Restructuring & Insolvency

The decisions a board actually faces as a company runs out of road

Distress is rarely a single event. It is a sequence of ordinary commercial judgments, each of which can be examined afterwards by someone holding the whole file.

Difficulty rarely announces itself. It arrives as small accommodations: a supplier paid a week late and then a month late, a facility renewed on terms nobody had time to read, a payroll met out of a receipt earmarked for something else. By the time the position reaches an adviser, the board has often been taking insolvency decisions for months without describing them that way.

The decisions themselves are few and they recur. Whether to continue trading, and on what basis. Whether to take on further credit, and from whom. Which creditor is paid this week when they cannot all be paid. Whether to tell the lender now or after the next set of figures. Whether to sell an asset quickly at a poor price to buy time, and what the time is for. Each looks like routine management when it is taken and like a choice when it is read back in order months later.

What changes as solvency comes into question is the audience for those choices. A comfortably solvent board answers to its shareholders for the way it takes risk, because it is their money at stake. As the position deteriorates, the people who stand to lose by a decision are increasingly the creditors, and the decisions come to be judged in that light. The shift is gradual as it is lived and abrupt in retrospect, which is why the moment to take advice is the moment the question first occurs to a director rather than the moment somebody else asks it.

Little of this is about protecting a director through inactivity, because a board that stops deciding has still decided. What assists a director afterwards is a record showing that the position was assessed on real information, that advice was taken, that the reasoning was set down at the time, and that the board did what it had resolved to do.

A liquidity problem and a solvency problem are not the same illness

They present identically: the money is not there this month. The treatments point in opposite directions, and the cost of confusing them falls on everybody.

A liquidity problem is a problem of timing. The business works, the order book is real, and the cash arrives after the obligations fall due. The remedies are timing remedies: rescheduling, reduced payments for a period, a further facility, faster collection of receivables, or money from shareholders. A solvency problem wears the same clothes, but here the business as configured does not generate enough to meet what it has promised, and no rescheduling changes that. Between the two sits the case most often misread: the trading operation is viable while the borrowing taken on against it is not, so the company is being asked to service a structure the business was never going to support. That case can be fixed, but not by an extension.

Distinguishing them is an exercise on documents rather than an act of judgment. It needs a cash forecast built forward from commitments rather than from a budget, a properly aged list of what is owed and what is owing, the contracts supposed to produce next year's revenue with an honest view of which will renew, the fixed costs the business cannot shed quickly, and the terms of every borrowing. Most companies in difficulty hold some of that material. Few hold it in a form a lender or a purchaser could use, and assembling it is usually the first real piece of work on the file.

The diagnosis matters because the wrong one is expensive in a particular way. Rescheduling debt the company was never going to service turns a bad quarter into a worse year: it adds fees and interest, spends the goodwill of creditors who will not agree twice, and leaves less to distribute and the directors with more to explain. The opposite error is quieter and just as costly, because a timing problem treated as terminal destroys a business nobody needed to lose.

The distinction is not only commercial. Section 212 of Cap. 113 puts both tests in the statute, and a company is deemed unable to pay its debts if either is met. Under section 212(c) it is enough that the company is unable to pay its debts as they fall due, and in deciding that the Court takes account of its contingent and prospective liabilities. Under section 212(d) it is enough that the value of its assets is less than its liabilities, again counting contingent and prospective ones. The cash flow test and the balance sheet test are alternatives, so a company can be solvent on one and insolvent on the other, and only one of them has to be satisfied.

Two further limbs are evidential rather than analytical. Section 212(a) deems the company unable to pay where a creditor owed more than five thousand euro has served a demand at the registered office and the company has for the next three weeks neglected to pay, secure or compound it to the creditor's reasonable satisfaction. Section 212(b) does the same where execution or other process on a judgment is returned unsatisfied in whole or in part. Both are routes a creditor can build deliberately, which is why an unanswered demand is not a correspondence problem.

What follows from the deeming is in section 211, which lists the grounds on which the Court may wind a company up. Inability to pay debts is paragraph (e), and paragraph (f) is the wider ground that it is just and equitable that the company be wound up. The other paragraphs cover a special resolution to be wound up by the Court, failure to deliver the statutory report or hold the statutory meeting, not starting business within a year of incorporation or suspending business for a whole year, and the membership of a public company falling below seven.

Against that stands the rescue procedure, and it is the part of Cap. 113 least often raised early enough to be useful. Part IVA, inserted in 2015, lets the Court appoint an examiner. Under section 202A(1) the conditions are that the company is insolvent or there is a likelihood of insolvency, that no resolution for winding up has been approved and published in the Gazette, and that no winding up order has been made. Under section 202A(2) the Court makes the order only if it is satisfied there is a reasonable prospect of survival of the company and of all or part of its undertaking as a going concern. That is the test the file has to be built to satisfy, and it is a forward looking one.

Section 202A(4) tells a board what the Court will look at. It may take into account whether the company has asked its creditors for significant extensions of time to pay, from which a likelihood of insolvency may reasonably be inferred, and whether it has used the restructuring process in the Central Bank of Cyprus Arrears Management Directives issued under section 41 of the Business of Credit Institutions Law. The accommodations that felt like ordinary commercial management are evidence at this stage. Section 202A(5) excludes credit institutions and insurance undertakings altogether.

Section 202B(1) is wider on who may apply than most boards expect: the company itself, a creditor or contingent or prospective creditor, including an employee, members holding not less than one tenth of the paid up voting capital, a guarantor of the company's obligations, or all of them together or separately. Under section 202B(2) the application proposes the person to be appointed, is supported by evidence showing good reason for it, and, where the company applies, includes a statement of assets and liabilities as at a date not earlier than fourteen days before it is filed.

What the application buys is time, and the statute measures it. Section 202H(1) provides that from the date the application is filed until the end of four months from that date, or the withdrawal or dismissal of the application if earlier, the company is under the protection of the Court. Section 202H(2) sets out what that protection does: no winding up proceedings may be commenced and any winding up resolution passed has no effect; no receiver may be appointed over the property or undertaking, though one appointed before the application may continue; and no attachment in the hands of a third party, sequestration, distress or execution may be levied, no secured creditor may take steps to realise a mortgage, charge, lien, encumbrance or pledge, and no goods held under a hire purchase agreement may be recovered, in each case except with the examiner's consent.

Read together those provisions decide the sequence. The moratorium runs from the date of filing rather than from the appointment, the four months is the outer limit rather than a starting point for negotiation, and the whole thing is unavailable once a winding up resolution has been published or an order made. A board that waits for the petition has usually waited past this.

What a lender is deciding when it is asked to wait

Nobody is being asked for a favour. They are being asked to prefer one estimated outcome over another, and they will do the arithmetic whether or not you have done it for them.

A secured lender asked to hold off is comparing two figures. The first is what it expects to recover if it acts now, net of the cost and the delay of realising whatever it holds and discounted for the chance that the asset is worth less than the valuation on the file. The second is what it expects to recover under the proposal, discounted for the risk that the proposal fails and for the time it will have waited. A restructuring is agreed when the second figure looks better than the first to the person who has to sign for it, and for no other reason.

Two features of the process are consistently underestimated. The first is that the individual across the table generally does not decide. That person prepares a recommendation for someone who will never meet you and will read only what is in front of them, so everything is written twice: once for the meeting and once for the file, and it is the file that governs the outcome. The second is that credibility is scored against your own earlier numbers, so a forecast that quietly contradicts the one given last quarter, without the difference being explained, does more damage than the bad news it was meant to soften. Silence is read as deterioration, because it usually is.

The lender will also want something for waiting: further security, information at intervals rather than annually, milestones with a consequence for missing them, restrictions on distributions and on payments to connected parties, and often personal support from those behind the company. Each has a price, and some shift risk onto individuals in a way that deserves thought before it is conceded. Trade creditors calculate differently again, weighing the loss on the existing balance against the value of continuing to supply a customer, which is why a major supplier is often more useful inside a plan than outside it.

What makes a restructuring proposal credible on paper

The plan that gets agreed is rarely the most optimistic one. It is the one whose author appears to have understood the position before writing.

The numbers

A proposal is read backwards from its cash forecast. That forecast has to be short enough in its intervals to show the pinch points rather than an averaged year, built from commitments rather than aspiration, and reconciled to the last management accounts. It should state its assumptions plainly, including the uncomfortable ones, and show what happens if the few that matter most are wrong.

The plan behind the numbers

Creditors are not asked to believe in a forecast. They are asked to believe in the actions that produce it. If the recovery depends on a cost being removed, the proposal says which cost, by when, at what one-off price, and who is responsible for doing it. If it depends on an asset being sold, it says which asset, on what evidence of value, and what happens to the proceeds. If it depends on new money, it says where the money comes from, on what conditions, and whether the person providing it has committed or is merely willing. Vagueness at those points is the commonest reason a proposal is refused, because it usually means the work has not been done.

The ask

The request should be specific, minimal and dated: what is sought, from whom, for how long, and what the company undertakes to do in return. A proposal seeking indefinite forbearance invites refusal, because it gives the creditor nothing to approve. One that asks for a defined period, with reporting during it and a review at the end, converts an open-ended risk into a decision somebody can take.

What sinks it

Proposals fail on presentation more often than on merit. Figures that do not agree with the accounts or with each other. Payments to connected parties continuing while creditors are asked to wait. A plan that leaves the people who caused the problem in charge of fixing it, with nothing said about that. A schedule of liabilities that turns out to be incomplete, which destroys confidence in everything else in the document.

Buying or selling a business in difficulty

A distressed sale is an ordinary transaction with the time and the comfort taken out of it, which changes what either side can sensibly ask for.

Selling

A business in difficulty is worth most while it still has its customers, its people and its supply, and each week of delay removes some of that, so the timetable is part of the value rather than a detail of the process. A seller needs to know before it starts which parts of the business are saleable, whether the key contracts survive a change of control or require a consent, whether the licences it trades under can pass at all, and which liabilities follow the business rather than staying behind. It also has to decide who is told and when, since an approach that leaks into the supply chain can end the exercise before a price is discussed. Where creditors will not be paid in full, a sale supported by a proper market approach and an independent view of value is far easier to defend afterwards than one agreed quickly with a familiar face.

Buying

A purchaser buys with less information, less time and far less protection. Warranties from a seller that may not survive the year are worth what the seller is worth, so protection comes from the structure of the deal and from diligence aimed at a few decisive questions: what is acquired and what is left behind, what is charged and to whom, whether the people and customers who make the business work will still be there afterwards, whether the price can be held back against what is found, and whether the transaction can be challenged later. Ordinary sale and purchase mechanics are dealt with under corporate and commercial.

The records, and why they degrade

Every route out of difficulty, whether a rescheduling, a sale or a formal process, is assessed on the same material:

• Management accounts and the cash forecasts prepared at the time, including those that turned out to be wrong
• Board minutes and the papers put before the board when each decision was taken
• Facility and security documents, and every waiver, side letter or variation
• Guarantees and other support given by individuals or connected companies
• Correspondence with lenders and major creditors, in date order
• Ledgers showing balances with connected parties, and the basis of transfers between them
• Valuations, and a record of what was paid to whom in the final months, and why

This material decays faster in a company under strain than in any other file. Bookkeeping stops being current when the bookkeeper is the first cost removed, finance staff leave and their mailboxes are closed, and records on an accounting system are lost when the subscription lapses. What survives is whatever the creditor kept.

Where the question is the recovery of money owed to you rather than the position of a company that owes it, that is covered under debt recovery. Where a claim is already threatened or on foot, or urgent relief is in contemplation, see litigation and arbitration.

From first contact to implementation

Every matter is different, but the route is broadly the same. Knowing it in advance makes the cost and the timetable easier to judge.