What are the ingredients of a successful creditor compromise?



Discussion of corporate insolvency in New Zealand is thin on the ground at best. This is understandable - it is a subject involving the restructuring, reallocation or liquidation of assets, and can be delicate business for company directors.

However, this lack of confidence in open discussion of what happens can mean that debtors and creditors overlook the alternatives to liquidation or business restructuring. These can be formal and informal - and of all available paths, many businesses will find a creditor compromise ticks all the boxes. Here is what involved parties need to produce a successful compromise.

1) Strong, clear communication from debtors

A creditor compromise is often the first port of call when a business struggles to pay its debts. As it is an informal process, it is crucial that directors get on the front foot with clear, transparent communication about what they hope to achieve. It can be proposed by either debtors or creditors.

A creditors compromise can help NZ businesses avoid liquidation.A creditors compromise can help NZ businesses avoid liquidation.

Directors need to illustrate the level of debt, current assets, ongoing company structure and what they can pay to creditors over a set period of time. Essentially, the start of a creditor compromise is drafting up a game plan for how debts could potentially be repaid.

Creditors do not have to accept this, but for a successful compromise, the first step must be a clear and transparent plan.

2) Significant paperwork to prove the case

A successful creditor compromise requires sound financial reporting. Without the paperwork to back up a suggested compromise, creditors may not have any confidence in a director's ability to execute the plan.

A successful creditors compromise requires sound financial reporting.

An inventory of assets, sufficient cash flow and profit / loss statements, as well as bank statements and invoices to ensure money will continue coming in can all strengthen the case for a creditor compromise. Directors (or other proposers) should also have a detailed record of all creditors, with evidence to indicate that as many creditors as possible can be satisfied with the new strategy.

3) Professional legal advice

While a creditor compromise is an informal process, it nonetheless requires a trained legal eye. Community law centres, private practitioners or insolvency specialists can point proposers in the right direction here, helping to shape a sound compromise that stands a good chance of being accepted.

At McDonald Vague, our director Peri Finnigan is the person to talk to for discussions around the feasibility of a creditor compromise.

4) A case for everyone

Creditor compromises must be a solution for the bulk of parties owed money. When a proposal is made, creditors will hold a meeting to vote on whether it goes ahead. A successful compromise requires the approval of at least 50 per cent of creditors by number, and by 75 per cent in terms of money owing.

A majority of creditors must agree for a compromise to be put into place.A majority of creditors must agree for a compromise to be put into place.

This means directors or proposers must establish a compromise plan that caters to the majority of creditors - focusing on the primary debts is only a good starting point. If creditors feel they have been given short shrift, they may apply to nullify the compromise which can lead to liquidation. In cases where even one party can successfully argue a compromise was prejudicious, the entire agreement can fall apart.

5) Realistic terms of debt

A creditor compromise is not just a proposal to help a company in debt survive - it is a restructuring of the very terms on which that debt was established. It can re-establish new rights and responsibilities for both parties, and as such must be a realistic reworking of what is owed.

If incoming legislation is going to impact a company's ability to make money, this should be factored in. Assets to be sold or new money to come in should be clearly identified, as well as how this helps the business to continue making money. Realistic time frames and amounts should be given, as aspirational figures without sound backing can worsen a business' financial standing.

6) Good faith from all parties

A creditors compromise is a show of good faith.

As the Companies Act 1993 defines, creditors are those who could reasonably make a claim under section 303 if a business went into liquidation. Essentially, they are parties likely to receive their money one way or another if the debtor has the assets or cash to pay them.

In this sense, a creditor compromise is a show of good faith - an agreement from those owed money that they believe the business can undergo a turnaround or pay its debts under these new conditions. As in all business relationships, trust is a founding principle.

7) Formal advice

All legal processes must be followed in a creditor compromise, and this includes reporting to the Registrar of Companies. While court approval is not necessary for this informal debt arrangement, there are reporting guidelines proposers should adhere to so the compromise can be green-lit.

Creditor compromises are tricky - they must please a vast majority of creditors at a time when debts are already outstanding. To gain approval, they must be detailed, backed up with appropriate information, fair and realistic.

Achieving this balance can seem impossible - but with the help of the team at McDonald Vague & Partners, a way forward can be found.

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