When Is a Company Financially Distressed, and What Does It Mean?

Southern Africa Accounting & Auditing The Companies Act When is a company financially distressed, and what does it mean? Chapter 6 of the Companies Act, 2008 (the Act) deals with business rescue. Business rescue is largely self-administered by the company, under independent supervision within the constraints set out by the Act, and could be subject to court intervention, at any time, on application by any of the stakeholders. For purposes of business rescue, it is important to understand the meaning of “financial distress”, as the requirements of Chapter 6 of the Act are triggered as soon as a company is in financial distress. Where a company is in financial distress, and the company failed to either adopt a resolution to go into business rescue, or provide written notice to shareholders, employees and creditors that it decided not to adopt business rescue, the company is in breach of the Act, and the auditors may have to report this as a reportable irregularity. Financial distress The Companies Act defines “financially distressed” in section 128(f), to mean that it appears to be: i. reasonably unlikely that the company will be able to pay all of its debts as they fall due and payable within the immediately ensuing six months, or ii. reasonably likely that the company will become insolvent within the immediately ensuing six months. 1 The first part of the test seems clear. A company will be in distress if there is a reasonable likelihood that the company may reach a position within the next six months where it will no longer be able to pay its debt as it becomes due and payable. “Reasonable likelihood” implies that there must be a rational basis for the conclusion that the company may not be able to pay its debt within the next six months. This conclusion amounts to an educated prediction, based on the current financial position of the company, and considering all relevant factors that may impact the company’s liquidity in the foreseeable future. The second part of the financial distress query deals with insolvency, and here the question often arises as to whether this refers to factual (technical) insolvency or commercial insolvency. There are conflicting views. Some argue that because part (i) clearly deals with commercial insolvency, part (ii) must deal with factual insolvency (i.e. a balance sheet test). In terms of this approach, a company is regarded as technically insolvent (and thus financially distressed) if the liabilities of the company exceed the assets. This approach does not take into account subordination agreements, or any other management action. On the other hand, others believe that one must consider the definition in conjunction with the definition of business rescue and the objectives of the Act pertaining to business rescue. Section 5(1) of the Act requires that the Act must be interpreted and applied in a manner that gives effect to the purposes set out in section 7. As such, when interpreting these particular provisions one needs to consider the purpose of the Act in this regard i.e. to provide for the efficient rescue and recovery of financially distressed companies, in a manner that balances the rights and interests of all relevant stakeholders. In turn, “rescuing the company” means achieving the goals set out in the definition of “business rescue”. Business rescue is defined in section 128(1(b) as “proceedings to facilitate the rehabilitation of a company that is financially distressed by providing for: The temporary supervision of the company, and of the management of its affairs, business and property; A temporary moratorium on the rights of claimants against the company or in respect of property in its possession; and The development and implementation, if approved, of a plan to rescue the company by restructuring its affairs, business, property, debt and other liabilities, and equity in a manner that maximizes the likelihood of the company continuing in existence on a solvent basis or, if it is not possible for the company to so continue in existence, results in a better return for the company’s creditors or shareholders than would result from the immediate liquidation of the company.” 2 It should be clear from the above that business rescue is meant to be employed only where a company requires ‘rehabilitation’, and where there is a need to ‘rescue’ the company. If the purpose of the Act and the purpose of business rescue are considered, it seems unlikely that a company which is factually insolvent, but still able to service its debt, can be regarded as ‘failing’ or financially distressed. If this approach is accepted, part (ii) of the financial distress test should consider the complete financial position of the company rather than merely pure technical insolvency. In order to adhere to the purpose of the Act, and in light of the definition of business rescue, one must consider the complete financial position of the company when determining whether there is a “reasonable” likelihood that the company will be insolvent within six months. In terms of this approach a company will only be regarded as in “financial distress” where it is insolvent even after all other circumstances were considered, including considering alternative fair values of the assets and liabilities, factoring in reasonably foreseeable assets and liabilities, as per the solvency and liquidity test in section 4, as well as considering any other proposed measures taken by management such as subordination agreements, recapitalisation or letters of support. This approach was confirmed in a recent Supreme Court decision in the United Kingdom (BNY Corporate Trustee Services Ltd v Eurosail [2013] UKSC 28) where the court found that the "balance sheet" test for insolvency must take account of the wider commercial context, and that courts must look beyond the assets and liabilities used to prepare a company's statutory accounts when deciding whether or not a company is “balance sheet” insolvent. By employing the narrower definition of “financial distress” (i.e. the factual insolvency test which excludes subordination agreements and other management actions) one arrives at an answer that may not serve the best interests of affected parties (shareholders, creditors and employees). There is very little point in writing to affected parties, informing them that the company is financially distressed when it is in fact perfectly able to continue to do business. Furthermore, start-up companies are generally factually insolvent in the first few years of trading and applying the narrower definition would impair their continued existence. This approach does not support the purpose of the Act, which also purports to promote the economic development of South Africa, entrepreneurship, investment and innovation, and may have a detrimental effect on both the company and its stakeholders. Does the Supreme Court of Appeal provide a possible answer? In Boschpoort Ondernemings (Pty) Ltd v Absa Bank Ltd (936/12) [2013] ZASCA 173 the Supreme Court of Appeal looked at the meaning of the term “solvent’ with respect to the interpretation of sections 79 to 81 of the Act (winding up of solvent companies). Although the judgment was given with specific reference to these particular sections, one may ask whether the Court will follow a similar 3 thought process (and perhaps reach a similar conclusion) with respect to the meaning of the terms ‘solvent’ and ‘insolvent’ used elsewhere in the Act. The court explained the difference between factual solvency (where on the balance sheet the assets exceed the liabilities) and commercial solvency (where the company is able to pay its debts), and confirmed that the principle that a company’s commercial insolvency is a ground that will justify an order for its liquidation has been a reality of law which has served us well through the passage of time. The court continues to state that “[W]ere the test for solvency in liquidation proceedings to be whether assets exceed liabilities, this would undermine there being a predictable and therefore effective legal environment for the adjudication of the liquidation of companies: one of the purposes of the new Act, set out in s 7(l) thereof”. The court further stated that “it must be presumed that the legislature deliberately refrained from defining ‘solvency’. It must have done so with a view to ensuring that the well-oiled machinery of the courts in matters of company liquidations should not stall. The legislature must have been content that prevailing judicial interpretations of solvency and insolvency respectively should continue to have effect. The meaning of those terms must be one that leads to a sensible and business-like result”. The court explained the inter-relation between the Act and sections 344 and 345 of the 1973 Companies Act, which address the circumstances of when a company may be wound up and when a company is deemed unable to pay its debts, and concluded that section 345 should be used to determine whether or not a company is ‘insolvent’ for purposes of section 79 of the (new) Act. Conclusion If one assumes that the court will follow similar reasoning when interpreting the meaning of the word ‘insolvent’ in the definition of financial distress in section 128(f), it would confirm the view above that the legislature intended that business rescue be applied in instances where there is a reasonable likelihood that a company may be commercially insolvent (unable to pay its debt) within the immediately ensuing six months, and as such business rescue can be used to rescue or rehabilitate the failing company (as per section 7). 4 Queries: Dr Johan Erasmus – [email protected] Home | Security | Legal | Privacy Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee, and its network of member firms, each of which is a legally separate and independent entity.

September 26, 2008 OVERVIEW OF THE FDIC AS CONSERVATOR OR RECEIVER This memorandum is an overview of the receivership and conservatorship authority of the Federal Deposit Insurance Corporation (the “FDIC”). In view of the many and complex specific issues that may arise in this context, this memorandum is necessarily an overview, but it does give particular reference to counterparty issues that might arise in the case of a relatively large complex bank such as a significant regional bank and outlines elements of the FDIC framework which differ from a corporate bankruptcy. This memorandum has three parts: (1) background on the legal framework governing FDIC resolutions, highlighting changes and developments since the 1990s; (2) an outline of six distinctive aspects of the FDIC approach with comparison to the bankruptcy law provisions; and (3) a final section illustrating issues and uncertainties in the FDIC resolutions process through a more detailed review of two examples – treatment of loan securitizations and participations, and standby letters of credit.1 Relevant additional materials include: the pertinent provisions of the Federal Deposit Insurance (the "FDI") Act2 and FDIC rules3, statements of policy4 and advisory opinions;5 the FDIC Resolution Handbook6 which reflects the FDIC's high level description of the receivership process, including a contrast with the bankruptcy framework; recent speeches of FDIC Chairman 1 While not exhaustive, these discussions are meant to be exemplary of the kind of analysis that is appropriate in analyzing any transaction with a bank counterparty. 2 Esp. Section 11 et seq., http://www.fdic.gov/regulations/laws/rules/1000- 1200.html#1000sec.11 3 Esp.

William & Mary Law Review Volume 21 (1979-1980) Issue 3 Combined Issues 3 & 4 Article 3 April 1980 Liquidation Bankruptcy Under the '78 Code Doug Rendleman Follow this and additional works at: https://scholarship.law.wm.edu/wmlr Part of the Bankruptcy Law Commons Repository Citation Doug Rendleman, Liquidation Bankruptcy Under the '78 Code, 21 Wm. & Mary L. Rev. 575 (1980), https://scholarship.law.wm.edu/wmlr/vol21/iss3/3 Copyright c 1980 by the authors. This article is brought to you by the William & Mary Law School Scholarship Repository. https://scholarship.law.wm.edu/wmlr LIQUIDATION BANKRUPTCY UNDER THE '78 CODE DOUG RENDLEMAN* TABLE OF CONTENTS I. BACKGROUND . 577 II. BANKRUPTCY UNDER THE '78 CODE . 579 A. The Bankruptcy Court and Its Power . 579 B. Procedure . 581 1. Voluntary Petitions . 582 2. Involuntary Bankruptcy . 583 C. The Bankruptcy Process . 584 1. Automatic Stay . 586 2. Interim Trustee . . 588 3. Creditors' Meeting . 589 4. Electing a Trustee . 591 D. The Estate . 594 1. Abandonment-Assumrptio Rejection . 601 (a) Abandonment . 602 (b) Rejection and Assumption . 603 III. THE TRUSTEE'S POWER TO AVOID . 609 A. Section 544 Avoidance Powers . 610 1. The Decline of Moore v. Bay . 615 B. Statutory Liens .

Liquidators, Receivers and Examiners Their duties and powers A quick guide Introduction We have produced this information booklet to explain the powers, duties and responsibilities of liquidators, receivers and examiners under the Companies Acts. What are liquidations, receiverships and examinerships? The liquidation of a company is also known as ‘winding up’ a company. The process takes the company out of existence in an orderly way by paying debts from any available assets. Receivership is used by banks or other lenders to sell a company asset that was promised to them if the company failed to repay its loan as agreed. Examinership is a process that protects a company from its creditors (the people to whom it owes money) while efforts are being made to keep it running as a going concern. What are liquidators, receivers and examiners? A liquidator is the person who winds up a company. A receiver is the person who sells particular company assets on behalf of a lender. Where a loan is secured on a company’s entire business, a ‘receiver manager’ can be appointed as manager of the business during the receivership. Once a receiver raises enough money to pay back the debt, their job is finished. Liquidators, Receivers and Examiners Their duties and powers Examiners consider if a company can be saved and, if it can, they prepare the rescue plan. Who can act as liquidators, receivers or examiners? Liquidators, receivers and examiners do not need to have any specific qualifications under the law. However, they are usually practising accountants. To make sure that liquidators, receivers and examiners work independently of the company, they cannot be: • a director or employee of the company; or • a family member, partner or employee of a director.

NBER WORKING PAPER SERIES REORGANIZATION OR LIQUIDATION: BANKRUPTCY CHOICE AND FIRM DYNAMICS Dean Corbae Pablo D'Erasmo Working Paper 23515 http://www.nber.org/papers/w23515 NATIONAL BUREAU OF ECONOMIC RESEARCH 1050 Massachusetts Avenue Cambridge, MA 02138 June 2017 We thank Gian Luca Clementi, Hulya Eraslan, and Vincenzo Quadrini as well as seminar participants at Carnegie Mellon, Rice University, University College London, Ohio State University, BI Norwegian Business School, Bank of Canada, Konstanz University, Macro Finance Society, Society for Economic Dynamics Meetings, and the Econometric Society Summer Meetings for helpful comments. The views expressed in this paper are those of the authors and do not necessarily reflect those of the Federal Reserve Bank of Philadelphia, the Federal Reserve System, or the National Bureau of Economic Research. NBER working papers are circulated for discussion and comment purposes. They have not been peer-reviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications. © 2017 by Dean Corbae and Pablo D'Erasmo. All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including © notice, is given to the source. Reorganization or Liquidation: Bankruptcy Choice and Firm Dynamics Dean Corbae and Pablo D'Erasmo NBER Working Paper No. 23515 June 2017 JEL No. E22,G32,G33 ABSTRACT In this paper, we ask how bankruptcy law affects the financial decisions of corporations and its implications for firm dynamics. According to current U.S. law, firms have two bankruptcy options: Chapter 7 liquidation and Chapter 11 reorganization.

April 2020 COVID-19 AND EXAMINERSHIP – WHAT THE EXAMINER WANTS YOU TO KNOW For further information Following our articles on: on any of the issues discussed in this article 1. Emergency liquidity for businesses adversely affected by the please contact: economic impact of the COVID-19 Pandemic: https://www.dilloneustace.com/legal-updates/the-abc-and- de-of-emergency-liquidity-solutions; 2. Standstill Agreements as the first item out of the financial first aid kit: https://www.dilloneustace.com/legal- updates/running-to-standstill; and 3. Ireland’s public sector lifeboat for SMEs and small mid-cap businesses: https://www.dilloneustace.com/legal- updates/liquid-spirit-government-guaranteed-working-capital- facilities-for-irish-smes-adversely-affected-by-the-covid-19- pandemic, Jamie Ensor Partner, Insolvency we turn to the main items for consideration by stakeholders in DD: + 353 (0)1 673 1722 circumstances where examinership is the chosen mechanism for [email protected] rehabilitation and long term recovery for a company in financial difficulty as a consequence of the Pandemic. Testing times In the current climate, it is unfortunately all too possible to imagine a business that has dealt with a severe business interruption by following the government’s advice and has: • lowered variable costs (while participating in the COVID-19 Wage Subsidy Scheme); • delayed discretionary spending on replacing or improving Richard Ambery assets, new projects and research and development; Consultant, Capital Markets DD: + 353 (0)1 673 1003 [email protected]

Schemes of Arrangement as Restructuring Tools Since the start of the current credit crunch there has been a huge increase in the use of schemes as a restructuring tool. In most cases a scheme will be the fall-back strategy for use in cases where consensual changes to creditors’ and/ or shareholders’ rights under finance documents cannot be negotiated. Often the need for a scheme will fall away, but the prospect of a scheme will have helped deliver the consensus. So as well as those schemes that see their way through to implementation, there are many draft schemes in the marketplace. The purpose of this client note is to provide an overview of the use of schemes as a creditor restructuring tool and to highlight some of the key practice points. 1 What is a scheme? constituencies. The dominant driver of the creditor negotiations will usually be the A scheme of arrangement is a very flexible and creditor(s) who hold security and/or enjoy a long-established Companies Act procedure priority in repayment on an enforcement at the which can be used to vary the rights of some or point at which the value of the business breaks all of a company’s creditors and/or shareholders. (known as the fulcrum). That said, the question As long as a scheme receives the support of the of the value of a business will invariably be a statutory majorities of each class of creditor contentious point between the various stake- and/or shareholder whose rights are affected by holders in a restructuring and the value of the it, and the court sanctions it, the scheme will be business is in any event likely to move during binding on all creditors and/or shareholders, the course of restructuring negotiations as the including those within each class voting against business continues its operations.

The Cross-Border Insolvency Concordat and Its Application in the Us-Switzerland Case Re Aioc Resources

THE CROSS-BORDER INSOLVENCY CONCORDAT AND ITS APPLICATION IN THE US-SWITZERLAND CASE RE AIOC RESOURCES Stefan Landolt Zurich, Switzerland [email protected] April 2004 Paper presented within the LL.M. Finance course ‘International Insolvency Law’, led by Professor Dr. Bob Wessels Institute for Law and Finance, Johann Wolfgang Goethe University, Frankfurt/Main, Germany I. Introduction As a direct consequence of globalization over the last decades –i.e. the growing importance of international trade, investments and multinational operations of corporations - countries have been increasingly confronted with multinational defaults of the same debtor. This trend is unlikely to slow in the future while legislation seems –so far - unable to keep pace with. The problem arising from this development lies in the potential conflict among different proceedings opened in several countries. Such multiple proceedings are threatening the widely respected principles of equal treatment and the liquidation of all assets of a debtor to the best satisfaction of all creditors1. A reliable insolvency law framework that is predictable and equitable, however, is an essential requirement for well functioning cross-border markets. Some of the negative implications of cross-border insolvencies may be precluded or at least reduced by virtue of cooperation between the involved judicial authorities (i.e. administrator, trustee or liquidator). The cornerstones of such coordination can in appropriate situations be outlined in a case-specific cross-border judicial agreement (a so-called protocol). Part II of this paper briefly touches the traditional approaches in multinational insolvency proceedings (territoriality vs. universality) and its practical implementations in common law (i.e.

Schemes of Arrangement as Restructuring Tools Since the start of the current credit crunch there has been a huge increase in the use of schemes as a restructuring tool. In most cases a scheme will be the fall-back strategy for use in cases where consensual changes to creditors’ and/ or shareholders’ rights under finance documents cannot be negotiated. Often the need for a scheme will fall away, but the prospect of a scheme will have helped deliver the consensus. So as well as those schemes that see their way through to implementation, there are many draft schemes in the marketplace. The purpose of this client note is to provide an overview of the use of schemes as a creditor restructuring tool and to highlight some of the key practice points. Timeline Over time, the English courts have become increasingly willing to accept companies’ innovative arguments regarding the establishment of a “sufficient connection” with England for the purposes of a Scheme. German company English governing English governing English governing Dutch company law and exclusive German governing law and exclusive law and exclusive jurisdiction New York governing law, amended to jurisdiction jurisdiction law and non- English law No UK lenders and Mostly UK lenders Mostly UK lenders exclusive jurisdiction no other connection No COMI shift to the UK establishments Some UK customers with England COMI shift to the UK UK 2010 2011 2012 2013 2014 1 What is a scheme? 2 Who can use a scheme? A scheme of arrangement is a very flexible and Schemes need to be implemented in accordance long-established Companies Act procedure with the Companies Act 2006 and involve two court applications.

Insolvency and Bankruptcy Board of India 27th April, 2019 Discussion Paper on Corporate Liquidation Process along with Draft Regulations This discussion paper discusses various issues, that have been brought up by stakeholders, relating to liquidation process under the Insolvency and Bankruptcy Code, 2016. Reorganisation of Corporate Debtor 2. The Insolvency and Bankruptcy Code, 2016 (Code) provides for a market mechanism for rescuing, failing but viable corporate debtors (CDs) and liquidating, failing and unviable ones. There is no precise mathematical formula, however, to identify a CD as an unviable one. The market may wrongly classify a viable CD as unviable and vice versa because of market imperfections. Accordingly, it may rescue an unviable CD and close a viable one. Rescuing an unviable CD may not be of great concern as it can be closed later. Closing a viable CD, however, is of grave concern as it impacts the daily bread of its stakeholders and it cannot be rescued later. The Code, therefore, has adopted a very cautious approach and envisages the market to make an endeavour first to rescue the CD and liquidate it after arriving at a conclusion that it is not viable. It also envisages course correction, if the market wrongly proceeds to liquidate a viable CD. The law does not envisage the State to intervene in wrong identification but provides a flexibility to market to make course corrections if it so wishes. The provisions in the law and judicial pronouncements support this, as explained hereunder: 2.1 The Code is a law for

CAN A STRUGGLING COMPANY EVER JUSTIFY PAYING SOME - BUT NOT ALL - OF ITS CREDITORS? In light of the financially fragile state some businesses are finding themselves in as result of COVID-19, we discuss in this briefing note when – if ever – payments or other benefits can be given to some creditors but not others, and when such a transaction might fall foul of the unlawful preference provisions of UK insolvency legislation. This is a fast-moving area and this briefing note sets out the position as at 7 April 2020. WHY ARE TRANSACTIONS CHALLENGED? When a company enters a formal insolvency procedure, the insolvency practitioner appointed Unlawful preference as liquidator or administrator of the company will review the transactions into which the transactions can be company entered in the run-up to its insolvency. They will then assess whether any of those unwound, leading to transactions might be challenged under the ‘antecedent transactions’ provisions of UK court orders to repay insolvency legislation. This provides an opportunity to bring money or other assets back into funds or return the company’s estate, which increases the pool of assets from which a distribution can be property. made to the company’s creditors. WHAT IS AN UNLAWFUL PREFERENCE? An unlawful preference can be challenged by an administrator or liquidator under section 239 of the Insolvency Act 1986 (the “Insolvency Act”). Under these provisions, a company gives a preference if: • the company does anything (or suffers anything to be done) which has the effect of putting

NAIC Model Laws, Regulations, Guidelines and Other Resources—October 2007 INSURER RECEIVERSHIP MODEL ACT Table of Contents ARTICLE I. GENERAL PROVISIONS Section 101. Construction and Purpose Section 102. Conflicts of Law Section 103. Persons Covered Section 104. Definitions Section 105. Jurisdiction and Venue Section 106. Exemption from Fees Section 107. Notice and Hearing on Matters Submitted by the Receiver for Receivership Court Approval Section 108. Injunctions and Orders Section 109. Statutes of Limitations Section 110. Cooperation of Officers, Owners and Employees Section 111. Delinquency Proceedings Commenced Prior to Enactment Section 112. Actions By and Against the Receiver Section 113. Unrecorded Obligations and Defenses Of Affiliates Section 114. Executory Contracts Section 115. Immunity and Indemnification of the Receiver and Assistants Section 116. Approval and Payment of Expenses Section 117. Financial Reporting Section 118. Records ARTICLE II. PROCEEDINGS Section 201. Receivership Court’s Seizure Order Section 202. Commencement of Formal Delinquency Proceeding Section 203. Return of Summons and Summary Hearing Section 204. Proceedings for Expedited Trial: Continuances, Discovery, Evidence Section 205. Decision and Appeals Section 206. Confidentiality Section 207. Grounds for Conservation, Rehabilitation or Liquidation Section 208. Entry of Order Section 209. Effect of Order of Conservation, Rehabilitation or Liquidation ARTICLE III. CONSERVATION Section 301. Conservation Orders Section 302. Powers and Duties of the Conservator Section 303. Coordination With Guaranty Associations and Orderly Transition to Rehabilitation or Liquidation ARTICLE IV. REHABILITATION Section 401. Rehabilitation Orders Section 402. Powers and Duties of the Rehabilitator Section 403. Filing of Rehabilitation Plans Section 404. Termination of Rehabilitation Section 405. Coordination with Guaranty Associations and Orderly Transition to Liquidation ARTICLE V.

Utah Code 7-2-9 Conservatorship, receivership, or liquidation of institution -- Appointment of receiver -- Review of actions. (1) Upon taking possession of the institution, the commissioner may appoint a receiver to perform the duties of the commissioner. Subject to any limitations, conditions, or requirements specified by the commissioner and approved by the court, a receiver shall have all the powers and duties of the commissioner under this chapter and the laws of this state to act as a conservator, receiver, or liquidator of the institution. Actions of the commissioner in appointing a receiver shall be subject to review only as provided in Section 7-2-2. (2) (a) If the deposits of the institution are to any extent insured by a federal deposit insurance agency, the commissioner may appoint that agency as receiver. After receiving notice in writing of the acceptance of the appointment, the commissioner shall file a certificate of appointment in the commissioner's office and with the clerk of the district court. After the filing of the certificate, the possession of all assets, business, and property of the institution is considered transferred from the institution and the commissioner to the agency, and title to all assets, business, and property of the institution is vested in the agency without the execution of any instruments of conveyance, assignment, transfer, or endorsement. (b) If a federal deposit insurance agency accepts an appointment as receiver, it has all the powers and privileges provided by the laws of this state and the United States with respect to the conservatorship, receivership, or liquidation of an institution and the rights of its depositors, and other creditors, including authority to make an agreement for the purchase of assets and assumption of deposit and other liabilities by another depository institution or take other action authorized by Title 12 of the United States Code to maintain the stability of the banking system.