Saving an Insolvent Company – How to Save an Insolvent Company
Filing a proposal under the Bankruptcy and Insolvency Act may satisfy creditors and prevent a business from going under – Save an Insolvent Company.
BY EARL SANDS
Bankruptcy Canada – Save an Insolvent Company Story – Jack Taylor was driving into town early one morning to keep an appointment he and his CGA, Marjorie Soo, had with the trustee in bankruptcy.
He dreaded the meeting. The last six months had been the worst in his working life. Not only was his business on the brink of failure, but the stress had also created problems at home.
Jack thought back to when he first started his business, Taylor-Made Kitchens, the struggles, then the success. Yet now the company he had built from the ground up was on the brink of bankruptcy.
HOW IT HAPPENED
Jack started his kitchen cabinet manufacturing business seven years ago. Taylor-Made Kitchens was successful from the beginning, and Jack knew he was good at his work.
He had an excellent ability to motivate staff, coupled with superb organizational skills.
His production line was one of the most efficient operations of its size in Canada.
Although everything had been going well with Taylor-Made Kitchens, Jack and his wife Susan decided they would withdraw just enough money from the business to maintain their existing lifestyle.
They plowed most of the profits back into the company so that it could grow – and grow it did!
Here’s where Jack went wrong. Approximately two years ago, he set plans in motion to open up a new showroom in one of the new, trendy parts of town. He also expanded into a neighbouring province with a new sales force and showroom.
As it turned out, the timing was atrocious with the decision to expand a disaster.
His two new showrooms opened just as the economy was on a downturn.
In addition, so much of his energy was taken up in establishing the two new outlets, he couldn’t devote enough time to his once successful manufacturing operation.
The result – the production operations had suffered many problems over the past year and, compared to the previous year, had contributed $300,000 less in gross profit.
Jack thought back to the advice his CGA had given him a year and a half before. “Expand slowly,” Marjorie had said. “Wait until the new outlets are established, so that if they aren’t successful you can withdraw with minimal loss.”
Jack had ignored this advice and got into serious trouble.
About six months ago, when it was apparent his company was in extreme financial difficulty, he went to his CGA for help. With Marjorie’s assistance, Jack reorganized the out-of-province operation.
Under the reorganization, Jack’s company transferred all of its out-of-province showroom operations (mainly leasehold improvements and a lease) to the employees at no cost. The employees set up their own business and were responsible for all its costs.
And the new entity was committed to buying product exclusively from Taylor-Made Kitchens for the next five years.
The restructured company was now a viable operation. However, the manufacturing company still had an insurmountable problem. The debt to suppliers and the bank was more than the company could ever pay back, and its suppliers were providing product only on a COD basis.
MEETING THE TRUSTEE IN BANKRUPTCY
Jack and Marjorie met at the office of the trustee, Barry Katz, and were now sitting in his boardroom. At a previous meeting, they had updated Katz on the history of the company: its successes, its expansion and its existing financial crisis. Katz reviewed the last three years’ operations and the budgets for the next two that Jack and Marjorie had prepared.
After asking Jack a number of questions, Katz found Taylor-Made owed Revenue Canada $55,000 in employee source deductions and $40,000 in GST. He asked Jack if he was aware of the debts for which a director is personally liable.
Jack said that Marjorie had informed him of director’s liabilities, which he understood to be all debts for which the director gave personal guarantees; statutory debts such as wages and vacation pay; source deductions owed to Revenue Canada; and GST and provincial sales tax, where the director was a hands-on operator.
Jack had not personally guaranteed any other debts, except, of course the bank line.
Katz informed Jack and Marjorie that his staff had visited the plant and showroom downtown, and it was his view that, if Taylor-Made Kitchens went into bankruptcy, there would be a shortfall to the bank, leaving nothing available for the unsecured creditors.
FILING A PROPOSAL
Katz informed Jack and Marjorie that it was not all bad news since Taylor-Made Kitchens had a good chance of survival if it filed a proposal with its creditors using provisions of the Bankruptcy and Insolvency Act.
He explained that more businesses go under or fail than is necessary. Even if the company is insolvent, it can often be saved if caught in time.
The way this works is that a company files a proposal with a trustee to the company’s creditors, asking them to accept a compromise on the monies they are owed in order to give the business an opportunity to survive.
The trustee works with the owners of the company in drafting a proposal that presents a win/win situation for both the company and the creditors. Typically, the creditors are asked to give up the rights to the monies owed in exchange for an offer from the company to pay so many cents on the dollar (say 20 or 50 cents) over time.
Sometimes a company may pay back 100% of what it owes, but it is granted a moratorium of, say, six months to a year in which no payments are made. Goods supplied within 30 days prior to filing a proposal, or filing an Intention to File a Proposal, do not have to be returned if the proposal is approved, but they may be eligible for return if the proposal is defeated or a receiver is appointed.
The proposal must include provisions to pay employee source deductions outstanding within six months after court approval; employee and former employees’ outstanding wages and vacation pay up to a maximum of $2,000 immediately after court approval; and the landlord for a penalty (if the tenant elects to cancel the lease) immediately after court approval.
With a successful proposal, the company wins because it gets a chance to survive. The creditors win because they retain a customer and receive more than in a bankruptcy.
Filing a proposal also has the following immediate advantages for a company under siege by its creditors:
- It stops all legal actions undertaken or contemplated by unsecured creditors.
- It gives the company some time to approach the creditors, explain the company’s financial situation and ask for their support.
- If a secured creditor has given notice to enforce its security, but a 10-day limit has not expired, a stay of proceedings will be effective against that secured creditor.
Katz said that, as trustee, it was his job to investigate the affairs of Jack’s manufacturing company and make a report to the creditors. He had prepared a schedule showing what the unsecured creditors would receive in a bankruptcy compared with what they would receive under a proposal.
He explained that filing a proposal creates a “do or die” situation, placing the fate of the company in the hands of the creditors.
At a meeting held approximately three weeks after the company files the proposal documents, the creditors vote, in person, by proxy or by mail, on whether or not to accept the terms of the proposal. The proposal must receive the approval of at least 66 2/3 in dollars and 50% plus one in number of the eligible creditors who vote.
In addition, the court must approve the proposal. Until it does, the trustee must monitor the business for a minimum of six weeks. In most cases, the court approves the proposal as long as it is clear that it would provide a better return to the creditors than a bankruptcy would.
If the proposal is accepted by the creditors and approved by the court, all the unsecured creditors – not just the creditors who vote in favor of the proposal – will be bound by its terms.
Katz warned that if the proposal doesn’t receive the required votes or the court doesn’t approve it, then the company will be immediately bankrupt effective back to the date it filed the proposal. And, if the terms of the proposal are not honored, the trustee or a creditor may apply to the court for the proposal to be annulled and the company placed into bankruptcy.
To establish the amount offered to the creditors, a company must consider what is the most it could afford to pay over a reasonable time, say three years, while still making it worthwhile to the principals for the time they are giving up to save the company. Katz told Jack and Marjorie that he felt the creditors would likely accept, and the court would approve, a proposal of approximately 20 cents on the dollar to the unsecured creditors, plus payment of source deductions within six months of court approval.
This proposal was advantageous to the creditors since they would retain a customer and receive payments of approximately 20 cents on the dollar – clearly better than in a bankruptcy.
Katz warned, however, that if the company had a history of feuding with a particular supplier or suppliers, those suppliers may vote against the proposal, even though it wouldn’t be in their financial interest to do so, in order to “get even.” Jack told Katz that he didn’t have such a history, and he felt his suppliers were sympathetic to his plight, although, of course, they wanted their money.
At the end of the meeting Jack and Marjorie asked Katz to go ahead and prepare the documents for filing the proposal. Katz said the documents would be available for Jack’s signing in three days, and the meeting of creditors to vote on the proposal would be three weeks after that.
Before filing the proposal, however, they all would have to meet with the bank, which was the only secured creditor, so that they could bring it up-to-date on the company’s plans. Katz advised that support for the proposal from the only secured creditor was necessary since the creditor could use its security to veto the proposal, putting the company out of business.
Katz, Jack, and Marjorie reviewed the budgets that had been prepared for the next two years. Katz noted that the detailed cash flow statements called for the bank line to be paid down at the end of the second year by approximately one-third of what the current balance was. Marjorie explained that this was necessary since the bank had demanded an improvement to its security position or it would withdraw its support of the company.
Katz concurred, noting that the bank’s security position had slipped in the past few months, and, in order for the proposal to be viable, the bank would have to be onside.
GETTING THE BANK’S SUPPORT
A few days later, they met with one of the bank’s senior officers, Monique Laflamme, from the special credit section, which handles accounts experiencing financial difficulty or involving potential insolvency.
After reviewing the proposal and cash flow statements, Laflamme said the bank was prepared to offer its support to the company, as long as its security position did not deteriorate. Katz said he thought the proposal, if successful, would enhance the bank’s security position, rather than diminish it.
He noted that, if there was a liquidation now, the bank would likely suffer a shortfall. But, under a proposal, the bank’s security position would be enhanced for two reasons: first, source deductions owing at the time of the proposal would have to be paid within six months of the court’s approval (if there was a receivership or bankruptcy, source deductions would rank in priority to the bank’s security); and, second, the cash flow statements provided by the company indicated the bank loan would be paid down by approximately one-third by the end of the second year.
Laflamme said she was satisfied with that explanation, and, assuming Taylor-Made Kitchens met its projections, the bank would continue to support the company.
Following this meeting, Jack signed the proposal documents, and Katz set up the meeting of creditors to vote on the proposal.
This story has a happy ending since the creditors voted in favor of the proposal. And, a few weeks later, the court approved it. Since the proposal was filed, Jack’s company has continued to honour its terms.
In this story, everybody won. The creditors won because they retained a customer and received in excess of 20 cents on the dollar, whereas in a bankruptcy they would have received none of the money owed to them and lost a customer. Jack, of course, won because he received an opportunity to save his company, which is now on the road to firm financial footing again. Jack’s CGA, Marjorie Soo, also won because, in addition to the satisfaction she received from assisting Jack, she has retained a client whom she’ll keep for many years to come.
Earl Sands, MBA, CIRP, CGA, is a member of the Canadian Association of Insolvency and Restructuring Professionals and a bankruptcy trustee.
He is the founder and former president of E. Sands & Associates Inc., a firm of trustees in bankruptcy that practises exclusively in bankruptcy and insolvency matters out of six offices in British Columbia.