Restructuring & Insolvency
The new Small Company Administrative Rescue Process is the hot topic in the company restructuring arena. Gerry Byrne canvassed the views of leading experts about SCARP and their advice for distressed firms
The new Small Company Administrative Rescue Process (SCARP) is billed as ‘Examinership Lite’ for SMEs. The experts give their verdict to Gerry Byrne
Mark Woodcock is brimming over with enthusiasm for SCARP, the new form of stripped down examinership for insolvent companies. It is expected to be passed into company law within months as professionals prepare for a strong post-Covid demand for corporate restructuring. But don’t we already have the examinership process to do this?
“The problem with examinership is that it is so expensive, because you’re in court a lot of the time,” Woodcock explains. “For smaller traders like shoe shops, there is never enough money in their business to justify it. SCARP will strip back the examinership process to its bare component parts, so you do not have to apply to court. The company can just resolve to put itself into a SCARP process.”
Woodcock is a partner in law firm Fieldfisher Ireland and chairman of Restructuring & Insolvency Ireland (RII), the trade group that played a pivotal role in lobbying for the introduction of the small company rescue process. “It will make the process of restructuring far easier for small companies, as 95% of Irish companies meet the qualifications for inclusion in SCARP,” he says.
In many ways an outcome similar to an examinership can be expected from a SCARP process. While an examiner is appointed in the former situation, a process administrator is appointed in SCARP. In both cases, he or she then sets about refinancing the company and negotiating debt and other liabilities downwards. But there are key differences.
In SCARP there is no court protection from creditors which is a key ingredient in an examinership.
Suppliers can turn up and demand their goods back. And a creditor can elect not to agree with the write-down of their debt, thus forcing the process administrator to go to court, which can be costly, or opt for a liquidation as the only remaining solution.
On the plus side, the time window for SCARP is shorter than for examinership. The process as outlined by minister Robert Troy provides that a rescue plan can be approved without court approval, provided that 60% in number and value of creditors vote in favour of the proposal, and no creditor raises an objection to the plan within 21 days of the rescue plan vote.
The approval mechanism provides that where one class of impaired creditor votes in favour of the plan, this decision can then be imposed on all classes of creditors. However, where an objection to the rescue plan is raised, there is an automatic obligation to seek the court’s approval.
The SCARP Bill provides that state creditors such as the Revenue must provide reasons if they wish to opt out of a SCARP process. “Revenue has always been a preferential creditor in an insolvency situation but there shouldn’t be indefinite preferential status for Revenue,” Woodcock contends.
He would also like to see creditors who object to a rescue plan pay towards additional costs this imposes on the process. “If a creditor is successful in rejecting the scheme and forces the company to seek court approval instead, they should have to pay for the cost of the administrator's court action. It would make people think, ‘am I doing better out of this process than I would be in a liquidation?’ and ‘if I am doing better, I should probably just accept it’.”
Cormac Mohan of Fitzwilliam Corporate Insolvency frets that previous attempts to shift restructuring schemes out of the High Court and into lower courts didn’t work out as planned. The requirement of 60% agreement by creditors for a rescue plan (compared with 75% in an examinership) is positive, he says.
“I think examinership will still probably be to the fore because it is tried and tested,” says Mohan. “If the fundamentals of a business are good and it can provide employment, then it should be given a chance.”
Mohan anticipates that insolvencies will start to spike later this year and into 2022. State wage subsidies, the warehousing of debt by Revenue, and the exhortations of the Central Bank for banks to go easy on Covidaffected firms, have all masked a perilous situation for many firms, in Mohan’s opinion.
“A lot of businesses that availed of payment breaks during the pandemic
will struggle coming out of it,” Mohan cautions. “Many bank loans have been sold to third-party lenders who are often more adversarial and aggressive than high-street banks. Revenue has been very helpful in warehousing debt, but that will only last so long. Tax debt may prompt some companies to explore insolvency mechanisms, especially those with a history of tax default.”
John Russell, managing partner of Russell & Co, believes SCARP could be the perfect opportunity for a viable company to deal with its current and legacy financial issues. “The introduction of SCARP will offer small business owners access to a hugely valuable business support,” he says. “A strong financial plan could be the beginning of a bright future.
“However, everything depends on the viability of the business after the Covid pandemic. Some businesses may never recover from this, and directors will need to account for both current cashflow needs along with dealing with any warehoused and unpaid costs. Examinership and SCARP will be a great opportunity to restructure the company and deal with legacy issues attaching to the business, including warehoused debts and overheads along with potential redundancy costs.”
Minister Robert Troy, who is steering the legislation through the Oireachtas, notes that while the new rescue law limits court involvement, he is conscious that the issue of corporate rescue extends beyond the distressed company itself.
“Therefore the process incorporates robust safeguards and allows for access to the courts at appropriate junctures,” says Troy. “The Bill provides that state creditors will operate on an ‘opt-out basis’ on prescribed grounds, such as if the company has a poor history of tax compliance. This should provide comfort to businesses that the state will not remove itself from the process for arbitrary reasons.
“Government will continue to prioritise this important legislation and I hope that it can be enacted quickly, so companies that are fundamentally viable, but experiencing temporary difficulties, have a genuine opportunity to trade out of difficulties and get back on their feet.”
Don’t know where the money to finance your company’s post-Covid future is coming from? That’s still no excuse for not drawing up business plans for the next three years, warns Brendan Hanratty at Kroll. There’s now a surprising variety of sources of finance available, and you need to be ready with a great pitch in case someone comes knocking on your door.
“You have to be able to present in a way that is concise, is robust and stands up to scrutiny with realistic projections. This allows an investor to quickly understand the nature of your business and the key fundamental drivers of your current position, and what your success is going to be going forward,” he explains. “The fatal mistake companies sometimes make is not being ready to have those conversations and thus approaching potential funders prematurely.”
Prior to joining Duff and Phelps (formerly accountants Farrell Grant Sparks and now owned by Kroll and named accordingly), Hanratty spent 11 years in banking and knows inside out how lenders look at funding requests from companies, and what the key assessment criteria are. He is now managing director of Corporate Restructuring and Debt Advisory at Kroll.
“We advise investors as well, so we see things from both sides. We provide due diligence and that obviously helps us understand how to advise clients in putting restructuring funding proposals together,” Hanratty adds. “There are a lot more funding providers now that have developed their own niches, and are prepared to look at businesses that have been very difficult to finance in the past.
“Many of them can operate with less security for facilities than traditional providers. Restructuring is an opportunity for savvy investors and funds to generate good returns, and on the flip side it provides businesses with access to funding that didn’t previously exist.”
The current volume of insolvencies and restructurings is well below normal, and Hanratty believes that there is a significant backlog waiting for the economy to emerge from lockdown. Not all of them will be formal examinerships or receiverships, he adds. “A big feature will be informal restructuring on the back of the SCARP legislation, which will facilitate companies to reorganise their balance sheet coming out of Covid.”
According to Hanratty: “Anyone who is looking to negotiate with creditors, with landlords or with Revenue should be aware that what can be achieved through a formal examinership process should guide the informal SCARP process as well.
The likely outcome of the formal alternative will be a good guide to a negotiated SCARP settlement.”
Indeed, informal negotiated restructurings will form a major future trend, Hanratty believes. “We are not that long out of the last recession, and the results of all that formal reconstruction has educated the market to a large degree,” he observes. “We pretty much know what the outcomes are likely to be, and with SCARP there is a framework to negotiate around.
It can be demonstrated to all stakeholders how it is in everybody’s best interests to comply.”
Is Hanratty surprised there have been so few insolvencies since trading restrictions were imposed over a year ago? “A lot of this is down to government supports, and the value it has brought to a lot of companies,” he states. “They have been invaluable to companies but they are going to diminish, so a lot will depend on how businesses manage that exit. It is going to be an uneven recovery, and you are going to see some of the natural insolvencies that would have occurred but for Covid. There will also be the after-effects of Covid and how it has changed the economy as well.”
‘You have to be able to present in a way that is consise, robust and stands up to scrutiny’
Declan McDonald, who leads the business recovery services practice at PwC, is an insolvency lifer. He has been with PwC for about a dozen years, and before that worked with Grant Thornton. Altogether, McDonald has 25 years experience of being a receiver, examiner, liquidator and adviser in distressed company situations.
Lenders in particular turn to McDonald and PwC when their loans go sour. The fallout from the property crash kept McDonald and his colleagues busy, a time that he recalls with hindsight as ‘a bit crazy’.
“We quickly got up the curve in terms of commercial real estate and development land. We’re still at the tail-end on a few of those that are still being worked through. It’s amazing really how long it’s gone on,” says McDonald
In McDonald’s view, the current commercial landscape bears no comparison to a decade ago. “It’s hugely different,” McDonald notes. “People have different views in terms of the wave of distress that potentially is going to arrive upon us when the supports are withdrawn and various elements of forbearance are scaled back.
“I think there will be a cohort of businesses that will struggle, and the statistics are speaking to that, insofar as insolvency numbers are abnormally low at the moment. That tells us that there are many businesses who’ve hung on with the supports and the forbearance. Companies that in normal circumstances would have been wound up will ultimately be wound up anyway. So what’s coming is an element of catch-up.”
At the same time, McDonald notes the interesting dynamic developing around inflationary pressures. “There are definitely signs of a bit of a postpandemic boom,” he says. “Anecdotally, you’re hearing about pressures within the construction sector in terms of supply and pricing, and staff shortages in hospitality. That inflationary environment may cause problems down the track.”
For the cohort of businesses dependent on supports, McDonald’s opinion is that if they were good businesses coming into the pandemic, they will be good coming out of it too. The impression McDonald has from conversations with banking executives is that there doesn’t seem to be signs of distress across their books at the moment. He believes there is going to be a level of pragmatism among lenders, particularly the traditional lenders, because they are conscious of the employment implications.
“I don’t think the banks will be that anxious to enforce against trading businesses where there’s decent dialogue going on,” says McDonald. “However, borrowers have to present proposals that share the pain. That could mean equity being introduced to the business, as well as looking for some sort of debt restructure.
“One of the things that frustrates the lenders is the quality of the information they receive from customers, even just the way it’s presented. In recent months, there has been a lack of trading visibility, and as that picture becomes clearer, it becomes easier to forecast. The advice I would give to businesses is that if you’re going in with an ask, it has to be backed up by quality information on your outlook, and financial information on your business.”
McDonald welcomes the new SCARP small company rescue process, though he wonders how successful it will be. “We’ve always had a liquidation culture in this country and I think it’s positive that we’re moving towards more early intervention.
“What I worry about it is that the legislation has been accelerated by this particular crisis instead of being part of a longer term vision. For companies with warehoused tax debt and landlord issues, it will be problematic to engage with SCARP.
“However, there was some scepticism surrounding the personal insolvency process when it was introduced, and it has proven to be a success. There will need to be a certain amount of pragmatism to make SCARP work.”
‘I think it’s positive that we’re moving towards more early intervention’