Director: ReVive Advisory & Turnaround
First to identify the classes of creditors which need to Directors are obliged to regularly review the solvency and liquidity of the company. That involves more than a cursory review of the cash flow forecast but also the risks and outlook for the Company. That diagnostic can result in the conclusion that some form of intervention is required.
When that involves a financial restructuring, and the banks and other funders are approached the solution is often an informal workout with creditors. Where the company has a substantial shareholder who believes there is a viable road to recovery that can result in a turnaround strategy and recapitalisation of the Company. These interventions are often done informally with multi bank creditors and financiers.
What are the rules of engagement between parties in multi creditor workouts? In this series of articles, I will explore the guidance principles set out by the International Association of Restructuring, Insolvency & Bankruptcy Professionals (INSOL International) given by Insol International and try to make sense of how those rules may play out in practice. This is an introduction only not a comprehensive review. The original guidance can be found here.
Let’s take a look at the first INSOL principle; where a debtor is found to be in financial difficulties, all relevant creditors should be prepared to cooperate with each other to give sufficient (though limited) time (a “Standstill Period”) to the debtor for information about the debtor to be obtained and evaluated and for proposals for resolving the debtor’s financial difficulties to be formulated and assessed, unless such a course is inappropriate in a particular case.
This is often the “Independent business review” requested by the principal financiers or Bankers and performed by an independent third party. In some cases, a “restructuring officer” is appointed to the Board to perform the review in large organisations.
All relevant creditors
Although the main impetus and interest in developing a global approach to multi-creditor restructurings has come from the financial community, regulators and other official bodies, the approach advocated by the principles can be applied to creditors other than financial institutions in appropriate cases.
The main objective of the global approach is to assist in the process of rescue (not Business Rescue or Chapter 6) or orderly workout. Accordingly, the approach should ideally be applied to all creditors whose co-operation is needed to make any attempted rescue or workout succeed.
On the other hand, there is usually merit in limiting the number of participants to the minimum necessary to see that objective achieved.
Be included in the process and then to decide which creditors in the affected classes are to be included. This could include major customers, supplier creditors, credit insurers and others involved in the provision or management of credit. However, it must be recognised that the identity of relevant creditor classes will vary from case to case and with the passage of time. With banks and other financial institution creditors, it is usual to include all the financial creditors (including those creditors providing interest rate, foreign exchange and other hedging or derivative products to the debtor) in the class regardless of the size of their exposure or the nature of their facilities. The process tends to rely on the internal financial records of the Company in distress, but it is always advisable to scrutinise the claims and their legal foundations as part of the Business review.
INSOL adds that one rationale for including all financial creditors is that, even though in a particular case one financial creditor might be less exposed than others and therefore have less interest in any rescue attempt, this relative position might be reversed in another case. Accordingly, the long-term and mutually beneficial advantages to be gained by financial creditors supporting and co-operating with each other about a co-ordinated approach to debtors in difficulty are reasonably clear. Financial creditors should, as a matter of principle, be prepared to support other financial creditors’ attempts to rescue businesses unless it is to their commercial disadvantage to do so. This is an act of mutual respect and in a market as small as SA is of vital importance in an informal workout.
Where it is proposed to include creditors who fall outside the traditional categories of financier in the rescue process, the argument for including all creditors within a class diminishes and it is usually simply a question of deciding whether the non-financial creditor has to be included to enable the rescue to progress. This can include Employees and suppliers of trade finance.
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Care must be taken by Directors that in starting this process they do not commit an Act of Insolvency giving a creditor a right to bring a liquidation application. (often abused to give the creditor more negotiating power and is really against the spirit of a workout).
Giving time to the debtor (the Standstill Period)
Where a debtor is in financial difficulties, its creditors tend to have two main strategies.
The first is to press the debtor for immediate repayment of the debt or the provision of security in the hope of removing or reducing the exposure.
In South Africa, attempts by a creditor to pressurise a debtor close to insolvency into giving it favourable treatment compared to other creditors can be open to legal challenge based on preference. A common action is for a cession holder over stock is to perfect a general Notarial Bond over stock and to wait the six months for it to mature before taking further action. If this is a pre-existing right, it may be successful. If it is additional security, it could be a preference.
In others, however, pressurising a debtor in this way protects the creditor from a preference challenge and therefore, if a creditor is successful in persuading a debtor to pay it off or to give it security, it may well be able to keep the benefit deriving from its tactics.
The problem with the “each creditor for itself” approach is that, even if such a strategy can in theory benefit the creditor in a way which avoids subsequent legal challenge, the likelihood is that it will, either by itself or by provoking other creditors into following a similar approach, result in the debtor being forced into formal insolvency, thereby destroying any prospective advantage the creditor was seeking to gain. This is very common precursor with the debtor seeking the Chapter 6 protections of a formal Business Rescue approach. It is this defensive response that contributes to the poor outcomes experienced in Business Rescue and these are often the “outcome better than liquidation” business plans we see.
This reality has caused the experienced financial creditors to conclude that their interests will usually be better served by a co-ordinated and measured response to the debtor in difficulty. It has also led debtors and their advisers to realise that giving in to pressure by one creditor usually destroys any chance of persuading the other creditors to hold off and give time for a rescue attempt. This is the flaw in large multi creditor workouts. One aggressive small creditor can derail the whole workout.
It also why we advise our clients to engage with their banks prior to Business Rescue being initiated. The process of building trust and restoring confidence begins in exploring the choices. Of course, the bank may respond with a hostile and aggressive approach and simply perfect their security, that may happen even if there is no consultation but at least the trust relationship is less damaged. It also allows the Business Rescue Practitioners to engage in a positive way rather than spending time apologising for being in the room.
The INSOL principle points out that the relevant creditors will often choose as the Standstill Commencement Date the date on which the financial creditors as a group (or at least some significant group or class of their number) were first notified by the debtor or by another financial creditor of a meeting called to allow the debtor to explain its position to the relevant creditors. Although a financial creditor has no duty to inform other financial creditors if it believes a debtor is in difficulty, where confidentiality restrictions permit this often does occur and quite frequently one financial creditor will press the debtor to make a presentation to all its financial creditors so that standstill arrangements can be put into effect.
In some cases, one or more financial creditors may have anticipated the problems of the debtor and managed down their exposure to a significant extent before other creditors have realised the potential difficulties and before any meeting of financial creditors has been called. Such a creditor may well benefit in the short term, but, particularly in cases where dramatic changes have occurred in its exposure over a relatively short period, it may have trouble in persuading others to lend their support to a rescue.
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The Standstill Period – Duration
INSOL points out that the length of the standstill period will vary from case to case, depending on the complexity of the information to be gathered and the nature of any restructuring proposals, but should be no longer than necessary for the carrying out of the above process in each case, since any unnecessary delay is likely to prejudice the prospects of a successful outcome.
It is customarily for an initial period of weeks or months, usually with a capacity for extension if all relevant creditors so agree.
These are complex legal and financial risks that need to be navigated in commencing an informal multi creditor workout. These principals explain the timelines included in Chapter 6 proceedings and the crucial need for a multi creditor committee (something some Practitioners avoid seeking rather to divide and concur than to seek consensus.)
Conclusion
It is always advisable to take Professional advice before commencing an informal workout. Take due care in selecting your advisors, the Company is in a vulnerable state and subject to predatory behaviours.
Informal workouts are an everyday event and often an internal process undertaken by your bankers when doing their annual review and advising on financial product choices and their required security for supporting the business.
When the indebtedness starts impacting forecast liquidity and solvency and that is combined with unfavourable social and economic events consult with your banks about your choices and select advisors who can help you navigate an uncomfortable few months.
