Covid 19 [the pandemic] caused rugged and rugged turbulence in business. It distressed business businesses in Malawi and the world. For many of them, the threat of insolvency is real. It is tough.
There ought to be an urgent, sure solution. This paper urges rethinking and/or utilizing the law on Corporate Debt Restructuring [CDR].
Proposals in this paper largely draw inspiration from research authors did for or with World Bank Group [WBG] and Insol International [Insol]. Possible areas of reform include but are not limited to informal CDR mechanisms such as compromises and arrangements; formal reorganization and/or restructuring; and emergency measures introduced through the state or otherwise to curb the effects of Covid.
Before that however, a synopsis of CDR, we provide a brief context of our legal framework and a section on why reform and/or utilization of our current legal framework is necessary.
- CDR and the legal framework
WBG defines CDR as the reorganization of a distressed business’ outstanding obligations to restore it to solvency and keep it in business. Essentially, CDR is a transaction in which an existing debt contract or arrangement is replaced by a new contract or arrangement, with one of the following consequences:
- required interest or principal payments on the debt are reduced;
- the maturity of the debt is extended; or
- creditors are given equity securities (shares or securities convertible into shares) or some of the assets of the business are sold to meet some of the creditors’ debts.
All CDR transactions are undertaken in response to an anticipated or actual default.
The following pieces of legislation primarily govern CDR in Malawi: the Republic of Malawi (Constitution) Act, 1994 (the Constitution); the Insolvency Act; the Companies Act; and the Taxation Act and tax-related legislation. Since we are dealing with a pandemic, another essential piece of legislation is the Public Health Act and/or Regulations
CDR mechanisms are many and varied. WBG broadly classifies them into 2 categories: formal and informal. This paper will however discuss a third category, which for the sake of convenience will be called “emergency measures”.
Informal CDR Mechanisms
- Compromises – the Companies Act in section 261, defines them as compromises between a company and its creditors, including a compromise—
(a) canceling all or part of a debt of the company; or
(b) varying the rights of its creditors or the terms of a debt; or
(c) relating to an alteration of a company’s constitution that affects the likelihood of the company being able to pay a debt.
The Insolvency Act further provides for and allows liquidators and/or insolvency practitioners to enter into compromises on behalf of the companies under sections 120 and 148 of the Insolvency Act.
- these are also defined under section 261 of the Companies Act as including a reorganization of the share capital of the company by the consolidation of shares of different classes or by the division of shares into shares of different classes or by both those methods.
- By entering into an arrangement, creditors have the benefit of converting debt into equity or shares of a higher class for instance preferential shares, and/or if the debt was owed to existing shareholders, they can convert their ordinary shares into preferential shares.
Out of Court Workouts (OCWs) –
- the World Bank Group defines these as private agreements with limited or no judicial involvement between a debtor and creditors with the aim of easing the debtor’s debt burden so that it can maintain its operations.
These can be in form of loan amortizations, debt rescheduling, deferment of payment of interest, cap on interest, refinancing etc.
- Restructuring – even though both the Companies Act and Insolvency Act permit reconstruction/restructuring, they do not define it. It is a transaction by which a company alters its capital structure (debt-to-equity ratio). It usually serves to limit financial harm of an ailing business.
- Reorganization – the Insolvency Act and governing legislation do not concisely define reorganization. Section 13(1)(a) and (b) of the Insolvency Act merely states that “a company is “in company reorganization” while the appointment of an administrator of the company has effect” and “a company “enters company reorganization” when the appointment of an administrator takes effect”.
Borrowing the definition by the World Bank Group again, reorganization is simply the “process through which the financial well-being and viability of a debtor’s business may be restored based on a reorganization plan so that the business can continue to operate through means that may include debt forgiveness, debt rescheduling, debt-equity conversions and sale of the business (or parts of it) as a going concern.”
- Government directives – these can be in the form or rules and/or regulations made under subsidiary legislation in order to address certain specific challenges. They include capping bank/commercial interest rates or introducing measures suspending interest accruals; introducing or raising the minimum debt requirement for creditors to initiate insolvency proceedings; introducing measures banning the repossession of property during COVID-19 etc.
- Taxation – measures could include tax breaks; tax windows; tax exemptions, elimination of particular interests and penalties, etc.
- Court proceedings – measures include placing a moratorium on insolvency proceedings or suspending non-urgent court proceedings.
Why Reform and/or Utilize?
Sound CDR regime, along with international best practices, has been linked to lower cost of credit; increased access to credit; improved creditor recovery; strengthened job preservation; promotion of entrepreneurship; increase financial inclusion; strengthened investment climate, and other benefits for small businesses. In essence, a comprehensive CDR regime has been seen to have promoted overall economic stability, effectively moderating the rough terrain of the world.
Areas of Reform and/or Utilization
The first area that merits serious attention is the OCW section. It is quite apparent that the Malawian legal framework does not provide any guidelines, rules, and principles on how corporates and Financial Institutions (FIs) can enter into and manage OCWs. In countries like the United Kingdom and India, they have gone as far as having draft template debtor-creditor agreements and framework agreements on OCWs. This is important because it helps minimize the inequality of bargaining power beginning with debtors and creditors and/or different classes of debtors. On the other hand, it also protects creditors because they are able to sieve out scrupulous debtors and have a binding and enforceable agreement.
Another area that needs consideration is emergency measures. The pandemic has left a lot of businesses in an indeterminate state. They can no longer operate in the same manner as before with the effect that profit is either minimal or non-existent. In order to preserve such businesses, there is a need for measures to be introduced, to help combat the effects of the pandemic. Such measures could include:
- providing rules under the Public Health Regulations relating to the temporary suspension of interest accruals on loans;
- simultaneously and in order to incentivize money-lenders, providing tax breaks and/or a haircut on certain taxes and penalties;
- raising the minimum debt requirements for insolvency proceedings;
- suspending non-urgent court proceedings;
The final area that is underutilized is reorganization and restriction. The law allows debtors who have not yet been declared insolvent to quickly restructure and reorganize. Two pieces of legislation allow for this. The first is the Insolvency Act, in particular, Part III which allows debtors and creditors to appoint an administrator for purposes of reorganizing the company where there are signs that the company is likely to be insolvent. The administrator is required to prepare a proposal that will rescue the company as a going concern; restore it to solvency and generally to achieve a better result for the creditors of the company (see also sections 32 and 33 of the Insolvency Act). If this can be shown, then the debtors and creditors can apply to the High Court (Commercial Division) for a Reorganisation Order.
The other provisions are sections 261 and 262 of the Companies Act or generally, Part XII, Division I. These rules allow debtors and creditors to enter into arrangements, compromises, reorganizations, and/or reconstructions or restructurings outside of court/insolvency proceedings. If utilized, they could achieve a better result for both parties.
Legal norms and principles do not arise out of a vacuum. They are born out of specific circumstances and factors within the society and environment. Covid is one such factor that has drastically changed the world and the manner of doing business. It can neither be wished away nor ignored. It is imperative that our legal framework reacts to its existence and/or is not underutilized. This paper summarily went through several key areas that require attention and must be made use of in order for both corporates and FIs to benefit and remain in business, despite the pandemic.