We have seen first-hand how natural disasters can negatively impact retail businesses.  The 2011 Christchurch earthquake destroyed several buildings in the city’s CBD.  The November 2016 Kaikoura earthquakes impacted several retail businesses in the North and South Islands. 

In a matter of minutes, many businesses lost use of their premises and many retailers lost a significant amount of stock.  Some retail businesses in Christchurch were unable to operate for months after the earthquakes while others never recovered.  Some of those affected by the Kaikoura earthquakes are facing the same issues.  While having a disaster recovery plan in place before you need it won’t prevent disasters from occurring, it could save your business by providing you with a well thought out plan that will help you to move forward.

It’s also important to properly insure your company and to review your insurance cover regularly to ensure your business is adequately protected.  If you have business interruption insurance, it can help protect your business against loss of income suffered because of an unexpected setback.  Key person insurance can provide monetary compensation/revenue replacement in the event that something happens to someone pivotal to your business’ ongoing success.  There are also various insurance products available that cover stock, machinery, and plant.  An insurance broker should be able to advise you on what insurance you should be carrying.

Changes in the economy can also wreak havoc on a previously stable business.  The Global Financial Crisis caused a downturn in many retail markets, including New Zealand.  Similarly, changes to legislation can see a booming retail business become unprofitable overnight, as happened to several retail businesses when the government banned previously legal party pills. 

If you buy products or services from overseas, it is important to monitor foreign exchange rates.  You can lock in foreign exchange rates (just like a fixed mortgage interest rate) to protect your business against exchange rate fluctuations.  If the exchange rate drops after you lock in your rate, you could end up paying a little more (to cover the cost of the hedge) but, if there is any increase in the exchange rate, you know you will still be able to afford to pay your suppliers.

Running a business can be unpredictable.  If your business has suffered an unplanned event or you’re looking to set up recovery plans, talking to a business risk or business strategy advisor could help guide you through these stressful periods.

Contact us to see how we can help.

In the modern world, retail businesses are part of our everyday lives and cater to our every need and want.  For this reason, owning a retail company may appear to be a guaranteed way to make money.  The reality for most retailers though is that they are surviving on ever-tightening margins because of competition and increasing overheads. 

Retail is a cash hungry business so poor cash flow can put your business in serious financial trouble.  Because stock ties up your capital, inventory problems and cash flow issues usually go hand in hand.  To remain profitable, you need to continually turn over stock so that you have working capital available to pay your bills.

While you need well-stocked shelves and warehouses so you can meet your customers’ needs, you don’t want to be paying for products to sit in a store room or on your store shelves for an extended period.  If you understand your customer base (who is shopping at your store, what products they want, and how much they are prepared to pay), you’re more likely to get your inventory/stock/cash flow balance right.  You also need to understand your customer base to develop a marketing strategy that works effectively.  If you can develop a loyal customer base, there should always be demand for your products. 

Once you understand your customer base, you can ensure you’re stocking products that will move quickly at a price your customers are prepared to pay.  If you misjudge your customer base and end up stocking any products that are not selling, discount them to move them on then replace them with products that sell.  If people are not buying a certain product, that product is not making you any money, taking up valuable space, and tying up your capital.  Focusing on reaching a target market by stocking certain types of products (such as eco-friendly children’s products or gourmet food products) can allow you to streamline your product line, raise product margins, and create a sustainable business.  If you stay on top of trends in product margins and product lines that are relevant to your customer base, you can introduce the right products and capitalise on these trends.  Making a profit on the goods you’re selling, puts cash back into your business, which is vital for its ongoing success.

Getting your inventory right can require some educated guessing and a bit of trial an error.  If you’re not quite getting the balance right or you’re thinking about making changes to your business model, talking to someone independent could help you figure out what you can do to make your business a success.

In most cases, a business doesn’t go from being profitable to being insolvent overnight.  If you’re busy with the day-to-day running of the business, you might miss the early warning signs that you’re heading for financial trouble

If you’re seeing the early warning signs of financial trouble, you need to take action.  Ignoring your problems and hoping they’ll go away won’t work because these issues don’t normally fix themselves.  We see a lot of businesses that stop paying the IRD when things start getting tight, in the hope of gaining some breathing room.  Unfortunately, while the IRD is not usually your most vocal creditor, the penalties that the IRD can add to your debt are significant and, if you do nothing, your debt can easily become too big to repay.  If your payments to the IRD are not up to date, we recommend that you contact the IRD and work out a repayment arrangement to sort out your tax arrears.  Our business health check might point you in the right direction to addressing what you need to change.

If you’re already in financial trouble, you need to address your cash flow issues urgently.  You will need to take a hard look at your business, get an accurate picture of your financial position, and find out what has caused your cashflow problems.  Your accountant or an insolvency practitioner can help you with this review and can advise you on restructuring and/or refinancing options for your company.  You can find out more about business restructuring options in our articles on our website.

Once you have a turnaround strategy, you can speak to your bank about whether you can borrow more money – if you can, make sure you can afford the repayments – or whether it’s possible to refinance your current debts so that you’re paying less to service them.  You will also need to address any IRD arrears.

If your company is or could be insolvent, you need to speak to an insolvency practitioner as soon as possible to see whether it’s possible to restructure your business and avoid having your company put into liquidation by a creditor.  You will also need to consider whether you are complying with your director’s duties and, if you’re not, what you can do to remedy any breaches.

An external account or business advisor is often one of the first people to pick up that something in your business may not be quite right.  If you’re worried about your business, speak to someone about it and get it sorted.

Want to know more?  Check out our articles and follow us on LinkedIn.

Thursday, 17 November 2016 16:08

Warning Signs: What to Look Out For

Struggling businesses generally show signs of struggling before they fail. The earlier you pick up on warning signs that your company is or may be heading for financial trouble, the more options you have for remedying these issues with a view to saving your business.

It can be confronting but it’s important that you look at your business critically to determine whether your business need some attention or help. We have set out below some of the questions we often ask our clients about their businesses to determine whether they’re in trouble and, if they are, how much trouble they’re in.

  Early Warning Signs Signs of Financial Trouble Signs of Insolvency
IRD Are you behind with your tax payments to the IRD? Is your company at risk of being reviewed by the IRD? Are you treating the IRD like a bank?

Creditors

Accounts Payable

Are you struggling to pay your creditors on time?

Are you struggling to fill your current orders meet new orders because you don’t have the goods in stock and don’t have funds available to purchase further goods?

Have any of your suppliers put you on stop credit, threatened legal action, sent your debt to a debt collection agency, or issued legal proceedings against your company?

Have your key suppliers put your business on stop credit?

Has your company failed to pay the amount demanded in a statutory demand?

Has your company been served with liquidation proceedings?

Bank

Finance

Do you need to increase your overdraft facility so that you can pay your existing creditors and/or your staff?

Do you have very limited cash available?

Is your bank refusing to extend you further credit or trying to reduce your overdraft facility?

Have you been unable to raise new working capital?

Do you have loans falling due and no way to pay or refinance them?

Performance

Balance Sheet

Are you getting further and further behind financially? If you’ve spoken to your accountant or your lawyer about your company, did they seem concerned?  

 

Getting assistance and advice early, before issues get out of control, is invaluable.  It’s better to get in the ambulance at the top of the cliff than to have it waiting for you at the bottom.

If you’re worried that your business might be in trouble or you’re after an independent review of your business, get in touch with the friendly team at McDonald Vague.  We’re here to help.

Want more information?  Check out our articles and follow us on LinkedIn.


An increasing number of building firms "went bust" in 2014 despite the building boom in Christchurch and Auckland, leaving homeowners, contractors, and the taxman out of pocket.  As the construction boom in Auckland gathers pace the situation is going to get worse.

Nearly 100 rebuild-related companies have gone into liquidation or receivership in Christchurch alone since the February 2011 earthquake. We see the same trend occurring in Auckland.

People often ask us why so many building firms are going under as they should be making a fortune.  The simple answer is that the good ones are, but there are many that have been caught out by over trading (transacting more business than the firm's working capital can normally sustain), thus placing serious strain on cashflow and risking collapse or insolvency.  Some of these companies shouldn't be in business in the first place.

This trend could worsen as mismanagement woes continue and big ticket construction projects open new avenues for white collar crime. 

More than half of the failures came in 2014

Construction-related liquidations more than tripled between 2013 and 2014 (mainly in Christchurch). Subcontractors were heavily represented in the liquidation numbers and the Serious Fraud Office ("SFO") received 29 complaints about suspect dealings in the rebuild and has launched six investigations.  As a result, the Government introduced new laws in 2015 to protect consumers, including mandatory written contracts, and builder requirements for residential building work costing $30,000 or more.

With an increasing number of small operators who were previously working as employees deciding to go out there and do it themselves there is increasing concern that many don't have the skills needed to run a business.  Many are good tradesmen, but not good businessmen.  Some don't manage their cashflow well and don't file PAYE returns, GST returns, or get their invoices out on time.  We often see overdrawn current accounts where the tradesman has operated the business account as their own personal bank account.

As the building boom gathers pace, tradespeople with varying levels of skills have poured into the industry as they see it as a cash cow. They often have little or no capital.  Many of them "gear up" with the latest tools and ute all purchased on HP.

New Zealand is an extremely expensive country in which to build houses.  McDonald Vague has recently been appointed over two large building companies (eHome NZ Limited and Shears and Mac Limited), both employing over 100 people and both manufacturing in a factory and then installing onsite.  eHome NZ Limited built houses in a factory and Shears and Mac Limited did commercial and shop fit-outs in New Zealand and Australia.  They operated in different sectors of the building industry but failed for similar reasons including:

  • High overheads and slim margins;
  • Missed deadlines;
  • Contract disputes;
  • Cost overruns;
  • Unhelpful bureaucracy and compliance costs.

High costs driving failures

We provide consultancy and turn-around advice to a number of building firms and often the problems are the same.  Fixed price contracts stay constant but the cost of labour and materials constantly increases in a construction boom.  The costs of labour and materials will continue to increase until there is a slowdown in demand. 

Why so many fail

  • Out of control pricing;
  • Characterised by small businesses (a ute and a dog);
  • Aggressive tendering trying to increase market share at the expense of margin;
  • Poor estimates/pricing - running a project at a loss;
  • Poor variation analysis;
  • Undercapitalised balance sheet;
  • Lack of building knowledge, the level of education in the industry is poor;
  • Leaky buildings (warranties and guarantees) ongoing issue without provision;
  • Desperate to climb the ladder - egos prevail in a testosterone dominated industry;
  • Poor documentation/record keeping leads to failure (PAYE, GST, creditors);
  • Variation sign-offs not formally completed leading to further costs borne by contractor;
  • Low margins;
  • Businesses are easy to establish and easy to close, with no capital requirements.

What can your clients do to protect themselves?

There are a number of things they can do, including:

  • Register on the PPSR;
  • Stop work when they don't get paid;
  • Be familiar with remedies under the CCA;
  • Do due diligence on developers or head contractors before doing work;
  • Take personal guarantees;
  • Enforce credit limits;
  • Look at liquidated companies on the Companies Office;
  • Be aware of phoenix companies;
  • Make credit checks;
  • Do directors' checks for liquidations;
  • Get money held in trust where possible.

We can help

Please contact the team at McDonald Vague Limited if you would like to learn more about how your client can protect/mitigate the risk of a customer going into liquidation.

 

 

 

Sunday, 07 September 2014 12:00

Independent reviews and corporate governance

There are approximately 500,000 small to medium-sized enterprises (SMEs) in New Zealand, most operating without a formal board.  Often there is no separation between family, management and governance.

An increasing amount of our work at McDonald Vague is involved in providing independent reviews focusing on restructuring and governance with the aim of helping companies lay the foundations to grow in to larger, more profitable businesses and avoid the mistakes we see time and time again. 

Why an independent review?

Typically, the need for an independent review is initiated when a particular issue or concern is identified.  This can provide an opportunity to introduce a sound corporate governance process that can not only solve the issue or concern itself, but set the business up for long-term sustainable and profitable growth. 

Be proactive

If your client's relationship with its financier and creditors is strained or the company is stagnating an independent review from a restructuring specialist may be the first step to unlock the business's full potential.  More often than not our recommendation will be to implement corporate governance.  This may include an independent board member who can cast a whole different lens on the business. 

What is an independent review and what does it entail?

McDonald Vague offers two types of reviews - a Snap Shot Independent Accounting Review and a Full Independent AccountingReview

Snap Snot Reviews are fast, independent and often cost-effective way of turning a business around if the recommendations are implemented.

The report will include the following: 

  • Review of the business's cashflow projections and short-term needs;
  • Review of assets and security;
  • Assessment of the business can be improved;
  • Review of governance;
  • Recommendations.

Full Independent Accounting Reviews offer a comprehensive review of the financial health of the business and recommendations on how to improve or restructure it.

An engagement approach will typically involve: 

  • Review of historical performance of the business;
  • Determining the current financial position and short-term needs of the business;
  • Determining an understanding of its operating activities, key drivers and commercial/contractual arrangements impacting financial performance of the business;
  • Security analysis;
  • Forecast projections;
  • Sensitivity analysis;
  • Benchmarking;
  • Understand and assess the business's:
    • Strategy;
    • Financial projections;
    • Utilisation of available resources/cash;
    • Industry issues and any potential future significant impacts;
    • Management capacity/capabilities;
  • Recommendations.

Corporate governance

Sometimes a business's corporate governance doesn't keep pace with the size of its turnover and exposure to a bank or financial institution.  It is important to have a sound corporate governance policy, clear strategic direction and be as transparent with your financier as possible.

Challenges for implementing governance often include:

  • The cost of engaging a consultant;
  • The uncertainty of the return on investment;
  • Where to find the right people to add value to their business;
  • Limited ability to attract high quality directors;
  • Owners may have to deal with interpersonal conflict and family conflicts;
  • Tough decisions will need to be made to improve the business.

A way of easing into improved governance is by bringing on board an independent consultant who can attend and observe board meetings.  This may then expand into an advisory board role.

An advisory board allows business owners access to independent opinion, along with strategic advice and expertise in an environment where they can discuss important business issues.  Advisory boards aim to benefit the business by better equipping the owners with the information needed to make significant business decisions. 

How can we help?

Our skill base is in diagnosing issues, deploying commercial solutions, and advising underperforming or distressed businesses. As a mid-tier chartered accounting firm specialising in restructuring, we are well placed to offer a co-ordinated, cost-effective service to companies facing financial challenges. 

One of McDonald Vague's experienced staff members can be appointed to an advisory board or through our network of business advisors.  We can recommend suitable independent advisors with the right skills to enhance a company's performance.

Statutory demands - minimising bad debts is critical for any business 

Debt collection is difficult for business owners.  Pursuing bad debts early on improves any chance of receiving payment.  A creditor that puts the most pressure on a debtor will most likely receive their money before others; however, they need to be conscious of the voidable transaction regime when they are dealing with an insolvent company. 

If you are owed a debt and that debt is not in dispute and you suspect the company you have been trading with may be insolvent, you can issue a statutory demand against the company.  Depending on your terms of trade, a statutory demand will require the debtor to pay you the outstanding debt, interest on the debt, and the legal costs for issuing the statutory demand.  The purpose of a statutory demand is to determine whether the creditor can pay and not that they are liable to pay. 

The statutory demand process provides a quick procedure for ensuring payment, or for at least achieving some knowledge on whether payment is possible.  This process is intended to be a first step in making an application to put a company into liquidation when a company genuinely cannot pay. 

It is important to get the process right and it is advisable to instruct a lawyer who has ethical obligations to ensure the correct steps are taken rather than issuing the demand yourself or a debt collection agency taking responsibility.  It is however an abuse of process if the statutory demand option is taken when there is no prospect of the company being placed into liquidation. 

The cost of issuing a statutory demand should not be taken lightly.  If there is a substantial dispute and the creditor is successful in its challenge, Court costs will be awarded against the creditor.  If a creditor gets this process wrong, not only are they out of pocket for additional costs but months may have passed and they are no closer to collecting the debt. 

Sections 289 to 291 of the Companies Act 1993 deal with statutory demands. 

The process 

Before serving a statutory demand it is sensible to ensure that the debt is not in dispute.  Sending a formal demand so any dispute can be raised will give you an opportunity to settle the debt without any further action being taken.  If, however, the debt is disputed you can file proceedings at the District or High Court and seek judgement on the claim. 

Step 1 - Serve a statutory demand for the debt 

The demand must be in writing and should be served on the debtor company's registered office.  The demand must require the company to pay the debt or to secure the debt or to settle it in some way.  If the debtor does not pay the amount claimed within 15 working days, you can apply to put the company into liquidation.  This is a powerful tool as it is quite likely the debtor will go to lengths to ensure that other creditors are not aware of liquidation proceedings pending or in progress.  The company has 15 working days after being served to comply with the notice. 

The statutory demand must specify exactly what amount is owed (and it must be over $1,000).  The document specifies when the sum must be paid and provides the alternatives to full payment such as to enter into a compromise (Part XIV of the Companies Act 1993), or otherwise compound, or give a charge over property to secure payment of the debt to the reasonable satisfaction of the debtor, all within 15 working days of the date of service of the demand, or such longer period if the High Court order. 

Once a statutory demand is served on the debtor company, the debtor has 10 working days to dispute the debt by filing an application to set aside the demand or pay the debt within 15 working days. 

Step 2 - Applying to the Court to place the debtor into liquidation 

In the event the debt is neither disputed nor paid, then, on the expiry of 15 working days the debtor is deemed to be insolvent and the creditor can apply to the Court to place the debtor into liquidation.  The onus is then on the debtor to satisfy the Court that it is solvent.  If the company is unable to pay then a liquidation with a Court appointed liquidator will follow, or, the shareholders within 10 working days of being served have an ability to appoint a liquidator by a shareholder resolution. 

A liquidation application can only be issued by certain persons and the order for the appointment can only be made on grounds specified in section 241(4) of the Companies Act 1993.  The decision on whether the company is placed into liquidation is at the Court's discretion.  The Court may only put a company into liquidation by the appointment of a liquidator if the Court is satisfied that the company is unable to pay its debts, or the company, or the board of the company, has persistently or seriously failed to comply with the Companies Act 1993, or the company does not comply with section 10 (essential requirements), or it is just and equitable that the company be put into liquidation. 

The alternatives to paying a statutory demand in full 

Compounding means "coming to an agreement with a creditor".  The most usual form of compounding is an acceptable offer of payment by instalments.  It can also be an offer of a deferred payment or a request to defer filing of a winding up proceedings. 

Company Compromise (Part XIV Companies Act 1993) is an agreement between the company and various classes of creditors that give the company an opportunity to survive by avoiding liquidation and trading out of financial difficulty.  In order to reach a compromise a majority in number representing 75% in value of each class of creditor voting in favour of such a resolution is required (at a meeting of creditors).  Once agreement is reached, all debts are frozen and no creditor can take action against the company during the term of the compromise.  The outcome could be creditors are repaid either in full or in part and over time.  It is specifically a good option if the business is solid and is in financial difficulty but customers and suppliers are prepared to provide support.  Find out more about Company Compromises

Another remedy upon receiving a statutory demand is to reach a full and final settlement.  However, it is always important to bear in mind voidable transactions when dealing with an insolvent company.  A payment from a third party or the director or a personal guarantee are wise. 

How to serve a statutory demand 

A statutory demand to qualify as being served on the company either must be delivered to a person named as a director on the New Zealand Companies register, to an employee of the company at the company's head office or principal place of business, be left at the company's registered office or address of service, and in accordance with directions as to service by the Court, or in accordance with any agreement made with the company.  It is recommended that the document is served by a document server.  The service of a statutory demand by facsimile cannot be relied upon. 

Disputing a statutory demand 

If a debtor can show that a defence or a counter claim or a set-off equal to the amount claimed in the demand exists, not only will a demand be set aside but the aggrieved creditor will be ordered to pay the debtor's costs and will be no closer to collecting the debt. 

A Court may set aside a statutory demand if the application is made within 10 working days of the date of service of the demand and the application was served on the creditor within 10 working days of the date of service of the demand.  The Court may grant an application to set aside the statutory demand if it is satisfied that there is a substantial dispute, whether or not the debt is owing or is due, or the company appears to have a counter claim, set-off, or cross demand and the amount specified in the demand, less the amount of the counter claim, set-off or cross demand is less than the prescribed amount or the demand not to be set aside on other grounds. 

A demand will not be set aside by reason only of a defect or irregulatory unless the Court considers that substantial and injustice would be caused if it were not set aside.  Under section 291 of the Companies Act 1993, if a Court is satisfied that there is a debt due by the company to the creditor that is not subject to a substantial dispute, or is not subject to a counter claim, or set off, or cross demand, the Court may order the company to pay the debt within a specified period and that in default of payment, the creditor may make an application to put the company into liquidation, or dismiss the application and make an order putting the company into liquidation on the grounds that the company is unable to pay its debts. 

The service of a statutory demand process can give great leverage to get paid quickly, however if a debt is disputed or the company that owes the money is not in financial difficulty the process is used at your own peril.

 

 

Friday, 28 October 2011 13:00

Establishing Insolvency

Many businesses are facing hard times in the current market. Your business might be one of them. Early action is critical in determining whether your business can be rescued or not.

Taking steps to ensure your company remains financially sound will minimise the risk of an insolvent trading action. It may also improve your company's performance.

There are serious penalties and consequences of insolvent trading including civil penalties and criminal charges. Insolvency can be established by either of the Cashflow or Balance Sheet tests. Note, importantly, that the company only needs to fail one of these tests to be insolvent.

  • The Cashflow test is simply whether the company can pay its debts when they fall due for payment. If you are paying your trade creditors at 90 days plus but the trading terms are 30 days, your company could be insolvent.
  • The Balance Sheet test is whether the company's assets are exceeded by its liabilities. It is important to point out that this test includes contingent liabilities. An apparently solvent balance sheet may include items that are overstated, such as obsolete stock, plant, and work in progress, or debtors that are not really collectable. After deducting these items many balance sheets become insolvent.

 

Your company must keep adequate financial records to correctly record and explain transactions and the company's financial position and performance. A failure of a director to take all reasonable steps to ensure a company fulfills this requirement contravenes the Companies Act 1993.

Some of the key pointers to insolvency are:-

  • Cash flow difficulties
  • Excessive debt and under-capitalisation
  • Inadequate accounting
  • Reliance on a small number of customers, suppliers etc
  • Net asset deficiency (liabilities greater than assets)
  • Exceeding overdraft facilities or defaults on loan or interest payments
  • Increased borrowings
  • Statutory demands, solicitors' letters, summonses, judgements or warrants issued against the company and winding up notices
  • Lack of cash-flow forecasts and other budgets
  • Change of bank, lender or increased monitoring/involvement by financier
  • Reliance on key customers
  • Loss of long-standing suppliers
  • No directors' meetings, management meetings, or clear objectives
  • Contract disputes
  • Regular late payment (or non-payment) of suppliers
  • Issuing post-dated cheques or dishonouring cheques
  • Suppliers placing the company on cash-on-delivery (COD) terms
  • Payments to creditors of rounded sums that are not reconcilable to specific invoices
  • Part payments and instalment plans with essential creditors
  • Failure to pay GST and PAYE
  • Late collection of payments from debtors
  • Artificial valuation of assets
  • Higher stock levels with static sales
  • Shareholder disputes and director resignations, or loss of management personnel
  • Increased level of complaints
  • Sale and leaseback of assets
  • Factoring of debtors
  • Irrecoverable loans to associated parties
  • Injection of directors' own resources to provide short-term relief

This list is by no means exhaustive, but it does give an idea of where to look for signs of impending trouble. You should constantly be on the look out for these signs - because your creditors certainly are!

As a director you need to be aware of your options so that you can make informed decisions about your company's future. If the company is insolvent it must not incur further debt or you could be made personally liable for that debt. Options include refinancing or capital injection (to return the balance sheet to a solvent position or to remove cash flow pressures), sale of assets, and restructuring or changing company activities. Generally the matter is left too late and the only options left are to appoint a voluntary administrator, liquidator or receiver.

Voluntary administration

Voluntary administration is designed to resolve the company's future direction. The administrator takes full control of the company to try to work out a way to save either the company or its business.

The aim is to administer the affairs of the company in a way that results in a better return to creditors than they would have received if the company had instead been placed straight into liquidation. A mechanism for achieving these aims is a Deed of Company Arrangement, whereby creditors agree to receive a proportion of their debt over time.

Liquidation

A liquidator is an independent person who takes control of the company so that its affairs can be wound up in an orderly and fair way for the benefit of creditors.

Receivership

A company goes into receivership when a receiver is appointed by a secured creditor who holds security over some or all of the company's assets. The receiver's primary role is to collect and sell sufficient of the company's charged assets to repay the debt owed to the secured creditor.

Of course, if your company is in financial difficulty, the best scenario is to avoid a crisis in the first place, and the best way to do this is to seek independent expert advice in respect of your duties and the options available.

DISCLAIMER
This article is intended to provide general information and should not be construed as advice of any kind. Parties who require clarification on issues raised in this article should take their own advice.

This article discusses when to accept a company compromise, and suggests what modifications and amendments can be asked for, and when to reject a compromise.

What is a compromise?

A compromise is an agreement between a company and its creditors. Most compromises have two basic features. They provide:-

  • That creditors are paid their debt in part or full over a period. If they are to be paid in part, then the creditors write off the balance of their debt
  • That during the term of the compromise, debts are frozen and no creditor may take any action against the company

A compromise as perceived by creditors

It seems to us that compromises with creditors can make otherwise rational people break out into a rash of prejudices whereby any suggestion of a compromise is met with a closed mind. On the other hand, we as insolvency practitioners have had some remarkable successes and we know of many creditors who have also been pleased with the results.

A compromise as perceived by the company

The company perceives a compromise to be an alternative to receivership, administration or liquidation, which gives the company the opportunity to survive. Although the directors may not be able to arrange for the company to pay its debts in full, they anticipate being able to provide continuing business to those creditors who have supported them.

The legislation

The legislation can be found in Part 14 of the Companies Act 1993. The following sections and schedules apply:-

  • Sections 227 - 234 (note: further sections, 235-239, deal with court involvement)
  • Fifth Schedule - proceedings at meetings of creditors

Voting requirements

Each class of creditors affected by a compromise must vote as a class. Classes of creditors can include:-

  • Trade creditors
  • Landlords
  • Other unsecured creditors
  • Hire purchase creditors
  • Other secured creditors including General Security Agreement holders
  • Employees for preferential wages & holiday pay
  • Inland Revenue Department for preferential GST and PAYE
  • Subordinated creditors

Clause 5(2) of the Fifth Schedule provides as follows:-

"At any meeting of creditors or a class of creditors held for the purposes of section 230, a resolution is adopted if a majority in number representing 75 % in valueof the creditors or class of creditors voting in person or by proxy vote or by postal vote in favour of the resolution."

Whether to accept a compromise or vote against it: some factors to consider

  • Does the compromise offer more to creditors than they would achieve in a liquidation?
  • How do you know?
  • Is there a statement of affairs?
  • Are there financial accounts?
  • Are the directors trying to avoid Insolvent Transaction claims against creditors to whom they have given a personal guarantee?
  • Are there actions which should be brought against the directors?

We comment that many compromises are based on hope, and make promises which cannot be delivered.

Compromise manager

The proposal should have an independent and experienced professional Compromise Manager. In our view, it is not appropriate to have either a complete absence of manager, or have the director or their solicitor acting as manager. An independent experienced Compromise Manager will be working for the creditors to ensure they get what has been promised. We, for example, will only accept the role if we believe the compromise will succeed and is in the best interests of creditors.

The documentation

The documentation must be professionally prepared and as provided for by the Companies Act, and there must be a separate document explaining the proposal and giving details of those affected. The documentation should be comprehensive and informative.

Compromise committee

Particularly in the case of a large company, the creditors may want there to be a committee of creditors to work with the Compromise Manager. The committee will also represent the views of creditors as a whole.

Powers of a Compromise Manager

We have seen compromises where the Compromise Manager has few powers and merely acts as a buffer between the company and its creditors.

It seems extraordinary to us that creditors will vote for a compromise where there is no external supervision of the compromise by an independent party with experience in this area. If the directors want a second chance they must be prepared to relinquish some of their powers to a Compromise Manager acceptable to creditors. The compromise itself can provide for the Compromise Manager to oversee the terms of the compromise and provide regular reports to creditors on progress and likelihood of success.

A Compromise Manager must have the power to bring a compromise to an end if he or she perceives it is not going to work. Never vote for a compromise which, for example, provides for a first payout after a year if there is no power to monitor progress. On the other hand, there should also be a power to extend the compromise for say three months, or a longer period with the consent of creditors.

Meeting of creditors

There should be a meeting of creditors at which they get the opportunity to exchange views and ask questions of the proponents of the compromise. At that meeting, creditors should be given the opportunity to ask for modifications to the compromise.

We were consulted some time ago about a failed compromise. In that case, we had the following major criticisms:-

  • Documentation was sparse and did not comply with the Companies Act
  • There was no Compromise Manager
  • There was no meeting of creditors (postal voting was used)
  • There were no scrutineers in respect of the voting

Conclusions

Compromises are capable of working well for creditors and at the same time can give a company a second life. If you have clients in financial difficulty who have a fundamentally good business, a compromise might be the answer. If you have to vote on a compromise, do so with an open mind. At the same time, be prudent and be satisfied before voting that the compromise is genuine and deserves to succeed.

DISCLAIMER
This article is intended to provide general information and should not be construed as advice of any kind. Parties who require clarification on issues raised in this article should take their own advice.

With the recent activity in high profile prosecutions of company directors by the Serious Fraud Office ("SFO"), we thought it opportune to revisit a case in which our firm was involved highlighting the point that it is not only the high profile directors that pay a heavy penalty when events do not go according to plan.

We pinpoint some useful tips for your clients who may be considering taking on a governance role in a company for which they do not necessarily have all of the prerequisite skills or experience.

The judgment for FXHT was released on 9 April 2009.

This case concerns a foreign exchange investment broker. The elements of the case involved fraud, breaches of directors' duties and ultimately the need to define the role and responsibilities of non-executive directors.

The defendant was a non-executive director in the company (by profession he was a medical practitioner). The defendant absolved all responsibilities to the executive director. He did however sign on behalf of the company, an employment contract, that required the executive director to report directly to him.

The defendant allowed the executive director to have sole charge of the running of the company, including being the only signatory to the cheque account. Directors' meetings were never held, no accounting records were ever maintained, no budgets or plans existed and segregation of duties were non-existent.

As a consequence, the executive director committed fraud whilst in charge of investors' funds. The defendant relied upon the executive director's "vast experience" which amounted to learning about Forex trading on a rugby trip.

No checks were made into the background of the executive director. If checks had been carried out, even the most basic of enquiry would have revealed that he had been involved in suspected fraudulent activities in South Africa.

As a consequence, the executive director faced seven counts of theft brought by the Serious Fraud Office in relation to these matters. The court in its judgment, found against the non-executive director for $300,000.

The message is clear for all professionals, when advising their clients who may be considering taking on directorships involving companies in which they have no experience-:

  • Be fully aware of the financial situation of the business at all times;
  • Ensure basic controls are firmly in place
  • Attend all board meetings;
  • If they do not have experience, they must be prepared to find out;
  • Seek advice where possible from experts in the industry;
  • Understand the risks and rewards associated with the industry.

Unless the clients are prepared to take on these responsibilities and put in both the time and effort required they should either:

  • Decline the directorship;
  • Take out expensive insurance protection;
  • Be prepared to face the extremely punitive consequences if things go pear shaped.

In conclusion, we are left with the opening statement of Justice J Venning:

"This case highlights the risk of a director becoming involved in a company whose business is outside the director's expertise. It also highlights the risk to investors who pursue high returns in speculative investments such as foreign exchange. It has led to loss by all parties concerned."

 

As an addendum to this article it is also pertinent to note that this case ultimately resulted in a successful prosecution by the SFO against the executive director, concluding with a term of imprisonment. This, however, was of little help to the non-executive director who ultimately paid the financial penalty.

Note: This article was written by Roy Horrocks who has subsequently left the firm.

DISCLAIMER
This article is intended to provide general information and should not be construed as advice of any kind. Parties who require clarification on issues raised in this article should take their own advice.

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