The worldwide economic meltdown caught many businesses unaware.
Gearing quickly became over-gearing, leverage -- instead of being a
catapult for new wealth -- became a noose, and business
leaders had to scramble to keep their companies alive. Of critical
importance is the injection of new capital to restore a balance
sheet to solvency by ensuring that assets -- fairly valued --
exceed liabilities, or to generate cash flow to remedy technical
solvency issues such as the ability to pay debts as and when they
In this climate, there are a number of commercial remedies
available that would benefit a stretched company. These involve
gauging whether the Company is able to raise further funding in the
form of debt (by way of borrowing from banks or by
disintermediation and directly accessing the debt capital markets)
or by way of equity in the form of share capital. Funding so raised
may be used to strengthen the balance sheet or for working capital
purposes or may be used indirectly to refinance more expensive
debt. In order to raise debt funding, the company will need to
consider which of its assets it is able to offer as security in
order to reduce the costs of raising such debt. Security may also
be granted in relation to the acquisition of or subscription for
shares in the company, subject to the financial assistance
provisions in the Companies Act.
A company may therefore cede its book debts to a lender as
security for a fresh loan, invoices can be discounted to
produce cash flow, assets can be mortgaged or hypothecated, and
sleeping assets can be brought to life. Share capital may be raised
by issuing new shares of various classes, each with different
rights, offering the new investors preferential rights whether in
respect of voting or to receive distributions from the company.
Expert legal and commercial advice would help in releasing hidden
value even in difficult market circumstances and where credit is no
longer freely given. Investors and lenders will be careful in
these circumstances to ensure that the security granted in their
favour is not seen to prefer one creditor over the other or is
subject to suspension during any so-called hardening periods in
terms of the Insolvency Act.
Where all assets of a business are already deployed and
cash flow can neither sustain fresh borrowings nor justify the
issue of fresh shares or preference shares, the question which
arises is whether the business would benefit from temporary
protection from its creditors in order for it to generate cash flow
or to release assets as security for further borrowings. At present
only judicial management or provisional liquidation would provide a
shield to the company against its creditors. Judicial management
has tended to be ineffective because creditors would change their
lending patterns and would no longer supply goods on account.
Provisional liquidation has even less to recommend itself.
Changes to the Companies Act in the form of business rescue
provisions will change this. While some commentators have been
critical of the practical aspects of the proposed changes, in
reality -- particularly where there are a number of significant
lenders involved -- many of the methods of business rescue are
already applied by creditor consortiums. The new legislation will
give the force of law to these voluntary, but effective, remedies
and will ensure an even hand to lenders with or without security,
trade creditors, employees and other role-players.
In the meantime, companies facing solvency problems need to be
properly advised how to deal with the issues. Directors and others
dealing with the companies' problems may be at risk of personal
liability. Giving selective or insufficient information to
creditors or employees may be tempting but unwise. Specialised
advice is required. Directors would be well advised to ensure that
all affected parties obtain their own advice. In the meantime
business rescue creditors' consortiums -- while cumbersome --
could well help by making sure that a balance is
introduced that brings fairness into play to promote workable
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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The Act has brought about fundamental changes in the manner in which shareholder resolutions are passed.
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