Financial Distress, Reorganization and Schemes of Arrangement

Financial distress is not an uncommon occurrence in any business organisation. Financial distress may be caused by many factors including: economic downturns, market crises, improper business management and decisions, and so on. While such situations may be dire, it is not always the case that distress will have life ending consequences on the business of a company. Think of it as an aircraft experiencing technical difficulties. The pilots employ several recovery procedures to rescue the distressed aircraft, and while technical difficulties abound, it is not often the case that it results in a crash. In the same vein, for companies, it is not always the case that financial distress results in winding up of the company. The company's board can employ recovery measures to set the company back on the path to profitability, and some of this recovery measures are known as schemes of arrangement.

A scheme of arrangement is an agreement (typically court-sanctioned) between a company and its members and creditors, to assist the company in fulfilling its debt obligations. A scheme of arrangement helps the company restructure its debt by varying the rights of its creditors. It can be used to achieve a solvent reorganization of the company, reschedule debt, and or carryout changes in an organisation. Now mention must be made of the fact that a scheme of arrangement has numerous uses; it can be used to restructure the debt of a financially distressed company, it can be used to effect an arrangement between a company and its creditors, it can be used to effect a merger and a scheme of arrangement can also be used as an alternative option to a takeover. A scheme of arrangement may also be carried out alongside and insolvency procedure such as administration. Today’s newsletter will however focus mostly on its financial distress use. A scheme of arrangement may be proposed by the company, or by its administrators and liquidators, its members or its creditors. However, it is often the case that the company itself makes the proposal.

As earlier mentioned a scheme of arrangement varies the rights and liabilities of the company’s creditors. Section 710 of the Companies and Allied Matters Act (CAMA) 2020 of Nigeria defines an arrangement to mean “any change in the rights or liabilities of members, debenture holders and creditors of a company or any class of them or in the regulation of a company, other than a change effected under any other provision of this act or by the unanimous agreement of all parties affected.” There are several reasons which may influence a company to adopt the scheme of arrangement in order to resolve its financial woes. Particularly, a company may adopt a scheme of arrangement in order to avoid publicizing its financial situation. Since the scheme of arrangement involves an internal reorganization, the company can deal with his financial woes as privately as possible. The scheme of arrangement also ensures that the company remains a going concern which is beneficial to both its members and creditors. Also, once the scheme is sanctioned by the court it is binding on all parties.

There are basically three main stages in any arrangement or compromise scheme. The scheme must first of all be proposed by the board on behalf of the company and then meetings are summoned. Secondly, meetings are held with the members and creditors to present the proposed scheme, and finally the scheme is sanctioned by the court, and then registered with the regulatory authority.

Under CAMA 2020, there are two broad classes of schemes of arrangement. Section 711 deals with proposed schemes between two or more companies, while section 715 deals with proposed schemes between a company and its creditors. The major difference between the two is that the former (section 711) does not require the court to refer this scheme to the Securities and Exchange Commission (SEC) to consider the fairness of the scheme, while the latter (Section 715) requires the court to do so. For the purpose of today's topic, we shall be examining the provisions of section 715 as it relates to schemes of arrangement. Section 715 empowers the company to reach a compromise or an arrangement with its creditors. Where the Board decides to propose a scheme of arrangement, the company or its creditors, or members, or liquidators may bring an application to the court, for the court to order a meeting of the company's creditors or class of creditors, or the company's members or a class of members. Section 716 of CAMA sets out the information which ought to be contained in any notice for a meeting of the creditors or members of the company. The meeting notice must be accompanied by a statement explaining the effect of the arrangement or compromise, and also stating any material interests of the directors of the company. And where the notice is given by an advertisement, the advertisement must include a notification of where the statement containing the explanation on the effects of the arrangement, may be obtained. The notice shall also give explanation in respect of the trustees of any deed where the compromise affects the rights of debenture holders.

Once the application is made to the court, the court has the discretion to give orders or directions as to the manner in which the meeting(s) may be conducted, and other procedural matters such as the length of notice for the meeting and proxy attendance. The court may order separate meetings of creditors and members where their rights are so dissimilar as to make it impossible for the two sets of parties to consult together. In the case of Re Hellenic General Trust Limited, which concerned a scheme to effect the change of control of a company, the court determined that the shares of one shareholder (which was a wholly-owned subsidiary of the acquirer) needed to be treated as a separate class of shares from the other shareholders, because their interest in the scheme was different. The proposed scheme is considered and voted on by those groups in the company that will be affected by the scheme. The courts have also held in a number of foreign cases, that the scheme of arrangement need not be put to parties whose rights are unaffected, not varied or discharged by the scheme.

After conducting the meetings, if a majority representing at least three quarters in value of the shares or a class of shares of the members of the company, or of the interest of creditors, present and voting either in person or by proxy, agree to the compromise or arrangement, the arrangement may then be referred by the court to the SEC, which shall appoint one or more inspectors to investigate the fairness of the scheme, and make a written report to court. If the court is satisfied that the scheme is fair, it shall sanction the scheme and it shall become binding on all the creditors or class of creditors, or members or class of members and on the company. It must be added that the court order does not have an effect until a certified true copy of the order has been delivered by the company to the Corporate Affairs Commission (CAC) for registration, and a copy of the order shall be annexed to every copy of the company's memorandum issued thereafter.

Any company which has commenced a scheme of arrangement, enjoys a moratorium and no winding-up petition or enforcement actions by a creditor shall be entertained against the company or its assets for a period of six months from the time the company provides to the court: a document setting out the proposed terms of the arrangement to its creditors, a statement of the company's affairs containing the particulars of the company's creditors, its debts, it's liabilities and assets and a statement that the company is desirous of protection from winding up proceedings pending the completion of the scheme of arrangement. A secured creditor of the company may however file within 30 days of receiving notice of the arrangement, to discharge the six-month moratorium period, as long as the assets being claimed by the creditor does not form part of the pool of assets to be considered under the scheme. The secured creditor may also be allowed to discharge the six-month moratorium where the assets involved are perishable goods which may dissipate before the end of six months, or where the creditor enforces its security over the assets before receiving the company's notice of proposed arrangement.

In recent years schemes of arrangement have increasingly been used to reorganize company capital. They are often employed as a debt restructuring tool for companies in financial distress to renegotiate their debts and restore liquidity so that the company can continue its business operations. The moratorium granted under the provisions of the Act ensure that individual creditors do not take actions for recovery against the company whilst the company is in the process of restructuring and dealing with its financial distress. A scheme of arrangement also helps the company to ensure that, rather than go into liquidation or commence winding-up proceedings, the company has an opportunity breathe new life into its business.