Creditor Compromise is a potential lifeline when insolvency looms, allowing a company to restructure its financial obligations, regain stability, and maintain creditor relationships. This article explains the Creditor Compromise process and when a company would choose to adopt it.
To safeguard your business and make informed decisions that may prevent liquidation, it’s crucial to understand all your options, including Creditor Compromise.
When a business faces financial challenges, the stakes are high. No business owner wants to reach the point of insolvency and the far-reaching consequences this brings for all stakeholders. However, between the first signs of challenges arriving and the finality of liquidation lie a range of options that can potentially save a business. One of those solutions is Creditor Compromise.
Understanding Creditor Compromise situations
In business, risks are unavoidable and often drive growth and progress. However, risk can also lead to a business finding itself in an unstable situation. While it’s important to avoid actions that harm a business, risks are part of the journey, and it is only when it starts to have a detrimental effect on business viability, that something must be done.
Regardless of what may have caused the company to find itself on the precipice of failure, the effect will soon start to impact the lifeline of the business. Sales will reduce, supplier reluctance will increase, performance will suffer, and compliance requirements will go into default. The decline accelerates, and suddenly, the company’s health is so tenuous it may not be able to operate.
There are many contributing factors that can come together and overwhelm a company’s viability. Regular trading activity might not be enough to overcome these issues, and it is a Creditor Compromise that could offer a viable solution.
What is Creditor Compromise?
In New Zealand, creditor compromise is a legal process under the Companies Act 1993 that allows a company facing financial difficulties to reach an agreement with its creditors. This process offers a more flexible option than liquidation or receivership, allowing companies to negotiate alternative payment arrangements, debt restructuring, or extending repayment terms while providing the chance of a better outcome for creditors.
A benefit of Creditor Compromise is that it gives a company a chance to survive and potentially return to solvency while maintaining business relationships with creditors. An independent Administrator is typically appointed to oversee the process and ensure creditors receive agreed-upon returns.
Affected creditors are likely to agree if the Creditor Compromise is better than the alternative – which is likely to be liquidation.
The benefits of creditor compromise
The benefits are clear to both the company and creditors alike.
- For creditors: there is certainty around payment arrangements, and even though the full-face value of their claim may be compromised, it will be better than immediate liquidation.
- For the Company: upon arrangements being made, it can continue to trade and rectify the situation over time. Importantly, no public disclosure is required, the directors will remain in control of the business, suppliers will stay in on refreshed arrangements, and compliance requirements can be corrected.
Creditor Compromise allows the directors to deal with creditors privately. The arrangement itself can be as creative as the directors’ devise and the creditors involved will accept. Typically, it will involve an across-the-board reduction of the amount paid to all creditors and extended terms available to pay the agreed amount.
How does Creditor Compromise differ from Voluntary Administration?
Creditor Compromise is focused on financial restructuring, which is part of Voluntary Administration (VA)—however, VA is a process that includes both financial and organisational restructuring.
In a Creditor Compromise, new funds will often be introduced where they would otherwise not be available. It may also involve an extension of current guarantees or new ones with new guarantors.
Why would a company use Creditor Compromise?
- Avoid liquidation: Creditor compromise offers an alternative to liquidation, giving the company a chance to survive and continue operations.
- Debt restructuring: It allows the company to negotiate alternative payment arrangements, such as partial debt forgiveness or extended repayment terms.
- Breathing space: The compromise provides struggling companies with much-needed time to evaluate their financial situation and develop a comprehensive restructuring plan.
- Retain control: Directors can maintain control over the company and its assets, unlike in liquidation or receivership.
- Minimise reputational damage: Although there may be some news out there, no public disclosure is required. This minimises the potential for harm to the Company’s reputation.
- A better outcome for creditors: The compromise aims to give creditors a better financial result than they would receive in liquidation or receivership.
- Maintain business relationships: By avoiding liquidation, the company can continue to provide business to creditors who agree to the compromise.
- Legal protection: During the compromise period, the company is protected from legal action by its creditors, allowing it to focus on implementing necessary changes.
- Flexibility: The company has the freedom to propose various alternatives to address its financial challenges, tailoring the solution to its specific needs and circumstances.
- Stakeholder involvement: The process encourages active participation from both the company’s management and its creditors, fostering communication and engagement.
If the stability of your company is feeling shaky, a Creditor Compromise might be the solution. If the circumstances are right, it is worth considering this option as it could be a positive step in getting your business back on its feet.
If you would like to discuss your options, contact Bryan today for a confidential, no-obligation chat.