Traditional and Untraditional Solutions to Insolvency Issues during the COVID-19 Pandemic
Canadian businesses are facing the largest economic disruption of our times from the outbreak of the novel coronavirus and the public health measures required to contain it. Although the impact of the social distancing requirements varies across industry sectors, the majority of businesses have experienced declining revenues that could threaten the viability of their enterprise as the crisis continues to unfold. Business owners concerned about their ongoing ability to meet financial obligations to lenders, landlords, and suppliers should be aware of the debt relief options traditionally available to insolvent companies, including formal proposals and informal “workouts”. Due to the extraordinary circumstances caused by the pandemic, novel approaches may also be required.
In cases where a company has a large number of creditors or requires significant changes to its business to continue in operations, a formal restructuring under the Bankruptcy and Insolvency Act (“BIA”) is likely the most appropriate option for obtaining debt relief. Restructuring under the BIA is commenced by filing of a Notice of Intention to Make a Proposal (commonly referred to as an “NOI”) and delivering it to the company’s creditors. The most significant advantage of filing an NOI is that it results in an automatic “stay of proceedings”, which means that all creditors are prevented from taking steps to enforce their loans or security. The stay of proceedings initially lasts 30 days but can be extended, on application to court, for further 45-day periods up to a maximum of six months. A Licensed Insolvency Trustee oversees the operations of the company during the stay of proceedings and administers the process under which creditors establish the nature and quantum of their claims.
In a typical restructuring, the main purpose of the stay is to allow the debtor company to continue in operations – and preserve its “going concern” value – while arranging for new financing or investments that will allow it to pay a portion of its debts and emerge from the process as a financially viable business. The restructuring process can also involve the sale of non-critical business assets, the disclaimer of commercial leases, or a reduction in the number of employees. The stay will usually be extended for as long as reasonably required to allow the company to develop a restructuring plan, which is presented to its creditors in a formal proposal and subjected to a vote. To achieve creditor approval, the proposal needs to be supported by each class of creditors (i.e. the class of secured creditors and the class of unsecured creditors) in the following thresholds:
- 50% or more of the number of creditors entitled to vote in the class;
- Sufficient creditors to represent two-thirds of the claims against the company by that class of creditors.
After creditor approval is secured, the debtor company must apply for court approval which, if granted, allows the company to implement the proposal and obtain the debt relief provided by its terms. In this way, the proposal’s terms can be “imposed” on the minority of creditors that opposed the proposal.
While there are risks to commencing a formal restructuring process under the BIA, it may be appropriate for businesses to consider employing it during the COVID-19 outbreak for the primary purposes of addressing a short-term liquidity crisis. If the business expects to be in a financial position to satisfy the claims of creditors in full (or in part) within the next six months but is unable to obtain the agreement of all of its creditors to deferred (or reduced) payments, an NOI could be an effective tool. The decision to embark on this process should only be made after receiving legal advice from experienced insolvency counsel.
For businesses with only a few significant creditors, negotiating forbearance terms is likely the best option for managing the cash-flow shortage caused by the recent economic disturbance. Forbearance agreements are commonly negotiated between a company and its senior secured creditor (usually a bank) as a means of addressing a short-term insolvency and enabling the company to recover its financial footing over time. In the circumstances caused by the pandemic, it may be that other creditors, such as suppliers and landlords, will consent to the deferral of regularly scheduled payments to permit the company to survive the crisis and return to solvency. If the company can negotiate satisfactory forbearance terms with each of its creditors, it can avoid the expense and uncertainty of a formal proposal under the BIA.
A similar “consent-based” strategy can also be employed by businesses with large numbers of creditors. A “workout” is a contractual arrangement between a company and the majority, if not all, of its creditors. It usually includes the creditors’ agreement to accept a reduction in the amount of their claims on the basis that the restructuring terms offered are better than the amounts recoverable in a liquidation or bankruptcy. Since a workout does not occur under an insolvency statute, it is not possible to impose the terms of the arrangement on dissenting creditors, some of whom may elect to take enforcement proceedings instead of participating in the workout process. However, where the company has the support of all of its secured creditors, the failure to achieve universal approval from unsecured creditors would usually not disrupt the restructuring process.
A workout has the same advantages as a series of negotiated forbearance agreements: greater certainty and less expense than a formal BIA proposal. Therefore, in circumstances where the company has support from all or most of its major creditors, a workout may be the best way to obtain financial relief.
The traditional framework for commercial insolvencies assumes a set of conditions under which the restructuring of a business occurs. These assumed conditions include: (i) a market for the sale of distressed assets; (ii) availability of refinancing or new equity investments; (iii) unimpeded access to the courts; and (iv) a reasonably ascertainable forecast of future economic conditions. Due to the extraordinary circumstances that currently prevail as a result of the COVID-19 outbreak, these underlying conditions are absent and may not reappear for some time. This unique environment may require novel approaches to insolvency issues. For example:
- Debtors and creditors may find that the best strategy for dealing with the crisis is to adopt a “holding pattern” type of agreement, in which the company retains control of its assets and defers restructuring attempts until there is greater certainty regarding the future prospects for the business or market for its assets.
- Where the company is unable to obtain the confidence of its creditors, it may attempt to put in place a creditors’ committee to oversee the restructuring process and allow it to proceed. This may be preferable to formal oversight by a receiver or insolvency trustee, since the cost of involving those professionals is significant and could reduce recovery to creditors or the equity remaining in the business.
- In cases where all of the creditors recognize the extraordinary circumstances facing the debtor and are willing to accept the “wisdom of the crowd”, a hybrid-type proposal could be formulated with features of both formal and informal restructurings.
- If priority disputes need to be resolved in an informal restructuring, creditors may consider submitting the dispute to arbitration rather than attempting to obtain a court date.
Early advice on the options available to the business is critical to a successful restructuring. Windows of opportunity for a business can close before the decision-makers have even had a chance to explore what opportunities exist. Professional advice can be invaluable in identifying early warning signs and helping business owners realize that they have options.
This article is intended to be an overview of the law and is for informational purposes only. Readers are cautioned that this article does not constitute legal or professional advice and should not be relied on as such. Rather, readers should obtain specific legal advice in relation to the issues they are facing.