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The Costs of Insolvency

As previously mentioned, insolvency and/or financial difficulties rarely happen unexpectedly. Several signs warn business leaders that such a situation is on its way. Unfortunately, these signs are frequently ignored.

Often, management allows the situation to deteriorate without making financial diagnostics. The line of credit is being used at full capacity, payments to vendors are stretched and in some cases management funds itself through sales tax rebates. The company, which is therefore in financial difficulty, no longer has enough funds to fulfill its obligations as they become due.

At this point, fewer options are available to the company and it has no choice but to file insolvency proceedings to protect itself from the creditors. In this case, significant disbursements will be needed to help restructure the company’s finances, with no guarantee of success, at a time where very little liquidity is available. These expenses include:

  1. Professional Fees: When Filing Insolvency Proceedings Under the Bankruptcy and Insolvency Act or the Companies’ Creditors Arrangement Act, the services of a Licensed Insolvency Trustee (“LIT”) must be retained. The Trustee will oversee the restructuring process and report to the creditors at the Court. Also, the services of a lawyer will have to be retained for the preparation of the motions presented to the Court.
  2. Suppliers: Routine services rendered by the company’s suppliers will require payment on delivery. It will be very difficult to obtain terms of payment and in some cases, suppliers will require security deposits. This will greatly affect the working capital of the company.
  3. Clients: It is common to see clients refuse to pay what is due after the filing of insolvency proceedings. They pretend to have problems with the quality of products delivered and they use the uncertainty around the provision of after-sales service and underlying warranty as a pretext. Therefore, it is expected that some receipts will be deferred in time which will cause additional pressure on the working capital of the company.
  4. Proposal/Plan of Arrangement: To discharge certain debts incurred prior to the filing of insolvency proceedings, a company will be required to pay an amount to its creditors,based on the agreed upon terms, to settle these debts for less than their nominal value. The proposal/plan of arrangement must be accepted by the creditors and the Court.

Considering that the company in difficulty no longer has the liquidity to pay these disbursements, it will have to develop a business plan with the help of the LIT to find the necessary financing to complete its restructuring. This financing, in the context of insolvency proceedings, is likely to be costlier for the company than in a context where there are no insolvency procedures in place.

Surely, restructuring is expensive and can leave a bitter taste for some suppliers. Therefore, it is essential to address the warning signs when they occur and make the necessary changes to ensure the sustainability of the business.

If you are experiencing a similar situation, it is high time to contact your advisor. By letting the situation deteriorate further, you may find yourself running out of options.

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2018-10-25

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