BUSINESS
 Saving
an Insolvent Company
Filing a proposal under the Bankruptcy and Insolvency Act may satisfy creditors
and prevent a business from going under.
BY EARL SANDS
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 neighboring province with a new sales force
and showroom. As it turned out, the timing was atrocious, 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 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 it was presently. 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.
WHAT HAPPENED?
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 honor 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 trustee in bankruptcy.
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.
Currently Earl is the President of BankruptcyCanada.com
and BankruptcyAction.com.
Email: webmaster@bankruptcycanada.com
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