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FROM: JUL-AUG 2009 ISSUE | BY GUNDI JEFFREY
During this unprecedented global financial crisis, it is inevitable that one or more of your clients – or even your employer – will succumb to financial pressures brought on by a drop in customer demands, inability to get appropriate financing at the right time, or costs spiralling out of control. And they’ll be looking to you – their most trusted advisor – to help them figure out how to get back on their feet and start all over again.
The more savvy of them will, of course, come to you before they drop over the edge, hoping you can steer them through this financial crisis relatively unscathed. But the best advice available won’t help everyone, and accountants in the insolvency business are finding their dance cards more than full.
Meanwhile, new amendments to Canada’s bankruptcy legislation have increased the complexity of the insolvency business. That, coupled with the fact that the credit pandemic has the whole financial world running scared, and you have an insolvency scene that few have experienced before.
Businesses are dropping like proverbial flies. The latest statistics from the Office of the Superintendant of Bankruptcy Canada – released in April – show that proposals under the bankruptcy act were up 27.5 per cent in February over the same month in 2008. Overall, insolvencies increased by 3 per cent over the year before. Those figures also show that the most vulnerable business sectors are retail trade, construction, manufacturing, transportation, and food and hospitality services. The hardest hit provinces are Ontario – the hub of manufacturing – Quebec and Alberta.
Larger financial failures, such as those predicted for GM and Chrysler – do a lot of collateral damage. Not only do thousands lose their jobs as a result, and investors their investments, but the businesses serving those companies and their workers are also hard hit – restaurants, stores, service providers of all kinds suddenly find the demand for their products dwindling to nothing. Suddenly they, too, are on the edge of insolvency.
Legislative Reform
While it may be too late for some, not all businesses in financial trouble need to end up bankrupt. Canada’s Bankruptcy and Insolvency Act (BIA) and the Companies Creditors’ Arrangement Act (CCAA) were overhauled in the past year specifically to provide more protection for everyone involved in insolvencies and to encourage the salvaging of more businesses. An unfortunate byproduct, however, is that the process for trustees in bankruptcies is now more complex and expensive.
According to Stephen Boale, CIRP, CGA, CEO of Vancouver-based trustee in bankruptcy Boale, Wood & Company Ltd., “in the current economic climate, the legislation allows companies an opportunity to restructure and continue to operate, thus allowing unsecured creditors to receive some money in an otherwise difficult situation.” But, he adds, some of the amendments, especially the new Wage Earner Protection Program Act (WEPPA), have added a lot more work and complication to the process.
The new amendments to Canada’s bankruptcy and insolvency legislation came into force in July 2008 and basically include the following pertinent to businesses:
- Creation of super priorities for wages under the newly enacted WEPPA as well as for unremitted pension contributions.
- Changes to the definition of “date of the initial bankruptcy event.
- More protection of registered retirement savings plans.
- The treatment of pre- and post-bankruptcy income tax refunds as part of the property of a bankrupt’s estate.
The idea, according to the Office of the Superintendant of Bankruptcy, was to “make the insolvency system fairer and to reduce the potential for abuse…and to provide a fresh start for the honest, but unfortunate debtor.” The changes, it said, would also encourage the restructuring of viable businesses as an alternative to bankruptcy.
Wayne Palmer, CIRP, CGA, an associate with RSM Richter in Toronto, notes that the federal government recently amended the WEPPA to include termination and severance amounts as part of the wages claim. “This amendment was made retroactive to January 27, 2009, and banks are now reserving amounts under new credit arrangements made with debtors for these potential obligations.”
The other reform of significance, he says, is that amounts deducted from employees as contributions to a pension plan, together with any matching employer contributions, that have not been remitted to the pension authorities are given priority over the interests of secured creditors. This priority does not extend to unfunded pension liabilities (i.e., an actuarial shortfall in a pension plan) or special payments that may have been ordered by a pension regulator.
Many proposed reforms are yet to be implemented, among them new rules governing asset sales, payment of professional costs, liability of trustees, suppliers’ rights, and more. One of consequence, says Palmer, will be the ability to appoint a national receiver. “Once that is implemented, there will no longer be a need to have multiple appointments where a debtor conducts business or has assets in more than one province.”
For now though, there’s enough to deal with. “The implementation of the WEPPA has been beneficial to employees of insolvent companies, but the administrative burden that has placed on the insolvency profession has made the cost of administering a receivership and a bankruptcy more expensive,” Palmer says. The regulators, with the aid of the Canadian Association of Insolvency and Restructuring Professionals (CAIRP), really need to take another look at the WEPPA reporting requirements to see what can be done to ease the burden they’ve created.
The Asset Challenge
It’s not only the WEPPA reporting requirements that are affecting the livelihood of Canada’s insolvency practitioners. Today’s unique economic challenges create threats of their own.
Because of the climbing number of bankruptcies and receiverships, receivers are dumping ever more assets on the market, driving down the value of those assets below what they would have fetched in better times. “If trustees look to getting their fees paid from the sale of the assets, there’s not much comfort these days that this will be possible,” says Harold Brief, FCA, CIRP, who heads Brief & Associates Limited, Ontario-based trustees in bankruptcy. Nor are they always able to collect outstanding receivables. “Customers have 1,001 reasons why they shouldn’t be paying off their debts.” He says he has had to turn away clients because he knew that, at the end of the day, any fees realized would not cover his expenses.
This situation also poses threats to lenders and other creditors who have offered financing or loans based on a business’s asset values. Suddenly, the assets become illiquid because there are no buyers or they are heavily discounted to the point they are almost worthless. This has so spooked banks that they now ask for more security to back up loans, and want to see strong business plans, sketching out best and worst case scenarios. Brief says one of his banking acquaintances recently told him “that we are no longer financing dreams.” It’s too risky.
Call in the Stress Busters
But there is a great deal accountants and insolvency professionals can do to prevent their clients getting pushed to the edge in the first place. “More businesses go under or fail than is necessary,” says Earl Sands, CIRP, CGA, a trustee in bankruptcy in Vancouver and developer of what is probably the most informative website on bankruptcy in the country, www.BankruptcyCanada.com. “Very often, they can be saved if caught in time.” The key, according to Sands, “is to exercise control over your business environment, get the best advice you can, and know when to quit.”
According to Adam Bryk, an Ontario CIRP who is currently working on North American cross-border insolvencies with Deloitte Mexico, “ideally, businesses should be asking for help as soon as they even suspect they’re in financial difficulty. It is at this stage that professionals can really help. The insolvency practitioner has, for example, an understanding of the processes that are available, of what is and is not accepted in the marketplace, and has relationships with banks and other creditors. By providing this knowledge, he or she is really able to open the communication between debtors and creditors so that the best solution can be found.”
The signs indicating trouble really have not changed during this crisis, adds Randolph Jones, CIRP, CGA, a vice president at the Moncton office of PricewaterhouseCoopers Inc. He cites depleted capital, the inability to meet bank covenants, underfunding, costs out of line, shrinking profit margins, and reliance on a small number of major customers or key employees as just a few of the red flags pointing to potential insolvency.
“We can look at a client’s business and help them identify these problem areas, look for a viable solution, and help them develop a go-forward plan,” Jones says. But, he stresses, “the best laid plans won’t succeed unless you can convince management to make meaningful changes to correct the problems that brought them to the brink in the first place.”
Get your clients to focus on cash, cash, cash, advises Gordon McFarlane, CBV, managing partner of national specialist advisory services with Grant Thornton LLP. “Undertake a critical analysis of their business operations and help them understand the resulting impact on liquidity. Focus on the components of working capital and the cash conversion cycle. Build and conserve cash. In a financially distressed business, build a war chest of cash, even at the expense of drawing down on interest bearing credit facilities. Forecast near-term cash receipts and cash disbursements based on realistic financial projections and a sound starting point and include an analysis of the impact of those assumptions on your client’s borrowing base.”
If things continue to go from bad to worse trustees can be invaluable at the proposal stage. Proposals to creditors are, of course, a good way to try and work with creditors to get them to help a company work through its financial difficulties rather than closing their doors. The trustee will help the company draw up a plan of repayment to creditors, either over time or by paying a certain amount on the dollar. The trustee knows what will and will not work, and provides the expertise for putting together a proposal that the creditors should find acceptable.
“Our biggest role here,” says Bryk, “is to facilitate communication between creditors and debtors. For example, we bring the bank’s point of view to the client – they’re in more trouble than they realize – and we give the bank some comfort that the client is, in fact, taking them into account. If they don’t believe in your client, they won’t be inclined to offer much help.”
The Final Solution
If, despite the best efforts of your client and its creditors, there’s no light at the end of the tunnel, bankruptcy may be the ultimate option. Sands notes that there are various models and predictors – several of them are described on his website – that can determine whether a business is truly bankrupt. “With the widespread use of personal computers, the utilization of an insolvency prediction model is now practical and available to all.” Of course, he adds, they don’t replace experience and professional expertise, but they can certainly point the way.
“If a business is totally underwater and clearly can’t survive,” advises Brief, “it’s time to pull the plug. Don’t start injecting personal capital to stave off the inevitable.” Unfortunately, he adds, “too many business owners are so in love with their business that they find it difficult to accept that they have come to the end of the line. Help them face the truth – it’s over.”
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