Alternatives to Bankruptcy

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Many businesses are facing significant economic hardships because of government-imposed restrictions, social distancing practices, and other measures taken to control the spread COVID-19. These include those in retail, hospitality, personal services, and others. Unfortunately, many of these companies have fallen or will fall insolvent and may end up filing for bankruptcy on 1. BKHQ. This article will outline some options for bankruptcy companies should look into if they find themselves in financial trouble.

Bankruptcy or Insolvency

Canada’s legal definition of bankruptcy or bankruptcy is “bankrupt“, which refers both to a legal status and a process. Individuals in financial distress are eligible for bankruptcy protection. When proceedings are started under the Insolvency & Bankruptcy ActR.S.C. 1985, C.B-3 (“ BIA“) This does not necessarily indicate that the debtor company or individual is bankrupt. However, the debtor can be insolvent, but it does not necessarily make them bankrupt. A person can be bankrupt if they have been subject to a bankruptcy or an assignment under the BIA.

Section 2 defines an “insolvent persons” as a person (a “person”, can be a corporation, an actual person, or a corporation) who isn’t bankrupt, isn’t a resident of Canada, or carries on a business or has property there, whose claims to creditors under the BIA amount up to at least $1000 and:

  1. Anyone who is unable fulfill their obligations as they generally become due.
  2. Who has stopped paying current obligations in ordinary business operations as they typically become due;
  3. The property of a person whose assets are not sufficient to cover all outstanding obligations. [1]

A “bankrupt” person can be defined as someone who has given a bankruptcy assignment or against whom bankruptcy orders have been made. [2] Also, an order for bankruptcy can be made against anyone who is not insolvent. Sections 42, 43 and 45 of the BIA give examples of various “acts of bankruptcy” that might support a request to make a bankruptcy orphan order. A person must first be declared insolvent to make a voluntary transfer into bankruptcy or a proposal according to the BIA.

Alternatives, Debtor’s Choices

There are many advantages to considering other options and avoiding bankruptcy. They allow companies to avoid the stigma that comes with bankruptcy, they can preserve their jobs, it helps to preserve enterprise value and it allows businesses the ability to maintain relationships with customers and suppliers.

Get organised

Companies in financial distress need to take time to organize their finances. These housekeeping tips can be used even if the company has good financial health.

  • By having the necessary security interests registered, you can protect any loans that were made by the parent company or affiliated companies to the troubled firm. This helps ensure that secured loans have better standing than unsecured creditors. This means that you will need to establish evidence of the loan.
  • A thorough inventory of company assets and liabilities is necessary to keep the company current and up-to-date. Assets include, among others, trademarks, licences and leases. It is important to determine who owns the asset by taking inventory. This could be the distressed company or an affiliate. It is vital to locate and organize all documents relevant, including profit and loss statements as well as financial statements. You should search for corporate documents, bring them up-to-date, and verify their accuracy.
  • If possible, ensure that the company has paid all fees, remittances and taxes due to the government.

Informal discussions

Depending upon the circumstances, debtors might be able contact creditors to negotiate a repayment program or lower interest rates. Creditors require that debtors present a simple plan that clearly outlines the debtor’s plans for meeting its obligations. Creditors require that debtors present realistic proposals. They should include reasonable payment plans, but keep in mind that the longer the repayment term the greater the interest.

Creditors are not required by law to offer alternative payment plans to debtors. Therefore it is vital that any informal discussions with creditors are honest and have the goal of convincing them that a special arrangement is in their best interest. To evaluate the feasibility and reasonableness of any proposed arrangement, creditors will need to examine the financials for the company in distress before considering it.

Proposals

In today’s economic environment, proposals have a greater chance of success than they did in the past. This article will address Division 1 and 2 of the BIA proposals, as well as those under the Company Creditors Arrangement Act. (the ” CCAA“) The fundamental difference between a restructuring conducted under CCAA and one under BIA is the fact that the BIA’s process is more formal and has strict guidelines, rules, timeframes and guidelines. The CCAA proceeding, however, is more flexible and judicially driven. [3]

Division 1 / Commercial Proposals

Section 50 of the BIA allows an insolvent person to make a proposal that creditors accept to avoid bankruptcy. The proposal is similar a contract. This will result in restructuring of debt and orderly payment for the amount that was agreed to.

A licensed insolvency trustee must be contacted by a debtor who wishes to make a proposal under BIA. The “proposal trustee” will then act on the behalf of the debtor. The proposal trustee monitors the affairs of the debtor, as it retains its assets. They also report to the court and creditors.

The debtor has two options: to file a Notice to Intention to Make Proposals (” NOI“), or to submit a proposal. Each will immediately suspend creditors’ rights. The debtor has the option to request a stay of proceedings. This allows him to have much-needed time to work on his proposal to creditors. [4]

Once a proposed is filed, the proposal trustee notifies creditors to call a meeting to examine the proposal. Creditors then vote on whether or not to accept it. Only creditors with proofs of claim may vote. The proposal will establish the classes that creditors are allowed to vote. While the unsecured creditors make up one class, the secured creditors may be classified in other classes. [5]

Making a proposal under BIA can have many benefits.

  • All legal collection actions brought by unsecured creditors against debts that are covered by this proposal are stopped.
  • It is possible for debtors not to be denied credit, or to borrow interim funds to pay the proposal.
  • The insolvency can’t cause creditors to end their agreements.
  • A debtor can cancel agreements that no longer benefit him, including premises leasing;
  • It permits the retention of employees.
  • The debtor has the option to sell certain assets and business lines while keeping other parts. [6]

Many of these benefits require court approval. This will impact the professional fees associated. Some mechanisms are also open to the court’s discretion. The court can decide if a particular BIA mechanism is available to the distressed business, depending on the facts.

Prerequisites

The following are the main requirements for a Division 1 request:

  • It must give creditors a better result than that which would be expected in bankruptcy. [7]
  • Without the consent of the government, the proposal must make certain tax claims fully paid within six months after approval by court.
  • If the lender is an employer, it must pay all employees and former workers of any unpaid wages or commissions. Maximum of $2,000.
  • If a prescribed pension plan exists, the proposal should include provisions for the payment of certain required payments. [8]

Unsecured Creditors

A Division 1 proposal might reach secured creditors. however, must always reach the unsecured creditors. If the proposal goes to both secured and unsecure creditors, there will be at minimum two classes of creditors that can vote separately. If the collateral secured has a lesser value than the debt and so a deficiency can be expected, a secured creditor might be treated as unsecure for the deficiency. Additionally, the debtor must maintain the terms of any secured or debt agreements throughout the proposal period. [9]

Cashflow Statements

Any debts the debtor owes after the date of filing the proposal or NOI will be put on temporary “hold” but the debtor must prove that it has enough cashflow in order to continue its obligations. This may include paying taxes, payroll, professional fees, rent, and other expenses. This is done by submitting a cashflow declaration, which must then be signed off by proposal trustee. [10]

Timeline

It is crucial that debtors follow the BIA’s timeline requirements. Failure to do this will result in a deemed transfer in bankruptcy. After filing the NOI the debtor has thirty days to file the proposal. It can also seek an extension from the court for up to 45 days. The maximum aggregate time allowed by the court is five months. [11]

After the Proposal is Filled

For a proposal to be accepted, all creditor classes (except those with equity claims) must vote for it to be accepted by a majority of creditors (with proven claims), present at the meeting in person or proxy, and two-thirds value. [12]

It is not unusual to contact creditors ahead of a debtor’s proposal in order to secure their support and ensure quorum. It is also common for amends to be submitted at or prior to the meeting. If certain creditors require additional information or request enhancements to the proposed proposal, the meeting can be adjourned. With the assistance of a proposal trustee, debtors can often negotiate terms of a proposal with certain creditors (usually with significant claims). This is because if the proposal gets rejected, the debtor may be considered to have made a bankruptcy assignment. [13]

CCAA

The CCAA allows corporations in financial distress to restructure their finances through a Plan of Arrangement, while still being able to continue operating. Similar to Division 1 proposals under the BIA Division 1, CCAA provides an opportunity for the company not to go bankrupt and allows creditors to receive some form payments for amounts owed. Division 1 Proposals are available to all individuals and corporations. However, proposals under CCAA are only available for larger corporations with debts exceeding $5 million. While the CCAA provides greater flexibility that allows for greater business discretion and judicial discretion over proposals under the BIA proposal, it is a complicated legal procedure and can result in significant costs. It also impairs the ability of unsecured creditor to collect money from a company with a debtor.

Restrictions Eligibility

The CCAA can be applied for by a debtor business if it is insolvent with more than $5 million in secured and unsecured claims. The CCAA is not accessible to banks, railways or trust and lending companies.

Like Division 1 Proposals but without the CCAA, the bankrupt company is not considered to be insolvent. The CCAA gives companies the option to address their shareholders, in addition to creditors, if they so wish. If the proposal has a significant impact on the company’s shareholders, they will often be given the opportunity to vote.

Court-Supervised Organizations

Superior court is where applications are filed, typically in the province in which the debtor has its head office or main place of business. Applications may be made by the debtor company as well as other interested parties like creditors, bankruptcy trustees, and the liquidator.

A monitor is appointed. This monitor must be a trustee as per the BIA. The monitor is responsible in overseeing the company’s financial affairs and business during the reorganization.

Once a court accepts a case, the CCAA grants the court wide-ranging discretionary power to make appropriate orders and remedies. With the support and assistance of its monitor, it will issue orders at company’s instance. This can often be done without the consent of creditors.

The following are common court actions:

  • Prohibiting parties degrading agreements with debtor companies
  • Contracts that have been entered into with the debtor company must be cancelled or disclaimed.
  • Authorizing post-filing security for debtors-in-possession financing or super-priority charges on the debtor’s company’s assets when necessary to allow debtor company to continue to do business during the reorganization;
  • Establishing the existence and validity of creditors’ claims using a time-limited process to determine creditors’ claims that might be disputed by the company;
  • Adopting a plan to arrangement by the debtor to settle or arrange debts owed some or all creditors.

The court can exercise broad discretion when deciding the next steps for the reorganization. However there are limitations on the court’s power. An order under the CCAA is not able to compel third party creditors to advance further money or credit. Creditors cannot also be prohibited from requiring immediate payment of services rendered to debtor companies during a CCAA proceeding. A stay of proceedings can be lifted by the court if the reorganization fails to succeed. This would bring an end to the CCAA proceedings as well as bankruptcy proceedings under BIA.

Informal restructurings

Informal restructurings are a way for distressed companies and individuals to come to a compromise with creditors and stakeholders before going to court.

There are many ways to informal restructuring: It can address debt problems with deferred or partial payments to creditors, exchange of debt against equity, or other forms. It can address operational issues as well, including the creation of additional corporations or the transfer of operations or assets or the sale of any or all of the business.

There are other forms of informal restructurings:

  • The partial liquidation of the debtor’s assets
  • Refinance existing loans
  • Bridge loans
  • creditor or stakeholder forbearance.

Benefits

There are many benefits to engaging in informal restructurings. This is because you don’t have to go through any formal proceedings. Not only does it avoid the stigma of bankruptcy filings, but informal restructuring also helps debtors avoid the costs and fees associated with formal restructuring.

Downsides

In turn, the lack of structure can also have its downsides. First, the absence of a formal process means that creditors and stakeholders can enforce and take other legal action against the debtor. While creditors are not obliged to settle, they are more likely than others to do so if they believe the offer will yield a better return than if their company was either liquidated or closed down.

In determining whether it is worth trying an informal restructuring, consider the complexity of debtors’ financial structures. The greater the debtors’ financial structure and the more stakeholders involved, the more difficult it will become to restructure.

In informal proposals to creditors, the debtor may need to present the creditors with the current financial statements, as well as an explanation for the financial difficulty. In self-directed informal restructurings, the CRA won’t compromise its debt. Interest and penalties will still accrue.

If you are considering informal suggestions, it is prudent that you first consult with a professional advisor. This is especially important before starting negotiations with creditors. Understanding the process of obtaining full debt relief and the consequences for stopping creditors’ payments is essential.

Forbearance Arrangements

Forbearance agreements may be offered by creditors to borrower who has entered into financial difficulties and defaulted on a credit agreement. Forbearance agreements often acknowledge that the lender is entitled to enforce its security, but the creditor will forbear for a specified period of times based upon certain important considerations.

A forbearance agreement allows the borrower to be granted time. This can be used to refinance or sell assets, receive equity injections, or deal directly with creditors who are necessary for a successful restructuring. The lender can obtain more information about the borrower’s current financial status and estimate its future financial needs. Both sides can take this opportunity to consult any consultants to help with determining solutions to the borrower’s current financial problems.

Forbearance agreements typically include the following terms:

  • Reporting requirements that require additional financial reporting
  • The preparation of cashflow projections for extended periods must be mandated. They should be regularly updated to reflect the actual results of borrower operations.
  • The grant of additional security by either the borrower nor a garantor
  • Correction of any deficiencies in the security agreement.
  • Right to be granted an extension for additional periods, provided certain milestones are achieved.

The lender could also designate a monitor or another consultant to help monitor the debtor’s business activity and make sure they meet their obligations under the agreement. This would be done at the expense the debtor.

These types of agreements allow the distressed company to seek alternate solutions, stabilize its business operations or sell some of its assets. All this without the need for a formal restructuring proceeding. Clear communication with customers as well as suppliers is vital in informal processes.

Conclusion

For debtors, it is important to be proactive and take insolvency advice early rather than later. Get your house in order and organize can lead to alternative financial solutions. This will also help facilitate discussions with creditors.

These are some of the things you should consider when making an action plan.

  • You can get the best outcome if you act quickly and are proactive.
  • It is not always the best solution to financial problems.
  • You should ask yourself if the management team responsible for putting the company in difficulties is the one that can lead it to recovery.

No matter which alternative is used, all stakeholders must work together to understand the debtor’s financial situation. Although creditors don’t have to agree to help or extend any courtesy, they are more likely not to do so if there is a better return on their investment than if the company goes bankrupt. It is important that you think about solving problems before things get dire. An ability to recognize the problem and put together a proactive plan will help maximize your options and possibilities.


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