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Tichawana Nyahuma
On June 21, 2015 in a piece titled “When a company falls ill”, I discussed two phenomena that have been known for some time now but became only commonplace in our country so soon after our local currency was thrown into disuse in February 2009.
These phenomena are judicial management and liquidations. In that article, I likened a company that is in financial distress to a sick person and that judicial management and liquidations are the two most common prescriptions that can be administered to cure or kill such a company.
Today, I look at the third medication that is not so common: The Scheme of Arrangement with Creditors which I shall refer to in this contribution simply as “the scheme”.
To start with, the name by which the scheme is known is somewhat misleading in that it creates the false impression that the arrangement is only a twin agreement between the company and its creditors only.
Remember, a company is in law, a separate legal entity which has its own existence outside and away from its shareholders who own it and the directors who run it.
The correct position is that the scheme is in reality between the company, its shareholders and its creditors. It is, therefore, accurate to say that in reality, the scheme is a tripartite agreement between those three stakeholders.
But how does the scheme come into being?
When a company has reached such a stage of disintegration that it no longer is in a sound financial position, it is the directors and management who will naturally be the first to know, being the persons on the ground and then the shareholders. The last will be the creditors. These will only begin to smell a rat when payments are delayed or when they are paid only in part and lastly, when no payments at all are received.
Now, shrewd directors will not allow things to continue to slide in their full glare. They will either apply for the placement of the company under judicial management and by extension, liquidation or they go for the scheme. Under the first two mentioned, creditors are also free to beat the path to court for an order placing the company under judicial management or liquidation depending on the circumstances.
They only have to prove that the company is failing to pay its debts and that in all probability, it is beyond resuscitation. However, under the scheme, creditors hardly have that option, it is entirely in the hands of shareholders and directors to take.
So, the scheme is really a gentlemen’s agreement between the key stakeholders of the company which is authorised by the court. As I have already said, these are the shareholders, the directors and the creditors. Once it is ascertained that the company is unable to pay its debts as they fall due or is suspected to be in an insolvent state, the directors can draft a plan to approach the shareholders with the proposal for the company to enter into the scheme. A resolution is passed for this purpose.
The biggest advantage of the scheme is that it circumvents the huge costs associated with both judicial management and liquidations. Readers might have come across recent Press reports pointing to complaints by Tetrad Bank Limited against what the bank viewed as excessive fees charged by the judicial manager for that bank.
So, instead of incurring further costs through judicial management, the company takes increased responsibility to try and stir the ship from the deep waters onto the shore.
Once the directors win the buy-in of the shareholders on the scheme proposal, they will then approach the creditors individually explaining the advantages of the scheme which is that the company is most likely to return to profitability if only the creditors suspend or defer their claims against the company for an agreed period of time. Better still, some of the creditors, usually the major ones, may be persuaded to waive their claims in return for a benefit to them.
Such benefit can include conversion of debt into equity. This is why shareholder approval is always required as such arrangements can affect their rights to control of the company. Quite often a scheme arrangement can target a class of shareholders or a class of creditors or all of them.
The key issue is that the directors must be able to garner support of three quarters in value of the class so approached. The overall effect of this is that in the end or at least for the time during which the company will be under the scheme, the company would have been relieved of the debt yoke. Accountants refer to such debts as historical debts.
However, the company will be liable for all the debts arising during the scheme otherwise if it does not service these, it will soon be back in another debt trap from which it may never be able to escape.
In some schemes of arrangement, significant shareholders can offer to buy out minorities at an agreed value per share. Upon successful takeover of shares they can bring in additional capital which may be in the form of equity or loans to retire debt.
This improves the balance sheet of a struggling company. When things have been arranged in this way, it then becomes much easier for the company to court new investors who can bring in new money as well as equipment to help in the resuscitation of the company.
In fact, there are many options that will suddenly become available to a company that is under a scheme. It can be taken over by a new shareholder with a huge financial muscle or it can easily be merged with its parent company, if there was one, which will be solvent and thereby increasing the probability of the creditors being paid.
A takeover bid can be submitted to the ailing company leading to takeover and formation of a new company altogether.
This can have the effect of increasing market share and, therefore, profitability. Under all these approaches, the creditors must approve the scheme at the Master of the High Court. If a company is divisionalised, the transferee company is obligated to sign a creditors and obligations take-over agreement. This must be sanctioned by the court.
The Companies Act requires that creditors must vote in order to protect their interests. In all schemes of arrangements directors, must declare their interests either in shares or contracts or as suppliers.
But what will be the fate of the directors in this new arrangement? Well, that largely depends on what caused the company to fall ill in the first place. If it was a result of imprudent management practices by the directors, then in all probability, they will be shown the Zuva Way.
If on the other hand, it was a result of other factors such as antiquated equipment which then failed to match competition or other issues beyond the control of the directors, then they will continue to navigate the ship.
When all is said and done and, however, the scheme is modelled and packaged, it is required to be registered timeously with the Registrar of Companies otherwise failure to do so is a criminal offence for which imprisonment may be imposed upon conviction of the offenders.
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