Insolvency Reform: What a Difference a Year Makes
Author: Christopher Porter
Date: January 2011
Publication: The Lawyers Weekly
The introduction of the federal government’s long-awaited insolvency reform package, which finally came into force on September 18, 2009, was expected to motivate financially challenged debtors to favour proposals and restructurings.
But has it worked as intended?
Over a year later, it’s interesting to assess how Canada’s business sector is faring under the amendments. The following chart provides the most recent personal and business insolvency statistics.
| |
Consumers |
Businesses |
Bankruptcies |
-18.1% |
-25% |
Proposals |
+29.9 |
-3.3% |
Overall insolvencies |
-7.7% |
-21% |
For 12-month period ending September 30, 20101
On the consumer side, it’s clear that proposals have been strongly favoured; new financial incentives encourage higher income individuals to make proposals rather than assignments in bankruptcy.
The impact on the business side is not quite so clear. While insolvencies overall are down, this was expected because businesses in 2009 were still coping with the “Sturm and Drang” of the credit crisis.
Digging beneath the numbers, however, there are some emerging trends, such as more restructuring activity. The credit crunch has eased and more alternative lenders are back in the market, enabling more companies to access funds to support them through a period of financial difficulty. Since a restructuring can take several months to orchestrate, these latest proposal statistics likely don’t yet reflect the number of organizations utilizing this option.
The amendments to the Bankruptcy and Insolvency Act (BIA) and the Companies Creditors Arrangement Act (CCAA) harmonized procedures and provided smaller businesses with more access to cost-effective opportunities to restructure or seek going-concern transactions. For example, the court may now authorize debtor-in-possession (DIP) financing under a BIA Division 1 proposal. Previously this was only possible through the more complex and expensive CCAA process available to companies with minimum debt of $5,000,000. For smaller businesses, the proposal process is simpler and cheaper.
Interestingly, in certain ways the amendments have impacted corporate borrowers more than financially troubled debtors. For instance, the Wage Earner Protection Program (WEPP), which was an earlier part of the insolvency reform package, came into force in July 2008. The WEPP protects, under certain conditions, up to $3,323 (for 2011) of unpaid wages, commissions, vacation, severance and termination pay owing to employees of a company in bankruptcy or receivership. Of these amounts, up to $2,000 is secured against the employer’s current assets and has super-priority rights over the claims of secured creditors in the event of an employer’s bankruptcy or receivership.
Since these potential payments impact the value of operating lenders’ security, many have introduced new measures to protect this security. Some banks, for example, require borrowers to deduct $2,000 per employee in margin calculations and to use a payroll service to ensure that all appropriate source deductions are calculated and remitted.
Additional amendments, now before Parliament, may further impact lending requirements. Bills C-501 and S-214 both propose super-priority status for unfunded pension plan liabilities. Should they pass, these Bills would increase the super-priority of unremitted employee pension contributions in the event of a company’s insolvency. It can be expected that the lender to a business with a pension plan would factor pension liabilities into borrowing calculations – and would also likely require verification that pension remittances are current. Not only would this decrease lending available to a company, it would be a further deterrent to offering pension plans to employees.
For lawyers with business clients who may be struggling with financial challenges, the following suggestions may help to minimize liabilities and guide a positive outcome in light of the new and proposed insolvency amendments.
Corporate directors and officers should be made aware of their potential liabilities. While the amendments provide directors and officers of insolvent companies with more protection from personal liability to encourage them to stay on board while a business undergoes restructuring, they remain liable for unpaid wages, commissions, vacation and termination pay if there are insufficient assets to cover claims. Management should be reminded to ensure that source deductions are remitted and wages and pension contributions are paid on a timely basis and that vacation accruals are regularly updated.
As well, management should be encouraged to discuss with lenders any serious financial challenges the company is experiencing. Lenders expect to be apprised of problems as well as the strategies being used to address these issues. Corporate leaders must be able to explain to their lenders what is happening in every area of the business and to have available current, realistic weekly cash flow projections.
The amendments also included provisions to encourage operating receiverships with the intention of finding going-concern solutions/purchasers and saving jobs. At this stage it is not clear that this has been the result. To realize upon any going-concern value, the principals of a company must be proactive in working with lenders and seeking a restructuring and/or pursuing a transaction through an insolvency process.
The reforms may have provided small and mid-size businesses with more flexibility for restructuring, however the stronger economy and greater availability of credit will likely be more responsible for lower business bankruptcy statistics this year. Overall, the amendments have not changed the best response to financial distress, which is for company management to proactively address problems and seek appropriate advice.
Christopher Porter, MBA, CA•CAIRP, is a vice-president in the transaction advisory services and financial restructuring practice of BDO Canada Limited (www.bdo.ca). You can reach him at (416) 369-3062 or cporter@bdo.ca.
