapore provisions. The company or the company’s creditors can apply for a court order to place the management of a company in the hands of an insolvency practitioner.
The filing of the court application will trigger an automatic moratorium, similar to that of a CVA. However, there is no set time limit for this moratorium and it lasts until the judicial management application is decided by the court.
Where the judicial management order is granted, the judicial manager will displace the directors and take charge of the company’s assets and business. The judicial management order will last for six months and may be extended for an additional six months.
The judicial manager will aim to put forward a restructuring proposal to the creditors for their approval. A meeting of the creditors will be called to obtain approval from 75% in value of the creditors. Once approved, the proposal becomes binding on all creditors.
The automatic moratorium would give much needed respite to a borrower company facing creditor actions. However, any secured creditor would have a veto vote over the making of a judicial management order. As will be explained further below, these secured creditors may have concerns over the powers of a judicial manager and may likely want to oppose the court application.
Nonetheless, the court can exercise an overriding power to appoint the judicial manager if the court thinks it is in the public interest to do so. We will have to see how the court strikes a balance between these competing interests. So for example, would an ailing national airline or a heavily indebted national car company fall within the consideration of public interest? The court would have to decide if that overrides a bank’s veto over placing that company into judicial management.
From the lenders’ perspective, there may be several issues of concern. Firstly, the automatic moratorium would delay its legal actions. Attempts to sell of the charged land or to appoint receivers would all be frozen during the moratorium period.
Secondly, the judicial manager wields wide powers. These powers are necessary to allow the judicial manager to pursue all options to restructure the business and debts of the company. Under certain circumstances, the judicial manager even has the power to sell off assets subject to a floating or a fixed charge. This would be of grave concern to the lenders who had enjoyed security over these assets in exchange for the loans extended to the company.
Corporate rescue and the ability to rehabilitate a company is a welcomed addition to our laws. Preserving a company as a going concern maximizes the value of its assets and its business. Selling off assets when a company has been wound up would attract only fire sale prices.
However, I foresee many legal challenges ahead when the different stakeholders test the limits of these new laws. Borrowers will want to enjoy the moratorium and will want in place a professional insolvency practitioner to save the company’s business. Lenders would have concerns about the impact of these new laws on their ability to recover their debts and enforce their security. It remains to be seen if corporate rescue will lead to some gain for borrowers, but with more pain for lenders.