Most people will be familiar with the examinership process and a number will have come across a Section 450 Scheme of Arrangement under the provisions of that section in the Companies Act 2014. Both are reasonably worthwhile procedures for the right circumstances. There is another approach to trying to come to an arrangement with creditors which has the benefit of being provided for in legislation and has statutory backing.
It is a little known procedure but in the right circumstances it can be very worthwhile and it has some distinct advantages:
- Not expensive
- Directors remaining in control
- Contains a cram down mechanism
- Plenty of time to develop and complete the scheme
The provisions are set out in Section 676 of the Companies Act 2014, which is essentially a replica of the old Section 279 of the Companies Act 1963.
Section 676 allows for a scheme of arrangement under its provisions and the form of scheme has some serious advantages over the other schemes mentioned above. The wording of the Section throws some light on how such a scheme can be developed and proposed to company creditors.
Section 676 sets out:
|“Provisions as to arrangement binding creditors|
|676. (1) Any arrangement entered into between a company about to be, or in the course of being, wound up and its creditors shall, subject to the right of appeal under this section, be binding on the company if sanctioned by a special resolution and on the creditors if acceded to by three-fourths in number and value of the creditors.|
|(2) Any creditor or contributory may, within 21 days after the date of completion of the arrangement, appeal to the court against it, and the court, on the hearing of the appeal, may, as it thinks just, amend, vary or confirm the arrangement.|
|(3) This section is in addition to the circumstances in which a compromise or arrangement in relation to a company may become binding under Chapter 1 of Part 9 “|
As can be identified from the section outlined above there are some basic points to be made about this scheme:
- It needs the approval of creditors and separately must be approved by the members by way of a special resolution
- The majority needed is quite different to most other majorities required in company law – the creditors must approve the terms of the scheme by a 75% majority in number and value of ALL creditors
- There is no need for a meeting of creditors in this case and instead what is required is written acceptance from creditors
- Unlike any other scheme there is no time frame within which approval must be obtained which gives the promoter(s) of the scheme an advantage in getting support
- Unlike in other schemes, there is no provision for classes of creditors and the creditors are treated as a single pool of creditors from whom the dual majority must be secured. There are pros and cons to that single class
- The scheme can be promoted either before or after liquidation has commenced and there is no qualification as to the type of liquidation. That is, if creditors assent to a scheme and receive their entitlement then it could be liquidated as a solvent liquidation. That could be of serious benefit to parties who, for reputational reasons, do not want an insolvent liquidation flagged against their name(s)
- There is no court involvement in this scheme other than where a creditor makes an application to court within 21 days from approval or completion of the scheme. Given the cost of a High Court application, a creditor would need to be seriously aggrieved and have the means to fund a court case
- The 676 process is essentially private with nothing filed in the CRO other than the special resolution passed by the members
- The process works best with a relatively small pool of creditors given the level of contact needed
This office has been involved in a number of these schemes over the years with the majority being successful. In a recent scheme, a building company had aggregate creditors of some €2 million and its main asset had a value of some €200k. The director did not want to place the company into insolvent liquidation mainly for reputational reasons and he had been examining a scheme of arrangement process for some months with his advisors. The company could not be put into an examinership process because it had ceased to trade and therefore did not meet one of the basic grounds for an examinership. In any event, an examinership process would have been unduly expensive and used up much of the free funds available
We issued a detailed proposal and looked for creditors to accept the terms of the scheme. There was a generally positive response which allowed us build up close to 50% in number and value over the first two weeks but it became clear that there was a pool of creditors who were not prepared to accept the terms of the scheme without further information. Over an extended period, we secured more information from the director as well as third party professional advisors and solicitors in order to provide information sought by the creditors.
A key learning point from this case was the need to have corroborative material that supported the director’s views of the company and the available assets – in fact after the director had trouble getting information from JV partners and advisors, the creditors eventually accepted less information than they had looked for.
In this particular case, we also convened a meeting of creditors as a number of creditors wanted such a meeting because it gave them a chance to question of the director.
Eventually after some time, we secured the approval of some 95% in value and 87% in number and we were able to complete the scheme and issued the return of 20c in the € to the creditors concerned. It is worth noting that a number of the creditors had insurance in place with credit insurers. In all cases involving the credit insurers; as long as they were satisfied that it was a rational decision they allowed their clients to accept the terms of the scheme.
The above is an example of a case where the 676 scheme worked.
Approach to creditors
In our experience it is usually worthwhile contacting a number of creditors before getting involved in drafting a proposal to see if creditors will be prepared to consider it – not approval in advance but ask them to confirm that they will be prepared to consider a proposal.
In general, we do not tend to canvass creditors and consider that is an approach to be taken by the directors although where creditors contact us then we engage with them. The rationale for this approach is to ensure that creditors can see that there is some independence.
If it is necessary then we will convene a meeting although there is limited purpose unless creditors are willing to sign off on a form after a meeting. The meeting really is of use to allow questions and usually the directors should be helped by an advisor at the meeting.
Trading or cessation of trade
There is a fundamental point to these schemes which is the phrase in the section “ …. about to be, or in the course of being, wound up”
This section has never been the subject of any material judicial consideration in this jurisdiction so the wording of the section has not to the best of my knowledge been considered. I believe that in ideal circumstances there is an argument that the entity should be placed into liquidation after the scheme has been voted on and the return has been paid out to creditors. In my view, where creditors have accepted the terms of the proposal and the return has been paid out as agreed then the liquidation can be a members voluntary liquidation. The creditors have after all compromised their claims (or been crammed down), received what they are owed and are no longer creditors.
In some of the cases I have been involved in the company has remained in place although it is arguable that the arrangement has not been “completed”. That is a matter or risk to be considered on a case by case basis.
Where there is an intention to continue trading while the creditors are considering the proposal, the company may have to continue its trade and where it does so, then the directors will need to make sure the company has access to working capital to allow the business to continue and meet its obligations as they fall due. I do not consider there is much room to take credit unless the directors are entirely comfortable that the scheme will be approved or the creditors are aware that they are advancing credit and they accept the risks.
Where there is a secured creditor involved in providing overdraft facilities or the creditor has security on a category of assets then the directors and whoever is helping them, will have to get the agreement of the secured creditors to use those assets to fund the trade. An example would be discounted debts which clearly would be the property of the secured creditor. It would be usual for an invoice discounter to allow proceeds of debts created in the arrangement to be drawn down for working capital but that area needs to be tightly managed.
If a company has a level of debt written off then it will give rise to a trading gain. Where such a gain is generated that may well be taxable and while I am not necessarily aware that this has been observed in schemes, it is arguable that the tax should be discharged. It is clear that where there are substantial losses then those losses should shelter the company from a tax hit.
A benefit to directors of this type of proposal is that the scheme is essentially a debtor in possession process which leaves directors in control and allows them to continue with the business or whatever is proposed to happen to the assets. . That may not be what creditors will feel confident about and one way of addressing those legitimate concerns of creditors is to put in place a supervisor position and that could the advisor involved in preparing the proposal to creditors. It does not have to be and where there is a concern about conflict of interests, the scheme could provide for a named officeholder to be appointed if the scheme is approved.
That way, creditors can see that the cash pool from which they should receive the promised return, will be “controlled” by a third party and not the directors.
This scheme is an economic way to push a return to creditors and where the creditors accept the proposed return, it will likely mean that no ODCE obligation will arise.
The scheme is a contract between the company and its creditors and this contractual base allows a scheme to be drafted however is wanted
The single class of creditors helps avoid the problem of a class potentially blocking a scheme as for instance in a S450 scheme or potentially in an examinership scheme. Equally where there is one material creditor, then that creditor’s buy in will be necessary. Needless to say, all creditors (other than priority creditors such as Revenue) should receive the same return.
Article by Barry Donohoe, Director of Restructuring Services