Nigerian Corporate Insolvency Law Redefined from a Practical Perspective

In this article Joe Nwodo discusses the main types of corporate insolvency and the intervention processes; concluding that, because insolvency processes can sometimes be destructive instead of reparative, care must be taken to ensure that the correct solu

Afew months ago, AMCON took over the management of Arik Air over a =N=135bn debt dispute and only a few weeks ago, telecoms giant Etisalat, terminated its management agreement with its Nigerian arm after talks with its lenders to renegotiate a USD 1.2billion loan failed. These events put corporate insolvency back in the spotlight, and underpins the importance of the need for Nigerian company directors to understand the concept of financial distress and business rescue from a practical point of view.

Definition of Insolvency:

That said, the first question for company directors is, what is insolvency? There are two ways of looking at this:

Firstly, the technical legal definition, and then the practical reality.

Turning to the legal definition, there are primarily two main tests under the Companies and Allied Matters Act 2004:

Cash Flow Insolvency

Cash flow Insolvency, is when it is proved to the satisfaction of a Court, that a company is unable to pay a debt exceeding =N=2,000 for a period of three weeks, after being served with a statutory demand for payment by a creditor.

Balance Sheet Insolvency proved to the satisfaction of the Court, that the company is unable to pay its debts, taking into account its contingent and prospective liabilities.

In a practical sense, Insolvency lawyers look at what is called the “Corporate Decline Curve”. The decline curve, provides an overview of what insolvency means from a practical point of view, and serves as a guide on how to get the necessary information to assess how serious a business’ difficulties are. When you apply the decline curve to a business, you begin to see how insolvency fits into the corporate spectrum, in the sense that it provides useful intelligence on the state of a company’s financial health. This ultimately determines, whether a company is a prime candidate for a corporate rescue.

Generally speaking, when companies start trading, profits will increase steadily over time. Shareholders would be paid attractive dividends, directors and employees get lots of bonuses, and suppliers of goods to the company are paid for the goods they supply. Many companies will stay on this trajectory over time. However, some will enter the decline curve and suddenly, the trajectory reverses.

The diagram above illustrates the three stages to the decline of a company. These are:

Underperformance: - This is the first stage of corporate decline, and as you can see from the diagram, the company begins to lose profitability because of weak- nesses in its business. This could be due to factors such as, loss of market share to its competitors (which by the way can be a perfectly natural process if you accept the proposition that in a vibrant market, there will always be casualties).

Distress: - This is the second stage of corporate decline. At this stage, the company is unable to fund any activity outside of its immediate operations, and has difficulty in meeting its financial commitments to lenders and trade creditors.

Crisis: - This the final stage of corporate decline. During this period, the company suffers a critical shortage of cash, and has no other option but to use all the cash generated by its business, to meet its debt obligations as they fall due.

Why is the Decline Curve Important?

It is important to understand the process of corporate decline, and see insolvency law in a practical context, because there is a moment along the decline curve where the process of decline becomes reversible - perhaps somewhere between “underperformance” and “crisis”, which in the diagram above, I have referred to as “Reversible decline”. At this point, even if a company is deemed to be technically insolvent under Nigerian law and thus a prime candidate for a receivership or liquidation (as the case may be), there are legal and commercial solutions which can be applied to that company to help improve returns, and in many cases, avoid a formal insolvency process all together. For example, you could get rid of a product which is draining the company of its resources, you could get rid of management (if you feel they are part of the problem and not part of the solution) and instil a board which is more fit for purpose or in many other ways, prune the company so it is able to pay its bills going forward.

However, note that along the decline curve, there is also a moment where it is virtually impossible to rescue the company, but may be possible to save its business – the commercial enterprise embedded in the company. I refer to this point along the curve as the “Irreversible decline” moment, and if you are an insolvency lawyer, it is incredibly frustrating when a company comes to you at this point when it is too late, and there are only a limited range of solutions you can apply to that company. At this juncture, there are two stages down which you pass into insolvency – The first stage is known as the “restructuring phase” and here, you should apply non – insolvency techniques focused on the restructuring of the company in an attempt to save the company’s business. Often these techniques are informal, and could be anything from a corporate scheme of arrangement or a consensual agreement with banks and trade creditors to a pre-packaged sale (“Pre-pack”) of the company’s assets, a process whereby existing management of the company find a waiting buyer and agree on a sale price for the company’s assets, before the company goes into receivership or some other insolvency process. All of this is done behind the scenes, before the company enters into a formal insolvency process, and once a receiver or a liquidator (as the case maybe) is appointed pursuant to a court order, all that is required of the receiver or liquidator is to sign the sale contract, which has been thoroughly negotiated and is in an agreed form. The transfer provisions in the sale contract, would bring all the employees of Oldco into Newco and Oldco’s creditors get a lion share of the consideration because of their security. So essentially, Oldco’s financial obligations to its preferential and secured creditors are addressed in one quick sale.

Pre - packaged sales are generally becoming the norm rather than the exception, because they preserve the value of a company’s business. Why is

this so? Well, if you accept the proposition that insolvency processes are value destructive, it therefor follows that, if there is any hint a company is going into an insolvency process, its value diminishes. For instance, any trading done during this period would stigmatise its business, key employees would leave because they don’t feel comfortable working for a distressed company, and contracts would dry up because counterparties would simply not feel confident trading with the company. This would wipe out the value of the company’s business and consequently, a business rescue becomes virtually impossible.

It is only when these options fail, that you know you are into the regime of insolvency, which is the second stage down the irreversible end of the curve. So, when we are talking about insolvency from a practical point of view, we are talking about the bottom end of the irreversible end of the curve. This is important, because you should not throw insolvency techniques right at a company with a vibrant and profitable business which may be technically insolvent under Nigerian law, but not practically insolvent from the point of view of the decline curve. The stigma, the lack of confidence, the lack of credit worthiness and the generally spookiness around the word insolvency, kills the value of a company.

Conclusion

In conclusion, insolvency processes do not add value, rather they are value destructive. To that end, care must be taken to ensure the right solutions are applied when dealing with companies that are technically insolvent under Nigerian law, but can nonetheless be rescued. This however, is only possible when we are able to see insolvency law in its proper practical context as illustrated above. When you restrict insolvency law to its technical meaning, you do not engage with the practical issues which determine whether an insolvent company can be rescued or sold as a going concern.

Etisalat Nigeria was a prime candidate for a business rescue. It owned a significant proportion of the Telco market, and recorded its best financial year in 2016. Additionally, proposals for its debts to be written off, were rejected by its lenders because they knew it was commercially viable and capable of repaying its debts. So clearly, there was a viable business to be rescued. So why wasn’t it rescued or at the very least sold via the Pre-pack route? Were its directors fully engaged with the practical issues discussed above, or was their understanding of insolvency law restricted to its technically meaning? A Pre-pack sale would have reduced the negative attention surrounding its financial situation, generated sufficient cash to pay off its debts, and preserved the value of its business whilst allowing it trade under a new company.

Directors should ensure that they seek professional advice, as soon as these early signs start to manifest. An early diagnosis, increases the chances of the company’s survival.

"INSOLVENCY PROCESSES DO NOT ADD VALUE, RATHER THEY ARE VALUE DESTRUCTIVE. TO THAT END, CARE MUST BE TAKEN TO ENSURE THAT THE RIGHT SOLUTIONS, ARE APPLIED WHEN DEALING WITH COMPANIES WHICH ARE TECHNICALLY INSOLVENT UNDER NIGERIAN LAW, BUT CAN NONETHELESS BE RESCUED"