My business is in financial difficulty. Is an arrangement with creditors the right option? – Finance and banking

If your business is struggling to stay financially viable, you could be deal with insolvency. Before that happens, one option you might consider is to negotiate a settlement with the creditor.

This is a regime that deals with the rights of your company’s creditors (people or companies to whom it owes money). This article explains how an arrangement with creditors works, including:

  • what compromises you can offer to creditors regarding the debts of your companies;
  • the processes involved; and
  • when you can use this restructuring technique.

What is an arrangement with creditors?

An arrangement with creditors (Scheme) allows you to restructure the debts of your company. Debt restructuring can occur in a situation where your business is in financial distress and is:

  • seek to reduce; and or
  • renegotiate debts

to improve its financial situation and continue its activities.

You may want to restructure your business debt to ensure that every effort is made to maintain/restore liquidity (cash flow).

Before a program is concluded, your company will need to prepare documentation indicating:

  • purpose of the scheme;
  • the compromises reached by the parties to the Scheme; and
  • the powers of the Scheme administrator (the Scheme administrator is a person who oversees the Scheme, usually a registered liquidator, alone or with a group of creditors).

What does a diet include?

A program can include a number of different proposals for reducing your business debt. You could:

  • renegotiate interest payments;
  • increase the time before having to pay in full; Where
  • offer to swap debt for equity (shares of your company).

For example, due to the COVID-19 pandemic, Virgin Australia sought to restructure its debt through a program that offered to swap its debt for shares in the airline.

Does my company have to be solvent?

A plan is an option available to a company when it is solvent (has assets that can cover its liabilities) and is a preferred strategy if you want to avoid placing your company in voluntary administration.

Although offering a plan is an option if your business is insolvent, it exposes the business to risk. Indeed, it can expose the administrators of your company to personal liability associated with an insolvent business. You should seek personalized legal advice in these circumstances.

How a scheme applies to creditors

A program ultimately allows your business to continue trading. A Scheme is offered to creditors on the basis that creditors, or a class of creditors, will be in a better position if a Scheme is agreed to than they would be if your business entered into Voluntary administration or liquidation.

When you negotiate an arrangement with the creditors, it is customary to ask the creditors if they accept your company either:

  • pay off a smaller amount of debt; Where
  • the payment of the debt being postponed to a later date.

To receive approval for a plan, you must be approved by the majority of your company’s creditors at a meeting of creditors. The creditors at this meeting must represent at least 75% of the total pool of creditors. This is to ensure that you meet the concerns of the majority of creditors.

When the majority of your company’s debt is owed to a handful of key creditors, consider asking for their support before the creditors’ meeting and document the agreed terms.

When to involve the court and the regulator

Before you can enter into an arrangement with creditors, you must:

  • inform the Australian Securities and Investments Commission (ASIC) about your proposed program and provide them with an explanatory statement; and
  • apply to the court, which will then determine whether to make an order calling a meeting of creditors and, pending creditors’ approval, will ultimately approve the terms of the Scheme.

ASIC has the opportunity to review the terms of the Scheme before the court issues an order convening a meeting of creditors. It is a legal requirement that the ASIC have a notice period of at least 14 days. This allows the ASIC to:

  • examine the terms of the compromises provided for in the Scheme; and
  • prepare a statement or submissions to the Court regarding the compromises sought (certain exemptions may be made to shorten the 14-day notice period in circumstances where the Court or ASIC permit).

Once a court has issued an order convening a meeting of creditors, the creditors vote on the proposals set out in the statement of reasons. If a majority of creditors decide to approve the Scheme, then the Court will have to be approached again to:

  • review the Scheme; and
  • determine whether the proposals are fair and reasonable

before the court grants its approval.

The court may require certain conditions to be met in order to grant plan approval. The court will not approve any plan that does not comply with public order, even in circumstances where a majority of creditors have decided to approve the plan at a meeting of creditors.

Once the court has approved the program, the final court order must be provided to ASIC before the program can begin.

When are creditor settlement schemes used?

Many companies facing insolvency prefer to avoid creditor regimes and instead use other restructuring options, such as voluntary administration. This is due to the fact:

  • the documentation associated with an arrangement with creditors is very complicated; and
  • it can be both time-consuming and expensive to go through the process of providing certain documents to creditors, ASIC and the court.

There are circumstances where a creditors’ regime would be preferable. For example, your company may seek to benefit from a program as:

  • clauses in the contract allowing a party to end the contract insolvency cannot be triggered when a company asks to enter into an arrangement with creditors; and
  • Creditors’ Schemes of Arrangement may bind secured creditors who do not vote to approve the Scheme.

Key points to remember

If your business is struggling to remain financially viable, you may be facing insolvency and considering ways to manage your debt. There are several ways to approach this, including an arrangement with creditors.

Whether you are a business owner or a creditor, it is important to understand your obligations, options and rights.

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April 16, 2020 (updated August 14, 2020)

The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.

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