Dealing With A Broken Business: Three Options For Insolvent Companies

It is said that the only an egg is better when it is broken. When a material financial crisis results in a company being broken, its ongoing viability needs to be immediately assessed to determine if the business is insolvent. While no company has a corporate goal of achieving insolvency, if it does become insolvent, the company (or its creditors) may begin to seek out protection and remedies available under the Bankruptcy and Insolvency Act (BIA) or other legislation. However, the issues that cause insolvency and the regulations that then apply can be complex and overwhelming. So where do you start?

Insolvency

The first step is understanding what insolvency means. The BIA is the primary legislation regulating insolvencies in Canada. An insolvent person (or company) is defined within the BIA as a person or organization who:

• Is unable to meet obligations as they generally become due;
• Who has ceased paying obligations in the ordinary course as they become due; or
• Whose assets are not sufficient to pay all of its obligations.

Once a company comes into the vicinity of insolvency, legal and accounting advisors should be consulted to consider how insolvency legislation applies to the businesses specific situation. The BIA requires the appointment of a Licensed Insolvency Trustee (Trustee) to independently assist companies through the formal insolvency processes and ensure protection of certain rights on behalf of creditors. A Trustee is often the go-to contact for both companies and their creditors as they discuss insolvency options.

It’s important for the directors of an insolvent company to be aware of the fact that they may be held personally liable for certain unpaid or unremitted amounts related to employees, taxes and other actions which may cause or further the insolvent state of the company. The director’s actions once a company is insolvent may be judged harshly by creditors who end up unpaid by the company. It is highly recommended for directors of insolvent companies to contact their advisors in efforts of minimizing the risk of personal liability.

The three main insolvency proceedings available to insolvent companies or their creditors are restructuring, bankruptcy or receivership. The benefit or impact of these proceedings depends on where you sit in relation to the insolvent company.

Restructuring

Where an insolvent company can avoid bankruptcy by restructuring or through an orderly liquidation, a proposal to its creditors under the BIA or the Companies Creditors Arrangement Act (CCAA, used for more complex matters) should be considered.

Management of companies entering a proposal process can benefit from the breathing room provided by a “stay of proceedings” which generally stops all interested parties from taking or continuing action against the insolvent company. In addition, management does not need to obtain agreement from all creditors as the terms of an approved proposal are binding on all creditors regardless of how each individual creditor voted.

Creditors need to contact the Trustee and their advisors to fully understand the implications of the stay of proceedings, any requirements to continue providing goods and services and how their claim is treated under the proposal. Accordingly, the period leading up to the vote on the proposal is a key time for creditors to try and negotiate improvements to the proposal made by the insolvent company.

Bankruptcy

A bankruptcy will be considered when a company is no longer viable. Companies become bankrupt either by assigning themselves into bankruptcy in order to “stop the bleeding” and minimize director liabilities or by creditors petitioning for a court order declaring the insolvent company bankrupt.

A Licensed Insolvency Trustee is engaged to realize on the corporate assets and then pay out the resulting funds to creditors according to legal priority. Generally, the Canada Revenue Agency is at the top of the priority list for certain amounts owing to them, followed by creditors who have valid security registered against the company assets. The rest of the creditors are then typically put into one pool of unsecured creditors that share rateably on any remaining funds.

Creditors of bankrupt companies should ensure the Trustee provides them with:

• Notice of the First Meeting of Creditors - the Trustee must hold a meeting of creditors where an update on the bankruptcy will be provided and votes held. Creditors are not required to attend the First Meeting of Creditors and an update on the bankruptcy process can be obtained by requesting a copy of the Trustee’s Report; and
• Proof of Claim – All creditors must file a proof of claim with the Trustee to confirm the amounts owing from the bankrupt company, regardless of any amounts showing on the original bankruptcy documents. Creditors will not share in any payout from the bankruptcy unless they have filed a proof of claim and it has been accepted by the Trustee. Any creditor with unique rights such as liens, security or other concerns should contact the Trustee to discuss how they intend on dealing with these issues.

Receiverships

Receiverships are the primary realization option for secured creditors of insolvent companies. Secured creditors must give the insolvent company 10 days’ notice of their intention to enforce their security prior to appointing a receiver. The insolvent company then has that notice period to negotiate an alternative with the secured creditor, agree to the appointment of the Receiver or initiate a restructuring process which would then stay the secured creditor from proceeding with the receivership appointment.

A Receiver takes control of the assets and operations charged by the security agreement (or as directed in the appointing court order). The Receiver has a general duty to all interested parties.

Creditors of companies in receivership should contact the Receiver to discuss how the company is being dealt with and get details surrounding payment expectations. Creditors should note that a company in receivership is often also assigned into bankruptcy, resulting in their claim being dealt with in accordance to the bankruptcy process.

If your business is struggling in today’s economy, you’re certainly not alone. Every corporate insolvency situation is unique. To determine which of these options will work best for your business, start by speaking with a corporate insolvency professional.