If a company becomes insolvent or experiences a liquidity crunch, which necessitates a restructuring or resort to higher-risk financing arrangements, the directors should consider whether to commence formal proceedings to facilitate the restructuring or financing.
Where the directors believe the company is still viable, the company may seek to implement a management-led restructuring by taking advantage of Bermuda's court-supervised provisional liquidation, commonly known as a "light touch" provisional liquidation, which gives the company the benefit of a statutory moratorium prohibiting the commencement or continuance of any proceedings against the company without the leave of the Supreme Court of Bermuda.
The principal purpose of Bermuda's provisional liquidation regime is to allow a company and its board of directors the time and space to implement and promote among existing stakeholders a restructuring which may return the company to solvency, while giving creditors comfort that management is operating under the supervision of a provisional liquidator and the court.
The process of restructuring may take different forms, including the purchase by a third party of distressed debt, an equity injection by a "white knight" investor, or promoting and implementing a scheme of arrangement (described further below) pursuant to which the company enters into a scheme with its members and/or creditors pursuant to sections 99 and 100 of the Companies Act 1981.
Companies wishing to take advantage of the provisional liquidation regime must first present a winding-up petition to the court under section 161 of the act. A petition may be presented by the company's creditors or the company itself, though in the context of a restructuring it is often the company itself that presents the petition.
Once the petition is presented, the company may make an application to appoint a provisional liquidator with limited powers based on the court's powers under sections 164 and 170 of the act. Once the provisional liquidator has been appointed, the hearing of the winding-up petition will most likely be adjourned in order to allow the restructuring to proceed. The appointment is typically headed "In Provisional Liquidation For restructuring purposes only".
The appointment invokes a statutory moratorium on any proceedings being brought against the company without the leave of the court, thereby preventing dissenting minority creditors from forcing the winding-up of the company while the directors evaluate and implement a restructuring to ensure that the company may continue as a going concern. It should be noted that despite the statutory moratorium, secured creditors remain entitled to enforce their security against the company provided they do not require recourse to proceedings to do so.
Maintaining control of the company a provisional liquidator may only exercise those functions and powers conferred on him by the order of the court appointing him. As a result, the company may request the court to empower the provisional liquidator with soft powers only, thereby limiting his/her powers to overseeing the company's board and management as the restructuring is implemented. This allows the existing board to retain control of the company's affairs and drive the restructuring under the supervision of the provisional liquidator and the court.
Schemes of arrangement
Once a provisional liquidator has been appointed, the company may enter into a scheme of arrangement with its creditors and/or its members (or any class of creditors and/or members) under sections 99 and 100 of the act.
A Bermuda scheme of arrangement is similar to an English scheme of arrangement under part 26 of the Companies Act 2006, or a Hong Kong scheme of arrangement under part 13, division 2 of the new Companies Ordinance, and is most commonly used to implement a distressed financial restructuring by varying the rights of the relevant stakeholders of the company, although it can be used for other purposes in a non-insolvency context.
Schemes are particularly helpful for companies dealing with dissenting creditors, whose claims may be compromised without their unanimous consent, provided that the requisite voting thresholds are satisfied. Schemes are also an important tool for implementing a restructuring in the context of longstanding listed companies with complex creditor structures that are the legacy of multiple rounds of financing over time.
More generally, a scheme of arrangement is a flexible tool that companies can use to implement a broad range of restructuring solutions, and since a scheme is not an insolvency process, it can (and where possible should) be initiated before the company has entered the "zone of insolvency", resulting in less stigma compared to formal insolvency proceedings.
In the context of a provisional liquidation, once the commercial terms of the scheme are agreed, the provisional liquidator will apply to the court for an order summoning a meeting of the creditors and/or members (or any class of creditors and/or members) as applicable, to place the scheme before them for approval.
Once the meeting has been summoned, a formal scheme document and explanatory statement outlining the effect of the arrangement, and in particular any material interests of the directors of the company (in their capacity as directors, members or creditors of the company or otherwise), will be circulated to the creditors or members with the notice of the scheme meeting.
The scheme must receive the approval of a majority in number representing 75% in value of each class of creditor or member present and voting at the scheme meeting (in person or by proxy). Court sanction of a scheme will be required before the scheme may become effective.
An agreed scheme of arrangement that has been sanctioned by the court and filed with the Registrar of Companies is a legally binding document that may be enforced as a matter of contract. If the required support cannot be obtained and a satisfactory proposal cannot be agreed upon, the provisional liquidator would report this to the court and, in most cases, a winding-up of the company would ensue.
Benefits of provisional liquidation
The "light touch" provisional liquidation procedure is recognized as a flexible tool that can be used to provide a company breathing space in which to implement a restructuring under the supervision of the court without displacing management, and to ultimately continue as a going concern. The statutory moratorium on proceedings against the company allows the directors to focus on implementing the restructuring free from the distraction or risk of creditors bringing winding-up proceedings against the company.
In addition to the benefits of the statutory moratorium and the ability of management to retain control over the restructuring procedure (albeit under the supervision of the provisional liquidator and the court), provisional liquidation gives confidence to both creditors and the court that the restructuring process has been completed thoroughly and with a focus on protecting creditor interests.
An original version of this article was published by Asia Business Law Journal, July 2019.
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.