The Coronavirus (COVID-19) has had a significant impact on businesses in Uganda and the world over, with governments having to enforce lockdown measures to contain the spread of the virus. In Uganda, statutory instruments were published by the Ministry of Health directing certain places of business to remain closed and prohibiting movement of public transport and private cars for approximately 56 days, leading to interruptions in business operations, a reduction in consumer demand and low cash flows to meet expenses and debts owed to creditors.
As a result, we are likely to see an influx in companies experiencing financial distress, breach of contract and default in payment obligations. These companies will need to take urgent action and may have to make the choice between using business rescue mechanisms, including formal insolvency proceeding, and out of court settlements or winding up/liquidating their businesses. Ugandan law provides for certain business rescue mechanisms and liquidation proceedings under both the Companies Act, 2012 and the Insolvency Act, 2011.
However, it is more advantageous for companies and creditors to consider business rescue over liquidation proceedings where this is viable. Despite this, there is a stigma surrounding insolvency proceedings as companies and their creditors are under the misconception that insolvency means the death of a company, yet these proceedings can be used as an avenue to actually revive companies in financial distress.
Business rescue mechanisms
Business rescue involves undertaking proceedings to facilitate the rehabilitation of a company that is financially distressed by affording it the opportunity to reorganise its affairs and room to fix the issues affecting the business in order to survive. This can be achieved through various actions such as cutting expenses, debt restructure, laying off staff and selling non-core assets in order for the business to continue operating as a going concern. Business rescue measures normally have the effect of keeping creditors at bay for the duration of the restructuring process.
Creditors may be required to make certain financial sacrifices, such as accepting a reduction in the debt owed, extending the repayment period, exchanging their debt for equity or any other terms as may be agreed by the parties. They will nonetheless receive more value than they would have had the business been shut down and are potentially better off with business rescue rather than liquidation.
The two major formal business rescue mechanisms include an arrangement or compromise under the Companies Act and administration proceedings under the Insolvency Act:
- Arrangement or compromise under the Companies Act: An arrangement or compromise is a court sanctioned process between a financially distressed or nearly distressed company and its creditors or members to reorganise the terms of its liabilities. The arrangement is contractual in nature and can cover anything that the parties may properly agree to among themselves. The arrangement is binding on all members of the class of persons to which it applies.
- Administration under the Insolvency Act: Administration is a formal insolvency procedure designed to give the company an opportunity to reorganise its affairs through the execution of an administration deed between the company and its creditors. An insolvency practitioner is appointed by the creditors as administrator of the company tasked with the implementation of the administration deed and later hands the company back to the shareholders upon its conclusion. The process is initiated by the company directors where they form the opinion that the company is insolvent or likely to become insolvent.
A financially distressed company may also seek informal out-of-court measures to revive the company, including:
- raising capital through making a call on shares
- obtaining equity injections
- mergers and acquisitions
- renegotiating contracts with creditors to remedy default and breach of contract
- consensual out-of-court arrangement schemes;
- obtaining debt such as bank loans;
- debt restructuring which may involve debt write off
- debt rescheduling; and
- conversion of a portion of debt into equity
These options may save time and are less costly, however, they may not be binding on third parties and the company misses out on the benefits of formal insolvency proceedings such as a statutory moratorium. These options would be most appropriate for companies that are smaller in size.
Further, the Bank of Uganda, on 14 April 2020, issued guidelines on credit relief and loan restructuring measures granting exceptional permission to supervised financial institutions to restructure loans of corporate and individual customers including a moratorium on loan repayment for borrowers that have been affected by the pandemic on a case-by-case basis, at the discretion of the financial institution for up to 12 months effective 1st April 2020. The debt restructure must be initiated by the borrower. The Bank of Uganda also reduced the CBR from 9% to 8% then to 7% June, 2020, in order to ensure access to credit and normal functioning of financial markets.
Liquidation of a company
The options available to a business that has no reasonable expectation of recovery and does not foresee any future cash flows, include liquidation for a company and bankruptcy for an individual. Liquidation may take the form of a voluntary liquidation, court based liquidation and court supervised liquidation. The different modes of liquidation may be initiated by the directors, shareholders, creditors, contributories, or the official receiver as provided under the Insolvency Act.
The effect of liquidation is that the company ceases to carry on business except as may be required for the winding up of its operations. The liquidator takes custody and control of all the assets in the company, disposes of these assets and distributes the proceeds from the assets in accordance with the Insolvency Act.
Advice to businesses in financial distress
Companies in financial distress should take prompt action by:
- immediately assessing business prospects through a full financial and business assessment;
- preparing a restructuring plan;
- engaging creditors and communicating their plans;
- engaging and negotiating with core suppliers for continued support with a plan to prioritise their payments, making realistic undertakings on payment of debts; and
- using alternative dispute resolution mechanisms such as mediation and arbitration rather than protracted litigation.
Early action is important as a company in financial distress and its stakeholders will have a greater number of options available to them. If they begin formulating a strategy for restructuring at an early stage, it preserves more value in the company.
Advice for creditors of a company in financial distress
Creditors can proactively engage the debtor company's management for a repayment or debt restructuring plan, negotiate inter-creditor agreements which may include debt subordination regulating the priority of payment of creditors debts and appoint a receiver, where applicable.
As the economic impact of COVID-19 devastates businesses, companies will need to strategise on how best to keep afloat. Business rescue affords companies the opportunity to restructure their financial affairs and offers a more advantageous realisation of the company's assets than would be achieved from liquidation.
Originally published by ENSafrica, August 2020
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.