Corporate Rescue Under the Companies Act 2016 (Part 2)
The Companies Commission of Malaysia (CCM) established a corporate law reform programme in 2003 for the purpose of modernizing the Malaysian company law to be in line with both local and global developments. The Company Law Reform Committee (CLRC) headed by Dato' K.C. Vohrah undertook cross jurisdictional benchmarking studies of countries with a similar corporate framework which included Australia, New Zealand, United Kingdom, Hong Kong and Singapore. The CLRC released their report "Review of the Companies Act 1965 - Final Report" (Final Report) in 2007. Subsequently, the CCM carried out a consultative process with the relevant interested parties. The Government adopted almost all of recommendations by the CLRC resulting in the enactment of the Companies Act 2016 (CA2016), which came into effect on January 31 2017, replacing the Companies Act 1965 (CA1965).
The insolvency framework under the CA1965 (read together with the Bankruptcy Act 1965) was primarily a liquidation module designed to assist creditors in enforcing their rights to recover their debts and protecting their interests. The CA1965 contained provisions relating to the appointment of receivers and managers by creditors holding fixed and/or floating debentures over the assets and undertaking of the company or the appointment of liquidators by the Courts on the petition by creditors whose debts remained unpaid by the company. On the other hand, insolvent companies could opt for a voluntary liquidation by way of a special resolution by its members. A financially distressed company (a term used to describe a company with on-going viable business experiencing insolvency problems) would propose a scheme of arrangement compromising of creditors claims or modifying rights and obligations between the parties due to changed circumstances of the company. Outside of this legal insolvency framework, a financially distressed company would enter into consensual agreements with major creditors to resolve their financial difficulties, a process commonly known as Corporate Workouts.
The influential 1982 Cork Report proposed the culture of "corporate rescue" in the UK Insolvency Act 1986 providing financially distressed companies the necessary time to sort out their financial problems. The United Kingdom then introduced corporate rescue in the form of Company Voluntary Administration (CVA) in 1986. Corporate rescue was incorporated into the Australian Corporations Act 2001, the Indian Sick Industrial Companies (Special Provisions) Act of 1985 (SICA), and the Singaporean Judicial Management in 1986 among may other similar jurisdictions. The United States of America has a similar process commonly known as Chapter 11 under the US Bankruptcy Code. The "Legislative Guide on Insolvency Law" prepared by the United Nations Commission on International Trade Law (UNCITRAL) recognized the need for corporate rescue in the legal framework and this framework was adopted by the General Assembly in 2004.
The rich history on the development of corporate rescue thus provided CLRC the opportunity to explore the best model to be adopted in Malaysia. The CA2016 introduced corporate rescue as proposed by the CLRC in the form of two mechanisms, Judicial Management (JM) (modelled after
Singapore) and Corporate Voluntary Administration (CVA) (modelled after the UK), with such necessary modifications, coming into effect on March 1, 2018. In order to appreciate the rationale behind the CLRC recommendation, Chapter 4 of the CLRC Final Report in relation to insolvency procedures sets out its aim as follows:
"The main thrust of this chapter is to review and propose a legal and regulatory framework that will enable companies that could not continue its business as a going concern to be wound up in an efficient manner, and that will enable companies that are facing financial difficulties, but where there is a business case for the continuation for the company's business, to be restructured."
And further added the advantages of corporate rescue as follows:
*... In Part B of this chapter, the CLRC considered the introduction of a corporate rehabilitation framework to help revitalise ailing companies in Malaysia where there is a business case for the companies to continue their business through a corporate rehabilitation framework, rather than liquidation. An efficient corporate insolvency framework that provides options to businesses to wind up or to be rehabilitated will promote the efficient and sustainable use of economic resources and encourage private sector development and growth."
Understanding and Defining Corporate Rescue
The concept of corporate rescue must be discussed within the narrow confines of the CA2016 as corporate rescue is related to the two mechanisms JM and CVA. CVA is similar to a Schemes of Arrangements in that it contains provisions for obtaining the collective agreement of the creditors and members to a proposal for a compromise or arrangement. The CA2016 does not provide any other details relating to CVA, save for the procedural matters. However, this is not the case for JM where the CA2016 sets out the key constructs in relation to corporate rescue including the conditions that must be present in order to commence the process, what the company aims to achieve, and the procedures needed to be undertaken to achieve its aim.
While the CA2016 does not provide any concrete definition of corporate rescue, an attempt will be made below to define it in the context of corporate rescue mechanisms in the CA2016. Corporate rescue can be described as:
the process by which the financial well-being and viability of a debtor's business can be restored and the business continues to operate, using various means possibly including debt forgiveness, debt rescheduling or debt equity conversions? resulting in the survival of the company, or the whole or part of its undertaking as a going concern or the approval under section 366 of a compromise or arrangement between the company and any such persons as are mentioned in that section or a more advantageous realization of the company's asses would be effected than on a winding up!"
There are therefore two outcomes that can result from a corporate rescue process, a"Company Rescue" whereby the company continues to survive as an entity with the whole or part of its undertaking as a going concern or a "Business Rescue" whereby all or parts of the company undertaking are preserved as a going concern and sold as a going concern.
Going Concern Value vs Liquidation Value
The primary aim of a corporate rescue can be simply put as the preservation of its business as a going concern of a financially distressed company on the premise that the preservation of the business as a going concern will provide creditors with a better return than in liquidation. McCormack states that:
"The underlying principle of corporate rescue is that a business is worth more if preserved or sold as a going concern than if the parts are sold on a piecemeal basis. In other words, there is a surplus of going concern value over liquidation values."
In a similar vein, the Legislative Guide on Insolvency Law prepared by the UNCITRAL states that:
*Not all debtors that falter or experience serious financial difficulty in a competitive marketplace should necessarily be liquidated; a debtor with a reasonable prospect of survival (such as one that has a potentially profitable business) should be given that opportunity where it can be demonstrated that there is greater value (and, by deduction, greater benefit for creditors in the long term) in keeping the essential business and other component parts of the debtor together."
In keeping with this concept of the surplus of going concern value over liquidation value, the surplus of going concern can be derived through the use of a quasi mathematical formula that can be adapted in the following quote:
"It has been suggested that whether a firm should be kept together as a going concern is answered by estimating the income stream generated from the assets used as a going concern taking into account the risk of failure and discounting the income stream to present value against the asset value on a breakup basis."
Not all debtors that falter or experience serious financial difficulty should necessarily be liquidated; a debtor with a reasonable prospect of survival should be given that opportunity where it can be demonstrated that there is greater value in keeping the essential business and other component parts of the debtor together.
The Business Plan incorporating a Corporate Rescue Plan and Financial Plan
Where there is an acknowledgement that a company is in financial distress and there is a need to undertake a corporate rescue, it is essential that a review of the company, its business and affairs be conducted with the aim of developing a Business Plan that will obtain the support of the stakeholders. This reviewis called by various names including a Business Review, Viability Report or even a Diagnostic Study. This Business Review will determine the current position of the company in all aspects of its business, its business model, the ecosystem and its ability to survive in the short and long term and the restoration of its financial health. The specifics would include the current financial position taking into account all contingent claims and an estimate of the breakdown values of the assets, profit and cash flow projections business and financial strategies underpinning the profit and cash flow projections, sensitivity analyst, review of the management and manpower capability to deliver the future results, the adequacy of the Management Information Systems and the solutions to address the financial failure.
On the basis that the company can overcome its financial difficulties the company will plan the way forward. This would generally translate into à Business Plan that incorporates all aspects of the company and its business including its Corporate Rescue Plan (CRP) and Financial Plan to restore the company to a solvent position. The Business Plan may include a number of features including the proposed injection of funds from existing shareholders or from new investors the businesses to be retained or disposed, the proposed haircut by creditors, debt rescheduling, debt forgiveness, debt equity conversions, exit strategies including call and put options; all of these would be reflected in financial projections of the company. All these proposals must be capable of achievement and based on the legal framework of the company's constitution, Companies Act and any other legislation relating to the company and its business.
The issue of credibility and transparency is paramount to all stakeholders involved with a financially distressed company. There is a need for full transparency on the affairs of the company and its business plan as "transparency will also enable creditors to clarify priorities, prevent disputes
by providing a backdrop against which relative rights and risks can be assessed and help define the limits of any discretion": The stakeholders, especially third parties such as creditors and bankers would exoect that the Business Review to be conducted by reputable professionals who are adequately qualified and independent so that credibility and transparency of the process is not questioned by the stakeholders.
The company would be well advised to consult key stakeholders to provide the necessary inputs when undertaking a corporate rescue. The company should attempt to obtain the "buy in" of all key stakeholders to the corporate rescue process. The "buy in" is a consultative process with all major stakeholders on the merits of the Business Plan, and where necessary to negotiate such terms and concessions necessary between the parties that meets with the tacit approval of these key stakeholders. The right balance between the rights and entitlement of all the stakeholders is necessary. For example, the largest haircut must be taken by the equity holders followed by the unsecured creditors and finally the secured creditors. It is also common for the creditors to insist on the appointment of an independent monitoring accountant to monitor the business affairs and finances of the company pending the commencement of the process of corporate rescue.
The key ingredients of credibility, transparency and "buy in" from major stakeholders to the Business Plan by the company are critical in undertaking a corporate rescue. A business plan that lacks these ingredients is very likely to find opposition by these stakeholders from the onset of the process. There is a tendency to cite the oft quoted statement by the stakeholders that the company is only "trying to buy time where is there no future for the company or its business" and to stave off the appointment of receivers/and or managers and liquidators by individual creditors. In the recent case of Leadmont Development Sdn Bhd V Infra Segi Sdn Bhd, a Judicial Management Order (JMO) was set aside on the basis that the secured creditor who had petitioned for the winding up of the Company opposed the JM on the basis that the secured had sufficient votes to defeat any proposal by the company and accordingly would not support any proposal by the company.
There is a need for full transparency on the affairs of the company and its business plan as "transparency will also enable creditors to clarify priorities, prevent disputes by providing a backdrop against which relative rights and risks can be assessed and help define the limits of any discretion.
Corporate Voluntary Administration or Judicial Management
A company deciding to undertake a corporate rescue may adopt either a Corporate Voluntary Administration or a Judicial Management. However, not all companies can avail themselves to the corporate rescue mechanism as there are certain restrictions under the CA2016.
A company which is a licensed institution or an operator of a designated payment system regulated under the laws enforced by the Central Bank of Malaysia® or a company which is subject to the Capital Markets and Services Act 2007 cannot proceed with either CVA or Judicial Management. Judicial Management cannot be applied when a company has gone into liquidation'' whereas in the case of a CVA, a CVA cannot be proposed for a public listed company, a company with pending queries from CCM or where the company's information with CCM is not up-to-datel or a company who has charged its property or any of its undertaking.
The Court shall dismiss an application for a JMO where the JMO is opposed by a "qualified debenture holder". A qualified debenture holder is a secured creditor having security over the whole or substantially on the whole of the company's assets and has or will be appointing a receiver and manager. There is an overriding provision for the Courts to consider making the JMO if the Courts consider it public interest to do so. This is notwithstanding that the Courts may not be satisfied that the making of the order would be likely to achieve the aims of a corporate rescue. The public interest connotes an interest or object that would transcend any or all of the statutory purposes as decided by the Singaporean Courts.
Conclusion
Corporate Rescue is an alternative to winding up and a temporary mechanism to allow a financially distressed company the necessary protection and powers to reorganise its affairs to achieve the going concern surplus. The design of the mechanism must be robust to allow for the preservation of its business of a financially distressed company as a going concern. The Legislative Guide on Insolvency Law by UNCITRAL sums up a corporate rescue mechanism as follows: "Reorganization proceedings are designed to give a debtor some breathing space to recover from its temporary liquidity difficulties or more permanent over indebtedness and, where necessary, provide it with an opportunity to restructure its debt and its relations with creditors. Where reorganization is possible, generally it will be preferred by creditors if the value derived from the continued operation of the debtor's business will enhance the value of their claims."
It therefore becomes incumbent on the financially distressed company to produce a credible and transparent business plan for a corporate rescue that has the "Buy In" or is capable of getting the "Buy In" of its major stakeholders. As this Business Plan forms the basis for commencement of any corporate rescue mechanisms, it must be well thought and address all questions or concerns that the stakeholders may have. The company should seek the assistance of necessary professionals with the necessary skills and expertise to support the company as it proposes to navigate itself through the legal requirements and procedures of corporate rescue. In Part 3, we will discuss the design of corporate rescue mechanisms and the key constructs to navigate a successful corporate rescue.