About reorganisation – in practice and theory

Reorganisation basically means helping a company out of temporary solvency problems. By applying different reorganisation measures, an attempt is made to restore the liquidity of a company suffering from economic difficulties, improve its profitability, and ensure its sustainable management. The Reorganisation Act has been in place for two years with the aim of rehabilitating companies. At the end of 2008, when the Reorganisation Act entered into force, Estonia, like the rest of the world, was hit by an economic crisis that involved almost all business sectors. Thus, the Reorganisation Act entered into force at the last possible moment for companies with solvency problems. Although the Act has been in force for a relatively short period, we attempt below to provide an overview of current practice in implementing the Reorganisation Act and analyse different possibilities that the Act provides for ensuring sustainable management of companies. We also tackle some of the bottlenecks in the Reorganisation Act and give a brief overview of judicial practice.

Reorganisation in figures

Estonia’s need for an Act providing an alternative to bankruptcy proceedings during economically unstable times is notably characterised by the fact that 93 reorganisation applications were filed with the courts in the year following entry into force of the Act. In 2010, when economic indicators started to improve, that number dropped by almost half, i.e. 51 reorganisation applications in total were filed with the courts. [1]

Although the number of legal persons who hoped to help overcome economic difficulties through reorganisation has been quite large during the last two years, only a few of these have a reorganisation plan in place. Six reorganisation plans were approved in 2009 and five in 2010, respectively. Of the companies that approved their reorganisation plan in the first year, two are under liquidation and two are bankrupt as of today.

Several reasons may lie behind the small number of companies reorganised. Firstly, the novelty of the Reorganisation Act and an inability to use the measures provided by the Act to one’s benefit in the best possible way. Secondly, and even more importantly, companies decide in favour of reorganisation when it is already too late. This means that their solvency problems have increased to the extent where the likelihood of restoring liquidity is almost non-existent. In such an event, it is significantly more difficult to win the support of creditors and get the number of votes in favour necessary for adopting the plan. Since, in the given situation, reorganisation proceedings may quickly change to bankruptcy proceedings, a majority of companies that applied for reorganisation – but lacking a reorganisation plan in place – are probably bankrupt today.

Meaning of reorganisation for companies

When to understand that a company might need reorganisation and how can reorganisation help a company out of temporary solvency problems? The first signs of threat that may refer to solvency problems of a company include its increasing inability to fulfil monthly obligations. If this inability lasts for several months, the financial condition of the company should be thoroughly analysed. For this, it is advisable to review the company’s cash flow to assess whether income created within the next half year, for example, could be used to fulfil liabilities created earlier, while continuing to cover monthly operating expenses. If it appears that the situation cannot be improved without applying measures to help the company, reorganisation should be considered and specialists in reorganisation law consulted.

Reorganisation measures

During reorganisation, the economic situation of the company is improved by applying different reorganisation measures. In practice, the most widely used measure is transformation of claims of creditors. For transformation of claims, the measures mainly used include staggering deadlines for paying creditors’ claims or reducing those claims. Staggering basically means that claims will only be satisfied when the company has managed to restore its liquidity and earns income on its activities. In that event, after creation of positive cash flow, creditors will receive successive payments under an established schedule. Transformation of claims helps companies with solvency problems by granting temporary release from performance of their obligations. This in turn should create sufficient liquid resources for the company to direct to everyday business activity in order step by step to overcome difficulties and restore positive cash flow.

Reorganisation plan

A reorganisation plan sets out how and what measures are intended to help a company out of temporary solvency problems. Legal consequences specified by the reorganisation plan will become effective as of approval of the plan by a court and will remain effective during the entire period of the reorganisation plan. In practice, a reasonable period for performing a reorganisation plan is considered to be five years on average. During the life of a reorganisation plan, statements of claim cannot be filed on the basis of claims to which the plan applies. Nor, indeed, can bankruptcy petitions be filed by creditors that had a claim before approval of a reorganisation plan but whose claim is not transformed by the plan. Thus, a reorganisation plan represents the action plan of a company for the period of reorganisation, of importance to the company as well as to creditors involved.

Law and judicial practice

Although reorganisation proceedings give companies hope to overcome economic difficulties, it should be admitted that the Act also includes some bottlenecks. Firstly, judges may find it difficult to identify merely on the basis of a reorganisation application as to whether reorganisation of a company would be possible at all. Therefore, companies that actually cannot be rescued could maliciously attempt to take advantage of the possibilities provided by the Reorganisation Act and thereby postpone commencement of bankruptcy proceedings. As it may take approximately three months from filing a reorganisation application until voting in favour of the plan, and commencement of reorganisation proceedings would not lead to consequences as strict as those in bankruptcy proceedings, some companies might attempt to damage the interests of creditors and withdraw assets from the company before becoming permanently insolvent. At the same time, in situations where the company has no realisable assets, reorganisation proceedings are definitely more favourable for creditors than bankruptcy proceedings. That is, if creditors might get nothing in bankruptcy proceedings from a company without realisable assets, in the event of successful reorganisation the creditors may have their claims satisfied in part as prescribed in the plan at the latest by the deadline for fulfilment of the plan.

Not all procedural aspects regulated in the Reorganisation Act are sufficiently clear and some are even partially inconsistent. For example, the Reorganisation Act does not unambiguously provide for whether a reorganisation notice is also to be sent to creditors whose claims are not intended to be transformed by the plan. On the one hand, it may be found that as reorganisation also indirectly concerns the interests of those creditors, they should be notified. On the other hand, other provisions regarding reorganisation notices regulate only the rights of creditors whose claims are transformed in the reorganisation plan. These uncertainties may cause futile confusion and disputes among companies as well as creditors.

Nor is it clear today as to how far reorganisation measures may be applied and how equal treatment of creditors is ensured by the Reorganisation Act. The Act does not provide an exhaustive list of applicable reorganisation measures but only lists a few possibilities that may be used for transformation of claims. On the one hand, this gives companies free reign in choosing how to rescue themselves from a difficult situation in the best possible manner. On the other hand, it may result in an unequal situation for creditors once the reorganisation plan is approved. Thus, the current version of the Reorganisation Act needs additional interpretation by and instructions from the court. The Supreme Court has not yet issued many judgments concerning the Reorganisation Act but some important conclusions have been reached. For example, the Supreme Court has determined that tax claims can also be transformed through reorganisation. This means that all transformation possibilities under the Reorganisation Act may be applied to tax claims, including a request to reduce or extend the term for fulfilling the claim. The Supreme Court has also determined that the interests of companies must be set above the interests of creditors, which indicates that adversely affecting the interests of creditors is a legitimate and permitted aim through, for example, reducing their claims in order to rescue the company. At the same time, the provisions concerning approval of a reorganisation plan have been interpreted and it has been concluded that the court may approve a reorganisation plan even if experts who have assessed the plan are of a different opinion.

Summary

Although the number of companies reorganised has remained small during the two-year practice of the Reorganisation Act, this does not mean that the Act has failed to serve its purpose. Reorganisation proceedings enable a company to be helped out of temporary solvency problems and, upon creation of wider application practice and an increase in awareness of companies, the number of reorganised companies may well grow. This in turn allows for preservation of jobs and helps ensure economic stability.