Devil is in the detail of new, non-road tested SME protection legislation

Sun, 07 Nov, 2021 - 19:00

It is almost 20 months since the onset of the pandemic in Ireland and we have yet to see the full impact of Covid-19 on business failure rates.

While there is generally a time lag between crisis events and resultant insolvencies, the delay is likely to be even longer this time due to the generous government supports made available to businesses as well as the supportive stance taken by the pillar banks.

However, with the remaining supports due to be phased out by April 2022 and warehoused Revenue debt falling due at the end of next month, we are likely to see an increase in insolvencies in the second half of 2022.

Many smaller companies, who find themselves struggling under debts at that time may find a pathway to survival through the new Small Company Administrative Rescue Process, which is a welcome addition to the range of corporate rescue tools available.

The process provides a low-cost alternative to examinership, as it is designed to eliminate, or significantly reduce, the requirement for costly court intervention, which is a feature of examinership. It is aimed at small and micro-companies which meet two of the following three criteria: turnover does not exceed €12m; balance sheet does not exceed €6m; and the average number of employees does not exceed 50.

That covers about 98% of businesses in Ireland.

Among the key attractions of the process is its relative simplicity and straightforward nature. An examinership application requires a report from an independent expert who determines if the company has reasonable prospects of survival should it go into the process. A positive recommendation from the independent expert generally leads to the appointment by the court of another insolvency practitioner to act as examiner. The entire process is overseen by the court which must also sign off on the final scheme of arrangement.

The Small Company Administrative Rescue Process on the other hand, is triggered by the appointment by the company of a process advisor who carries out an assessment of the business to establish whether the company has a reasonable prospect of survival after a rescue plan is implemented. Once that assessment has been carried out, the company can commence the process by company resolution with the same advisor handling the rescue process.

The process advisor then has 49 days to agree a rescue plan acceptable to creditors who then have a further 21 days to consider it.

On the face of it, this certainly appears attractive and is definitely a lower cost and simpler alternative to examinership. There are some disadvantages, however.

First of all, there is no protection from creditors during the process. This may lead to creditors initiating debt recovery actions or objecting to the process, which at the very least will require court involvement to stay any proceedings and, at worst, may threaten to derail the process before it is complete.

More notably, Revenue is defined as an excludable creditor under the legislation and can opt out of the process in certain circumstances such as where the company is deemed to have a history of non-compliance with its tax obligations.

Given that Revenue has acted as lender of last resort to many businesses through their warehousing scheme, it will be very interesting to see the position adopted by Revenue in the inevitable cases in this process that will unfold over the coming months.

Furthermore, repudiation of onerous contracts, such as property leases, requires court approval and this will add further costs to the process, particularly where the landlord does not consent. This is likely to be a recurring theme facing companies in distress given the move from ‘bricks and mortar’ to ‘click and order’, as well as the move to the hybrid working model that looks to be here to stay.

The above issues are not reasons for companies to turn their back on the process, however. They just make careful advance planning and transparent communications with creditors all the more important.

First and foremost, the company must focus on putting together a rescue plan that is acceptable to creditors. It is essential that creditors understand that they stand to do better under a rescue plan than they would under a liquidation.

That makes early engagement with creditors critically important. The company must explain to them what it is trying to achieve and how it is in everyone’s interest for the process to proceed. This engagement must continue throughout the process. Open and transparent communication with all creditors will lessen the prospect of costly objections.

When considering creditors, the company must ensure that its tax affairs are in order to make it unlikely that excludable creditors such as the Revenue have grounds for objection.

If considering a Small Company Administrative Rescue Process, up-to-date and reliable financial information is key and the company should have projections for the period of the process and 18 months beyond.

The company must also determine the level of working capital that will be required to get through the process to cover ongoing day-to-day running costs given that most creditors will be operating on a ‘cash on delivery’ basis over the rescue period. The company has to stay alive and trading during the process, after all.

Finally, the level of investment required to implement the plan and pay for the various dividends and costs arising from this will need to be determined at the earliest possible juncture. If creditors are not confident in the ability of the company to execute the plan they will naturally seek to withdraw from the process.

In summary, the aim is to arrive at a rescue plan acceptable to all which sees the company survive and creditors and staff do better than if it was placed in liquidation.

If that level of consensus cannot be achieved and the process is likely to be beset by objections, optouts, and frequent court appearances, the advantages and benefits will quickly disappear. In such circumstances, it may be better to opt for examinership and its 150-day period of protection from creditors.

Overall, the Small Company Administrative Rescue Process, is most definitely to be welcomed. In theory, it offers many benefits for distressed companies, but it has yet to be road-tested. As ever, with new legislation of this nature, the devil is in the detail, and we will have to see how it works out in practice during 2022 and beyond.