Embracing a different view to the benefit of important stakeholders

One of the growing trends that I have taken note of in the business rescue/turnaround profession is that there is a growing interest in informal restructuring. But this is not being driven by the candidate that most professionals immediately think of when scrutinizing this trend.

In the past, many companies turned to informal restructuring waving a white flag of surrender. It is the final act of a company that is desperate to avoid the emotional and administrative stress of business rescue. However, many companies are now approaching business rescue professionals with a request to have a look at their company because they feel that it could be on a collision course with trouble. This request is made a lot earlier than the afore mentioned presentation of the flag of surrender. Business owners are aware of the red flags – and pressure points – that lead to distress, and they prefer to have them addressed sooner rather than later.

This trend was confirmed in the recent Deloitte Restructuring Survey which will be discussed next week.  

What is the difference between formal and informal restructuring, and which benefits outweigh the other?

Legally speaking
The Werksmans Attorneys article points out that business rescue proceedings are formal legislated proceedings, under Chapter 6 of the South African Companies Act 71 of 2008 (“The Companies Act”), that are aimed at restructuring the affairs of a company in such a way that either maximises the likelihood of the company continuing in existence on a solvent basis, or results in a better return for the creditors of the company than would ordinarily result from the liquidation of the company. 

It provides for the temporary supervision of the company by a business rescue practitioner; a stay on the rights of claimants against the company which arose prior to business rescue or in respect of property in its possession; and the development and implementation, if approved, of a business rescue plan to rescue the company by restructuring its business, property, debt, affairs, other liabilities and equity.

However, companies often consider informal restructurings as an alternative to business rescue.  An informal restructuring requires a company to work with some or all of its creditors outside of a formal process in order to come to a negotiated solution where the company can return to financial health. Many surveys point out that informal restructuring options seem to have a higher (overall) success rate than business rescue. This suggests that informal restructurings have significant advantages over business rescue.

Increased transparency
The article points out that a survey done in 2016 (which is downloadable below) reported that pre-packs were often used during informal restructurings and that it increased the level of transparency and accountability which built trust in the process.

Further, as informal restructurings are usually confidential, the company’s reputation remains intact, and its market value and relationships with employees, customers and supplier are preserved.

The Werksmans article adds that, an informal restructuring, if run in a sensible and credible manner, can also offer the same protection to the company’s management and directors against incurring personal liability for conducting the business of the company in a reckless manner.  In this regard, the South African Supreme Court of Appeal in the case of Fourie NO v Newton [2010] JOL 26517 (SCA) stated that where there are sufficient other potential or existing sources of funding, it does not follow that where group support is or may be withdrawn, the members of the board would immediately have to shut up shop on pain of contravening Section 424 [of the Companies Act 61 of 1973, which is comparable to Section 77(3)(b) as read with sections 22 and 218 of the Companies Act].

The essential question is whether the board would be acting recklessly in seeking to exploit the other sources of funding. The answer to that question would in the first place depend on the amount of funding required, for how long it would be required, and the likelihood of it being obtained ─ whether timeously or at all; and in the second place, on how realistic the possibility is that the company’s fortunes will be turned around. The second consideration will materially depend on whether there is a credible business plan or strategy that is being or could be implemented to rescue the company. A business that may appear on analysis of past performance to be a hopeless case, may legitimately be perceived as a golden opportunity for a turnaround strategy.

Significant disadvantage
The article points out that the greatest disadvantage of an informal restructuring is that companies cannot rely on the statutory moratorium (stay) which business rescue offers.  That is, a race to collect can easily develop; and creditors may seek to get paid in advance of other creditors.  Aggressive creditors may even apply for liquidation of the debtor company in order to enforce payment.

In addition, section 129(7) of the Companies Act requires a board of a financially distressed company, which does not adopt a resolution placing the company formally in business rescue, to deliver a written notice to each affected person (which includes all creditors, shareholders, employees and trade unions) setting out that the company is financially distressed, why it is distressed, and the reasons for not adopting a resolution to place the company in business rescue.  The likely result of delivering such a notice will be commercial suicide, as most creditors will choose not to continue with the supply goods and services on favourable credit terms.  If such a notice is not delivered, then the directors may be held liable under section 218 of the Companies Act for the damages suffered.

The article adds that, consequently, an informal restructuring must be commenced well before the company becomes financially distressed as defined in the Companies Act.

Early intervention
The article points out that an early intervention will, of course, have the added benefit of increasing the prospect of the informal restructuring succeeding.

The article adds that in other jurisdictions a hybrid approach is often followed, where pre-packs are agreed with the majority of company’s creditors and key suppliers before the company enters into a formal process.  Not only will the company’s relationship with those creditors and suppliers remain intact, but it can also be confident that the restructuring plan will be approved in the formal process with the benefit of the protection that such a formal process provides.

Getting creditors onside
Creditors are just as reticent to go through the business rescue/restructuring process as distressed companies are.

Not only is there an immediate stop on all company proceedings while a diagnoses on the root causes of distress are made, but there is also no guarantee that a creditor will receive all of the money that a distressed debtor owes them. More often than not,  creditors either have to wait for a payment agreement to be made or they have to wait an see what value they would get if the company is placed into liquidation. Then they have to make peace with the fact that they may not get a rand-for-rand value on their payment.

Informing creditors of your intention to enter into informal restructuring lets them know that the company is going through change, but that solutions to the problem are being sought out. This is better than the situations mentioned above. After all, creditors are important stakeholders in the company.