Updated: Aug 13, 2020
This article focuses on what can businesses do to survive the aftermath of the pandemic which brought forth an inimical economic reality by providing a quick insight on the various corporate rescue mechanisms that may be deployed by a distressed company with the hopes of minimising the damage to the corporate sector and for the jobs to which it is a vehicle to.
The effect Covid-19 hit our shores in March when save for essential services, the Malaysian economy almost came to a standstill. Thus, there is a need to state the law on corporate rescue mechanisms in light of a potential wave of business failures that may be about to engulf Malaysia.
It is in the best interests of our national economy to have businesses up and running, paying staffs and taxes but unfortunately not all businesses are in the healthcare industry or a glove maker. It will be a systemic problem if businesses, especially listed companies are entangled with disputes or claims against them regarding rentals, utility bills and loan repayment when they fail to meet the shortfall stemming from the period when they have little to zero revenue. Being pursued for unpaid debts is a hugely stressful situation for businesses, but creditors just simply want to be paid what is due and owing to them.
Corporate rescue mechanisms
There are three formal corporate rescue mechanisms embodied in the Companies Act 2016 [Act 777] (“CA 2016”) that financially distressed businesses may utilise to alleviate creditor pressure, they are namely:
Corporate Voluntary Arrangement
Scheme of Arrangement
These mechanisms are formal simply because it involves court supervision and filing of certain documents to court required by the CA 2016. This article will not discuss about any informal corporate rescue mechanism i.e. CDRC (“Corporate Debt Restructuring Committee”) by Bank Negara. The newly introduced corporate voluntary arrangement and judicial management is adopted from the United Kingdom Insolvency Act 1986 and Singapore’s Companies Act 1967 respectively.
Why should a company deploy a corporate rescue mechanism?
Put simply, if RM 10 million is due and owing to be repaid in one year to a creditor, a calendar day is worth about RM27,397.26. Therefore timing and the expediency of matters are vital in a distress situation. Some rescue mechanisms offer a buffer against legal action; thus, it is better to start early before the issue escalates. A distressed company which is aiming to deploy a corporate rescue mechanism is suggested to consider the below factors for formulating and finalising a rescue plan:
can the company survive in the immediate short term or is it better to cut losses, close shop and come back when the economy is better
with the gradual lifting of the MCO and a progressive pickup in consumers' spending habits, when is the expected recovery to achieve the same levels of revenue and profit during the "good times"
are the numbers on the company's accounts that truly reflect the company's financial position viable to be sustained and managed
how well can the company manage its' business fixed cost i.e. rental, utilities, employees' wages and industry specific maintenance (see news on mouldy cinema seats and leather apparel)
does the provisions of the CA 2016 restricts the deployment of any rescue mechanism to the company
if there is no restriction, what is the expected timeline of the rescue mechanism
what is the cost for the entire exercise
what are the chances of obtaining a buy-in from the creditors
what are the chances of obtaining court approval
does the company need a moratorium i.e. it has potential or existing litigation against it
Corporate Voluntary Arrangement (“CVA”)
The CVA is one of two newly introduced mechanism in the CA 2016 and is the simplest corporate rescue mechanism. An example of a successful business in Malaysia that undergone a CVA exercise is a distinguished bakery known as The Loaf. See news regarding the creditors of Toys R Us in UK that strongly supported the CVA exercise.
CVA does not apply to public companies, hence it mainly caters for SMEs and micro enterprises. It costs fairly lower and its process is much faster compared to the other rescue mechanisms because there is little court intervention save for certain statutory court filing requirements. CVA is a go-to considering the time pressure in a distress situation and a company does not wish to incur costs which may not relieve its financial condition.
A CVA is a simple process where an insolvency practitioner prepares a proposal and the board of a company appoints a nominee (who is an insolvency practitioner) to implement the proposal. Thereafter, the directors submit to the nominee the documents setting out the terms of the CVA and statement of the company affairs. The nominee then assesses the situation and submits a statement of his opinion to the directors on the viability of the proposal.
The nominee shall submit to the directors, his opinion indicating whether or not:
the proposal has a reasonable prospect of being approved and implemented
the distressed company is likely to have sufficient funds available for the distressed company during the moratorium to enable the company to carry on its business; and
a meeting of the distressed company and its creditors should be summoned to consider the proposal
If the nominee approves the proposal, then the relevant documents and papers are then filed in court. The documents to be filed inter alia are the nominee’s statement, nominee’s consent to act and the documents setting out the proposed terms of the CVA. Like a judicial management, an automatic moratorium immediately commences on the filing of the documents to the court for 28 days. This insulates the distressed company from legal proceedings and enforcement actions by creditors. Upon satisfaction of certain conditions, the moratorium period may be further extended for 60 days if more time is needed as in practice 28 days is very short period of time.
Thereafter, a creditor’s and member’s meeting is to be convened to seek their approval of the proposal and if approved, the proposal takes effect and creates a legally binding agreement between the distressed company and its creditors. An example of a CVA may monthly contributions of a certain amount.
At the time when a moratorium is in force, the nominee’s name and a statement that a moratorium is in force shall be published on documents a company uses for business i.e. every invoice, order for goods or services, business letter or order and every official website of the company.
Comparison with other rescue mechanisms
Similar to a scheme of arrangement, if approved by the statutory voting majorities i.e. 75% of the total value of creditors, the proposal will bind all creditors. A simple majority in respect of shareholders is required to pass a resolution to approve the proposal for a CVA and once approved, the distressed company can continue trading to generate revenue but under the supervision of the nominee.
The distressed company’s management should take note not to do conduct fraudulent trading i.e. “carrying on business with intent to defraud the creditors of the company” as this constitutes a criminal offence under S.540 CA 2016 liable to imprisonment.
Unlike for judicial management, company need not be insolvent (unable to pay its debts) to qualify for a CVA. This allows a distressed company to start talking to creditors early to come up with a viable and realistic proposal in the current market environment in the specific industry.
The implementation of the proposal for a CVA is supervised and not managed by an insolvency practitioner unlike judicial management. A CVA is a management driven procedure or a debtor in possession scenario i.e. the management of a company does not change hands. This is different from a judicial management where a judicial manager is appointed to manage the distressed company.
Key Takeaways for CVA
Creditors are likely willing to support a CVA despite the low probability in recovering all that they are owed, as compared to liquidating of the debtor company which usually results in creditors receiving significantly less. It is vital that the repayment model is viable and realistic i.e. if company proposes to make monthly contributions from its working capital, the numbers projected should be substantiated with evidence or third party reports.
However, the practical application CVA is narrow and far removed from the commercial reality as a CVA does not apply to a company with a charged property. Companies often obtain funding for their operations from financial institutions. The creation of charges as security to the financier is in exchange for the granting of cash facilities. In instances where the major shareholders of a company creates a charge over their own assets, CVA is available to those companies.
Furthermore, most companies in distress have bank facilities or loans which companies charge their property, creditor pressure often emanate from banks seeking to enforce their security, or initiate foreclosure proceedings.
Bearing in mind that the CVA was adopted from the United Kingdom Insolvency Act 1986, the UK legislation does not have the same condition regarding charged properties. Hopefully, there will amendments by the legislature to widen the application of CVA.
Scheme of Arrangement (“SOA”)
A SOA is applicable to all companies and there are no restrictions on the type of company. A SOA may be utilised to regularise a distressed company’s financial condition. For examples of a SOA, please see Perisai Petroleum Teknologi Bhd and Kinsteel Bhd restructuring exercises. A SOA is not confined to simply debt restructuring of distressed companies in financial distress but also to adjust the rights of members and creditors, reorganise the company’s share capital or to perform internal restructuring in the case of a group.
A SOA may be initiated by a company, its creditor, the liquidator or the judicial manager. A SOA begins by an applicant applying to the court for an order to convene a meeting of members and various classes of company creditors (“scheme meeting”). At this meeting, it may be (i) all the unsecured creditors; or (ii) the different classes of creditors; and then to obtain an order to hold separate meetings for each class of creditors.
Once the court order is obtained, an insolvency practitioner is to devise a scheme that a company intends to make to its creditors during the scheme meeting. A notice summoning the scheme meeting shall contain a statement explaining the effect of the proposed scheme.
If 75% of the total value of creditors or class of creditors approve the scheme, then the scheme manager (an insolvency practitioner) will bring the scheme back to court and notify the court of the approval by the creditors. Thereafter, the court will endorse the scheme which effect will make the scheme binding on all creditors of the company.
The court may scrutinise to determine whether any creditor or class of creditors have been placed in a disadvantageous position but generally the court will endorse what the creditors have approved.
Comparison with other rescue mechanisms
Similar to a CVA, this mechanism is not exclusive to insolvent companies and the control of the company remains with the board. The cost expected for such an exercise is expected to be in between one of a CVA and a judicial management as the entire process requires court intervention from start to finish and the services of an independent liquidator if appointed by the court.
An advantage of a SOA is that different schemes can be come up with for different classes of creditors and shareholders. As being an insolvent company is not a qualification for a SOA, a SOA can be used to do a reorganisation to prevent the company’s situation from developing into a more dire state.
However, there is no automatic moratorium granted for a SOA resulting in the possibility of a creditor defeating the purpose of the SOA.
Restraining Order ("RO")
A company may apply to the court for a RO. The application for a RO is generally heard ex parte with usually the legal counsel representing the applicant in court.A RO can be granted for three months by the court and may be further extended for nine months upon satisfaction of certain conditions
The Court may grant a RO restricting all creditors from taking action against the company pending the holding of the meeting of creditors and pending the approval of the Court subsequently.
Although an application for a RO is made ex parte, recent cases held that if there are existing creditors who have already taken action against the company, the application for a RO should be served on them.
There are many criteria stipulated by the CA 2016 to obtain a RO. Such criteria include:
an independent director nominated by a majority of the creditors
a statement of particulars as to the affairs of the company made up to the date of the order or application
The independent director acts as a safeguard to creditors to ensure that the company does not abuse the RO as a dilatory tactic during its duration. Bearing in mind there may be several classes of creditors, the above first criteria is very difficult to meet in practice as often times the person to be nominated needs to have a positive reputation with the creditors.
Key Takeaways for SOA
An independent liquidator is able to adopt an objective assessment of the commercial viability of the proposed SOA and also to provide assistance to the court and creditors when necessary. A liquidator will have powers to be given access to the accounting and financial documents for the purposes of verifying the viability of the proposed scheme.
Generally, the court will take into consideration the following factors before granting leave for a scheme meeting:
whether all statutory prerequisites have been fulfilled
whether there is full and frank disclosure of all material facts
whether the arrangement is such that an intelligent and honest man, a member of the class concerned might reasonably approve
if an approved liquidator is appointed, does his report states the proposed SOA is viable
did all the creditors and shareholders when voting made an informed decision
are there sufficient facts that explains the proposed scheme’s structure, purpose and effect to satisfy the court that it is not a facade
Case in point : High Court case of Transmile Group Bhd v Malaysian Trustee Bhd
The CA 2016 statutory framework safeguards the interest of creditors and perhaps removed the stigma of a SOA being seen as a dilatory tactic and a disguise to delay legal proceedings against the debtor company when the RO previously can be extended indefinitely. When a RO is in force, any disposal or acquisition of the property of the company not in the ordinary course of its business shall be void.
If the company has no chance to recover such as there is little to no operations ongoing, creditors might perceive a proposed SOA or CVA as an attempt to delay creditors from enforcing their rights against the distressed company.
When presenting a proposal or scheme, creditors want to know the where is the source of funding. It will be difficult to convince creditors that a company is able to pay both existing and future debts if such funding comes from the working capital. Creditors will want to know what is their benefit for approving your proposal or scheme. To get creditors' buy-in, it is advised to have that dialog with them early, present material information that truly reflect the company's financial position substantiated with professional advisors' reports
The Malaysia Economic Stimulus Package 2020 was announced by the government in February to counter the economic impact of the pandemic. A 100% stamp duty exemption is granted on the loan agreement entered into for restructuring, rescheduling and moratorium exercises entered into between 1 March 2020 until 31 December 2020 on condition that the stamp duty on the original loan agreement has been paid and is subject to clearance from the stamp office (LHDN). Example of such agreements potentially include new loan agreements connected to a restructuring scheme, or new securities granted to secure previously unsecured credit facilities.
Other alternatives for capital injection
Distressed companies may consider fundraising methods such as issuance of shares to white knights or equity crowdfunding platforms as the Securities Commission Malaysia in April lifted the fundraising limits of the latter. White knights may come in as a new shareholder and inject assets or funds into the share capital.
Distressed companies may also choose to conduct a mergers & acquisitions (M&A) exercise. For corporate M&A, there will be a strict timeline to adhere to and lot of pressure to conduct due diligence by professionals i.e. lawyers, auditors etc. This may lead to an increase in their fees. If a distressed company chooses to be bought out, the management of the company have to address questions such as business valuation, method of payment and completion, business resilience e.g. in terms of supply chain, business continuity in a social distancing environment, etc.
Furthermore, the government issued the Pelan Jana Semula Ekonomi Negara (“PENJANA”) which exempts stamp duty on any instruments executed for mergers and acquisitions between 1 July 2020 to 30 June 2021. There is also an income tax rebate of up to RM20,000 for newly incorporated entities in their first three years of assessment incorporated between 1 July 2020 to 31 December 2020. It is suggested for businesses to take advantage of the fiscal policies introduced by the government in consideration of a restructuring or M&A.
This article does not and is not intended to constitute as legal advice. This article represents the views of the writer alone. Information in this article may not constitute the most up-to-date information. Specific professional advice should be sought regarding your specific circumstances.