Ideas & Debate

Why firms in distress need voluntary rescue measures

covid

Summary

  • When faced with any crisis that impacts their operations, businesses should urgently undertake an assessment on their liquidity position through cashflow forecasting and, based on the outcome of this assessment, manage affected stakeholders proactively.
  • The liquidity assessment may reveal that the business will struggle to meet its obligations to creditors or breach covenants.
  • In such a situation, businesses have various options to deal creditors.

When faced with any crisis that impacts their operations, businesses should urgently undertake an assessment on their liquidity position through cashflow forecasting and, based on the outcome of this assessment, manage affected stakeholders proactively.

The liquidity assessment may reveal that the business will struggle to meet its obligations to creditors or breach covenants. In such a situation, businesses have various options to deal creditors. They could renegotiate debts repayments with lenders by seeking a moratorium on debt service or restructure the debt, negotiate extended payments terms with suppliers, dispose idle or underutilised assets and/or cut operational costs.

On the other hand, depending on the severity of the distress and the extent of cooperation by creditors, there are other statutorily available remedies such as company voluntary arrangements and administration which are intended to rescue viable but financially distressed businesses.

In Kenya, these remedies are codified in the Insolvency Act 2015 (“the Act”). The administration procedure is a key remedy available to struggling businesses under the Act.

A common misconception of the administration procedure is that it is only available when all else has failed, or beyond the point of possible rescue. Section 522 of the Act provides that the primary objective of administration is to maintain the company as a going concern.

It is only when this objective cannot be achieved that other actions such as realisation of assets are to be pursued.

Several high-profile companies such as British retailer Debenhams, Virgin Australia and Air Mauritius have voluntarily entered administration in recent weeks to pursue rescue after finding themselves in financial difficulties resulting from the Covid-19 pandemic.

An administration process can provide an entity with a conducive environment to re-organise its affairs without the threat of enforcement by creditors because a key provision of the Act is a moratorium which prohibits enforcement actions against a company by its creditors unless approved by an administrator or the courts. This relief can enable a business to continue operating without the threat of winding-up proceedings, which can distract management from their day-to-day functions.

Companies can also use the administration procedure to overcome strained liquidity conditions. This is possible because of two features of the administration procedure. First, when a company is placed under administration, there is a freeze on payment of its existing debts.

This has the effect of easing the pressure on a company’s strained cashflows. Second, funding provided to a company during the post-administration period, including payments to suppliers, are given priority when distributions are made by an administrator.

This makes it easier for the company to secure the necessary funding required to meet a company’s working capital and other business obligations.

The procedure is unique in that it can provide ample cover for implementing multiple options that are necessary for the survival of a business. From experience, more than one solution is usually required to truly rescue a struggling business.

This can include a mix of debt renegotiation, asset disposals, cutting costs, restructuring operations, among others. Once they are appointed, administrators are required by the Act to come up with a statement of proposals for achieving the purpose of the administration.

The administrator then evaluates the best possible options for pursuing the objectives of the administration. These measures may be easier to implement as creditors are more likely to engage with an administrators given expansive their powers under the Act.

Administration can also maintain business continuity and stability which is essential when a business is in distress. This is because an administrator does not unnecessarily need to change a company’s management team once appointed, especially where challenges facing a company are general to the economy or sector and are not a direct result of management incompetency. Therefore, administrators working collaboratively with management may have the best chance of helping a distressed business.

In considering the various options available to a company, directors should also be cognisant of their obligations to other company stakeholders such as creditors.

Directors should be aware that under the Companies Act 2015 and the Insolvency Act 2015, they can be personally held liable for civil and criminal actions should they be found guilty of wrongful or fraudulent trading.

Wrongful trading is where a company continues to trade at a time when there is no reasonable prospect of avoiding an insolvent liquidation or administration.

On the other hand, fraudulent trading arises where directors knowingly carry on a company’s business with the intent to defraud creditors by incurring credit that a company cannot repay. It is critical for directors to consider these aspects in evaluating the various rescue options available to a distressed company.

To ensure the objectives of placing a company under administration are realised, it is important to secure the cooperation of all major stakeholders and take action early in making the administration decision.

Delayed action and conflicting stakeholders’ interests are some of the common pitfalls that bedevil administration appointments.

Warren Buffett said, "In order to succeed you must first survive." In times of distress, companies should consider whether the administration process could be the key to their survival.

is a partner with PwC’s Business Recovery Services practice in Eastern Africa region. He is also a Licensed Insolvency Practitioner in Kenya and Rwanda.

s a Senior Associate with PwC’s Business Recovery Services practice in Eastern Africa region.