How to decide whether to rescue or dissolve
Given sufficient warning, firms can be nursed back to health
Monday, March 19, 2001
When firms can't pay their bills, some shut their doors; others have them closed in insolvency proceedings.
Brian Denega, senior vice-president of Ernst & Young in Toronto, says the main causes of insolvency are consolidation or rationalization of industry. That leads, as he says, "to weaker players being eaten up. The economics of the industry shift and small firms that are not efficient enough have to be wound up."
There are other causes of insolvency, he adds. "We see cases of fraud where misrepresentation of a firm's finances or performance induces another company to extend credit where that should not have been done. Although due diligence can reduce fraud, it is not possible to find every case."
And some firms fail because they don't control their costs well enough, Denega says. "We see firms that have either taken their eyes off the ball or have simply not set up financial controls and reporting mechanisms to know where they are spending their money."
As companies head into insolvency, it is possible to save firms or just parts of them, he continues. "The early warning signals are defaults on technical covenants with lenders, or trade suppliers putting a client on a cash-on-delivery basis or refusing to extend more credit."
Given sufficient warning, firms can be helped back to health. Denega says that half of all seriously troubled firms can be saved.
Once insolvency proceedings begin, however, the odds that a firm will emerge in operating conditions decrease. Creditors insist on being paid, even while stockholders may believe that if debt payments can be suspended or reduced, the firm has a fair chance of returning to health.
Bruce Kaplan, senior vice-president of BDO Dunwoody Ltd., is a Winnipeg-based chartered insolvency practitioner and trustee in bankruptcy. He notes that formal bankruptcy proceedings are less the rule than the exception because many unsuccessful firms merely close their doors and wind up their own affairs.
When bankruptcy happens, though, it can be either the troubled firm or its creditors that make the first move, Kaplan says. A creditor, perhaps a bank, will seek formal appointment of a receiver. "That action is brought on by a secured creditor, which then becomes liable for payment of the receiver's fees and disbursements."
If a debtor firm can be kept going while in reorganization, then, Kaplan says, under the Bankruptcy and Insolvency Act the firm may file a proposal to creditors that is dependent on acceptance by some of them. "You generally need to have the secured creditors on side for the proposals to be accepted," he explains.
Or, in cases of major insolvencies, the Company Creditors Arrangement Act can be used. Typically, the statute applies where claims exceed a $5-million threshold, Kaplan says.
Once a firm is in the process of dismemberment, trustees acting for the courts seek to satisfy creditors, but, Kaplan says, they are obliged to be reasonable in their actions. For a sole proprietorship, there will be goods exempt from sale, including private wardrobes, household furniture, tools of trade and even automobiles, though the exemptions vary by the province of the debtor's residence, he says.
Well before a firm finds itself insolvent, there are warning signs, Denega says.
"If there is rationalization in your industry, if profit margins are shrinking, if sales are growing more slowly than expected and if there are systematic issues that show you are being squeezed by costs, then get help," he advises. "It is not enough that you have a model that worked in the past. If the model ceases to work or if a business is past its prime, it is time to seek professional guidance."
That help does not come cheaply. Rescue plans can range from a simple rejig of a business plan to assisting in a major reorganization, Denega adds. For that work, fees may range from $5,000 to $10,000 or more. But if a firm can be saved, creditors paid, jobs preserved and perhaps a life's work rescued, it may be some of the best money that management can spend.