Compromises with Creditors

Businesses get into difficulty for a range of reasons.  When directors have acted in good faith and react to the situation early enough, and where there is a good prospect of recovery, a compromise may be acceptable to the company’s creditors.  The purpose of a compromise proposal is to increase the likelihood of some classes of creditors receiving more than they would if the company were put into liquidation.

Often, voting outcomes rely on the creditors’ opinion of the director(s) but issues can arise when related parties, who may be seen as voting to protect their own interests, are involved.

Statutory Requirements

The statutory requirements of a compromise are set out under Part 14 of the Companies Act 1993 (“the Act”).  Sections 227 to 234 of the Act set out who may put forward a compromise (called the proponent), the information the proponent must compile and provide to creditors of the company who will be affected by the compromise, the effect of the compromise if adopted, and the powers of the Court in relation to compromises. 

The information to be provided to creditors includes –

- Names and addresses of the proponents and the capacity in which they are acting;

- Events that led to the need for a compromise;

- What the compromise proposal entails in relation to the amount and timing of the payment(s);

- An assessment of what creditors would be likely to receive in the event of a liquidation; and

- A copy of the list of creditors who will be affected by the proposal and the amount owing or estimated to be owing to each of them.

Full details of the notice requirements and the duties of the proponent are included in sections 229 and 230 of the Act.

Once approved, a compromise binds all creditors to whom notice of the proposal was given, even those creditors who voted against the proposal and, once payment has been made under the terms of the compromise, any residual balance must be written off by the creditor.

Creditor Approval

For the compromise to go ahead, it must receive the approval of at least 50% by number and 75% by value of the creditors in each class of creditor who vote on the proposal either at a formal creditors’ meeting or by way of postal votes.  A compromise generally requires the approval of all classes of creditors before it is approved.

The correct identification of the different classes, based on their legal rights and their economic interests, is of great importance to the success of the compromise.  If the correct classes are not identified, the compromise may be subject to Court scrutiny pursuant to section 232 of the Act.

Case Study

In this 2016 case, several creditors were not in favour of the compromise proposal, applied to the High Court for orders that the company’s compromise proposal approved by the company’s creditors be set aside.  In this case, a related party creditor waived a security it held over the company’s assets, which allowed it to vote as an unsecured creditor, which meant that three related entities voted as unsecured creditors on the compromise. 

All three related entities agreed that they would not take part in any distribution but still registered their votes in favour of the proposal.  The three related entities accounted for just over 75% of the total value of the debt.  By casting their votes in favour of the proposal, they had ensured that the 75% in value voting requirement was met.   

Some of the smaller creditors were unhappy with the outcome of the voting.  They alleged that the related parties’ conduct was unfairly prejudicial to the challenging creditors.  The High Court agreed and held that the related entities should have been a separate class of creditor for the purpose of voting on the compromise and that the manner in which the creditors’ meeting and voting had been structured was unfairly prejudicial to the challenging creditors.  The High Court found that the compromise would not have been approved if the challenging creditors had been put in a separate class of creditors instead of the general body of unsecured creditors.  The approved compromise was set aside as a result.

The outcome of this case shows the importance of engaging independent and experienced insolvency professionals, who can give unbiased, accurate advice and can assist with putting an accurate proposal to each class/all classes of creditors, as compromise managers.  An accredited insolvency practitioner’s involvement will give creditors confidence that they are being treated fairly and give the proponents confidence that the issues will be put to creditors in a proper manner, which lessens the likelihood of any challenge to the results of the voting.

If you are considering putting a compromise to your creditors or you need some advice on what to do next, come and talk to the McDonald Vague team.  They can discuss the options with you and guide you through the process.

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