Bracing for a wave of insolvencies

Experts have been saying for months that to truly measure the pandemic's impact on Canada's economy, wait for the government-sponsored programs to end. Though there are extensions of the main recovery programs to get businesses through the winter, will it be enough? And how are lawyers positioning their practices to handle a potential wave of financially distressed businesses?

The tremors have already been felt in certain industries. But the next six to 18 months will be clutch for many businesses. Lenders' forbearance agreements may already be exhausted. Landlord rent deferrals will run out when government supports dries up. Once companies see their Q4 sales and 2020 tax bill, corporate executives may be rethinking short-term strategy.

"Lenders, particularly banks and other financial institutions, have been quite patient with borrowers during what has been a truly unprecedented period of financial challenge," said Tushara Weerasooriya, a partner in McMillan LLP's restructing group. Weerasooriya, along with several experienced lawyers, will be presenting a CPD-eligible series for the CBA on essential skills for corporate lawyers to help clients through tough times (running from October 26, 2020 until February 25, 2021). 

She said time-tested early signs to look out for include worsening accounts payable, loss of supplier credit, breaching lending covenants, frequent bank overdrafts and a general lack of financial transparency. Once they manifest themselves, it's important to reach out to local lending institutions or stakeholders candidly. Doing so with a plan of action may be the most effective approach. 

 "In too many cases, a company and its management team fail to accept that the company is in trouble until it is too late," Weerasooriya says. "They simply run out of road to negotiate a reasonable solution with their stakeholders."

Karen Fellowes, Q.C., is the Western Canadian Leader in the insolvency and restructuring group at Stikeman Elliot LLP in both Vancouver and Calgary. Many companies already in financial distress saw their situation deteriorate in 2020, she says. But surprisingly perhaps, some businesses have seen their bottom line do quite well if they have been able to substantially cut costs or operate under different circumstances. 

"It won't always be because the business has reached the end cycle; it may be that the business takes this opportunity to restructure and get leaner and leaner and shed themselves of some uneconomic contract or assets, or change their capital structure or their share structure and live on," Fellowes said. "And that's the hope — that it won't be a complete liquidation burn earth scenario here, but that we'll actually see some companies successfully restructure."  

There are industries more clearly adversely affected by the pandemic than others: travel, hospitality, arts-based industries, restaurants, retail, etc. The good news is that those businesses will likely be able to benefit from evolving judicial discretion under statutes like the Companies' Creditors Arrangement Act (CCAA). 

"So, the creative insolvency lawyers out there, or insolvency professionals in general have always been testing the limits of what could be accomplished under a CCAA proceeding, and I think we're seeing more and more of that," Fellowes said.

Acting at the first sign of distress is paramount in taking advantage of all the options on the table. One way may buy time for the business is to discuss creating a private forbearance arrangement with a secured creditor in return for a certain number of things: an injection of capital by shareholders; monthly or other fees to cover the bank's costs; signing a consent for the appointment of a receiver in the event of default, or agreeing not to take issue with lender security in the event of an insolvency. 

Richard Schwartz is based in Winnipeg, and is a frequent lecturer on bankruptcy, insolvency, and commercial litigation matters. 

The advantages of a private forbearance, he said, include the element of privacy—no court filings or notice posted, and it's by far less expensive than the formal insolvency process. 

"The distinct advantage from the customer's perspective is that they're still in control, they're still running their business," he says. "Now, it gives them time either to weather the storm, if that's what it is, or to refinance, that is, go to another lending institution who may be more accommodating or more willing to lend it to that particular industry," whether or not the banks are willing to admit it. 

Regardless of the approach one takes, companies will need to assess and prepare for the worst-case scenario in industries that are suffering. 

Weerasooriya says that for companies facing financial distress,“[C]ash is king. It is no longer business as usual. Companies who focus on conserving cash, by delaying long term projects and capital investments and working to reduce costs, will ensure that they can continue to operate in a period of distress.”