Companies generally raise money to finance their businesses through equity (i.e., share issue) or through debt (i.e., by taking loans). The person who takes gives money in exchange for shares becomes a shareholder. And the one who gives money or goods on credit to the company becomes a creditor. Whereas the fortunes of shareholders are tied to the performance of the company, creditors expect to receive payments for loans and other credit lines advanced to the company (no matter how well the company performs).
The question this article seeks to answer is what happens to creditors when a company is placed in administration (i.e. when a financially distressed company is temporarily placed under the control of an administrator to turn around the fortunes of the company)?
The Corporate Restructuring and Insolvency Act 2020 (Act 1015) puts creditors into four major groups. These are creditors who offered the company post-commencement financing, Preferential Creditors, Secured Creditors, and Unsecured Creditors.
Post commencement financing is a very interesting one. When a company goes into administration, a fresh injection of cash may be necessary for the company to be able to get back on its feet and settle its outstanding liabilities. This injection is known as post-commencement financing. It is mainly financing obtained by the company in the course of the administration.
This includes loans, trade financing, or venture capital. Monies due to employees in respect of salaries or employment benefits (during the administration) are also included as post-commencement financing. Due to the role of post-commencement financing in turning the fortunes of a company, the framers of the Act ringfenced post-commencement financing as a superior claim (Class A Debt) placing it even before preferential claims. This gives the providers of finance comfort that their monies would be repaid as a priority out of the available assets and revenue of the company.
Then comes preferential creditors. Preferential creditors are also paid in full. They are not secured by any assets but comprise remuneration owed to employees and payments owed to government authorities mostly in respect of taxes, rates, social security benefits, etc. These are paid as a priority before claims secured against assets of the company.
Creditors, therefore, have a lot of interest in the work that the administrator does and his ability to sustain the company, its operations and ultimately pay back monies owed to them.
The insolvency law creates a creditors committee which is a committee comprising three to five creditors who serve as the representative of creditors. This committee receives reports from the administrator on matters that concern the company, approves the remuneration and other terms of engagement of the administrator, and gives advice to the administrator on matters concerning the administration. The creditors’ committee provides the creditors with a means to be more involved in the administration of the company and therefore the outcome of the administration and ultimately the fate of the company’s indebtedness to them.
You have to remember that creditors have to monitor the fate of the companies that owe them with eagle eyes to protect their investment and also to ensure that the administrator at all times is acting in a manner to protect their interest and create value in the company. The role of creditors in the administration of companies cannot be underplayed. However, in as much as they serve in an advisory role to the administrator, you also have to remember that the ultimate liability for the acts of the administrator lies in the administrator’s own hands.
The creditors are crucial in the administration process. And their co-operation in the steps leading to the turnaround of a business cannot be underplayed.