INTERVIEW: “Corporate rescue and insolvency in Cyprus”

Ioannis Sidiropoulos*, associate at Elias Neocleous & Co LLC answers at our questions regarding  “Corporate rescue and insolvency in Cyprus”

1. What are the main goals and options in regards to corporate rescue?

The primary and expected aim of corporate rescue proceedings is to avoid corporate insolvency. Maintaining a company as a going concern has apparent advantages as it serves, among others, the continuation of the business, avoidance of employment disruption and loss of know-how, and prevents a probable domino of insolvencies. Moreover, it is beneficial for the creditors in the long term; the company is given this “second chance” to reorganize its operations and finance and recover its ability to refund its debts.

The classic binary setting of corporate rescue is one of informal and formal/judicial reorganization proceedings. I will address the latter later (question 4). As far as “informal re-organisations” are concerned, they can be defined as a reorganization route that takes place outside the statutory framework, with the objective of restoring the health of a company in financial difficulties within the same legal entity. Within an informal re-organisation, it will often be necessary to reach an agreement with the company’s lenders (usually banks), and sometimes other stakeholders (e.g., trade creditors, employee representatives/unions, tax authorities) about changing agreements made earlier and/or new agreements on financing or employee lay-offs.

When such an agreement is effected voluntarily, we have a “workout agreement," while the process to come to this point is often called “informal workout." The definition of an “informal workout agreement” is described as an agreement concluded between the interested parties of a business in distress within an informal reorganization with regard to the review of conditions pertaining to funds made available and the way forward regarding the necessary turnaround measures on operational strategy, without resorting to legal procedures to effectuate this.

2. What are the main reasons for corporate failure in Cyprus?

Unfortunately, in Cyprus, it is widely observed that due to the fear of stigma and delusional hopes of recovery, company leaders are rarely willing to initiate business rescue proceedings. These kinds of initiatives are often left to creditors, with the risk for company management being that proceedings will get out of their control. There is also the risk that (unless the creditor is reliant on the business for supplies) their main focus is on recovering their money and not ensuring the business's long-term survival. These companies are often referred to as “Zombie” companies as immediate and radical turnaround management is necessary, yet insufficient efforts to achieve this are initiated from the inside.

Another quite important aspect is the underrepresentation of the finance function at the board level. This means that, in many cases, there is an issue of lack of required control on fundamental key-performing indicators such as average creditor days and average debtor days. Insufficient information on accounting issues exemplifies one category of such business failure. As a result of the abovementioned lack of (self) awareness, disproportionate business expansion has also been a critical factor in corporate distress in the Cyprus market.

The above brings the problem of excessive debt exposure in Cyprus into the spotlight. This is often the result of a lack of (intentionally or not) dependable studies/estimations of investment and lending (on behalf of the banks) purpose and any possible excess of investment budget. It has also been found that a common problem for Cyprus SMEs in decline is the inability to compete in price due to high fixed and variable production costs and small profit margins. This creates a vicious circle putting an additional strain on rescue efforts. Of course, the above deficiencies were exacerbated by the adverse effects of the pandemic on the economy.

3. In what circumstances does a decision to proceed to insolvency proceedings for a company need to be taken?

Distressed companies are those facing financial crises not resolvable without a considerable recasting of the firm’s operations, structures, and finance. This can be brought about through a company’s failure to make a substantial payment of principal or interest to a creditor. Distress can also be seen in terms of financial ratios, such as liquidity and longer-term solvency. The basic and most prevalent forms of corporate distress assessment are the cash flow and the balance sheet tests. Under the cash flow test, a company is insolvent when it is unable to pay its debts as they fall due. Under the balance sheet one, the entity is insolvent if the book value of its assets, as listed on the conventional balance sheet, is less than its reported liabilities.

The long-term assessment required for the application of the balance sheet test is based on the notions of prospective and contingent liabilities. Prospective liabilities are a debt that will certainly become due in the future, either on some date that has already been determined or determinable by reference to future events. Contingent liabilities may include cases where the debt is for an unliquidated amount or if its payment is uncertain or dependent upon some future event.

Both the tests mentioned above are applicable in Cyprus, and contingent and prospective liabilities are also considered in both. Moreover, two additional indicators can be used: ‘if a creditor (by assignment or otherwise) to whom the company is indebted in a sum exceeding EUR 5,000, then due has served on the company, by leaving it at the company’s registered office, a written demand requiring the company to pay the sum so due and the company has for three weeks thereafter neglected to pay the sum or to secure or settle it to the reasonable satisfaction of the creditor’; or ‘execution or other process issued on a judgment, decree or order of any court in favour of a creditor of the company is returned unsatisfied in whole or in part.' It should be noted that these indicators constitute a number of circumstances that create a legal presumption of non-payment of debt, but do not exhaust the scope for any other testimony which might produce the same effect.

4. What is the legal framework for corporate rescue and insolvency in Cyprus?

The Companies Law provides the main procedures for dealing with financially troubled companies. In ascending order of finality and rigour, they are:

• arrangements and reconstructions under sections 198 to 201, including the provisions for the merger and division of public companies introduced by Law 70(I) of 2003;
• the appointment of a receiver by a charge-holder or by the court (receivership);
• the appointment of an examiner, whose objective is to restructure  the company and preserve it as a going concern (examinership);
• voluntary winding up, also known as voluntary liquidation; and
• winding up by the court, also known as compulsory liquidation.

The above consist a two-tier restructuring and insolvency framework. The provisions dealing with arrangements, receiverships, and liquidations are long-established, and there is a wealth of case law from the English and other courts to assist in their interpretation. The examinership was introduced with the 2015 amendments to the Companies Law, is based on Irish legislation, and is akin to the administration process in the United Kingdom. It supplements the traditional provisions and is designed to promote an enterprise culture by facilitating restructurings. This new procedure is largely untested. Meanwhile, the traditional form of voluntary arrangement and compromise has been used to complete restructurings successfully.

5. Is there a prospect for reforms in the field?

With the adoption of Directive (EU) 2019/1023 on preventive restructuring frameworks, discharge of debt and disqualifications and measures to increase efficiency (Preventive Restructuring Frameworks Directive) and amending Directive (EU) 2017/1132 on certain aspects of company law (codification), EU member states are required to incorporate minimum common standards into their national restructuring and insolvency laws by 17 July 2021. Cyprus has been given an 11-month extension by the European Commission to transpose the EU Restructuring Directive into national law. The bills prepared so far are under discussion and evaluation by the competent authorities, with a deadline for implementation in June 2022.

In particular, this Preventive Restructuring Frameworks Directive aims to reduce barriers to the free flow of capital resulting from differences in member states’ restructuring and insolvency frameworks and to improve aspects of the rescue culture in the EU.

Key features that member states must adopt include the following:

• An effective preventive restructuring framework to enable debtors experiencing financial difficulties to restructure early to prevent insolvency and ensure their viability.
• A stay of up to four months extendable to up to 12 months to support negotiations of a restructuring proposal, which should prevent individual enforcement action and include rules preventing the withholding of performance, termination, acceleration, or modification of essential contracts.
• An ability to cram down dissenting classes of creditors.
• Adequate protection for the financing needed to allow the business to survive or preserve the business's value pending a restructuring and for new financing necessary to implement a restructuring plan.
  
  
  

6. What have been the main challenges for Cyprus businesses during the last years? Do you see a larger amount of companies that need to be insolvent?

The adverse economic developments that emerged in Cyprus in 2013, following the 2008 global financial crisis, were only additional problems for the Cyprus economy, which had already entered a period of a severe recession. In particular, during 2012 and the first few months of 2013, the Cyprus economy faced a series of negative developments. The prolonged crisis in the banking sector and the fiscal deterioration inevitably created a deep and prolonged recession, with a significant increase in unemployment and companies facing severe financial difficulties.

Between 2013–2017, the filings for insolvency processes had increased significantly compared to any period before 2013. However, it should be said that during the last two years before the pandemic, the filings for insolvency processes had settled into a modest mode due to the stability in which the Cyprus economy entered following the deep recession of the previous years. During the post-crisis years, the challenge for the Cyprus credit system was and continues to be the reduction of non-performing loans (NPLs).

The Covid pandemic has caused severe social and economic disruption worldwide and is expected to flood the markets with new waves of NPLs in the years to come. Companies worldwide have found themselves facing severe cash flow difficulties as they may be owed and/or owe significant sums. The disruption of supply chains, the various challenges faced by the workforce, and the worsening of credit conditions are all issues that exacerbated the problems already existing as the legacy of the 2008 financial crisis.

According to the Cyprus Insolvency Service statistics, total insolvency proceedings in 2020 demonstrated only a marginal increase compared to the figures of 2019. The same applies for the first three months of 2021 compared to the first three, pre-Covid months of 2020. This can be attributed to some extent to the measures taken by the government to support businesses in light of the adverse effects of the pandemic. However, short-term measures have only a short-term impact, and what will happen after their discontinuation depends on the resilience of businesses. Analysts estimate that there will certainly be an increasing trend in insolvencies in 2021.

7. Insolvency impacts a greater network of business beyond the company that needs to be liquidated. What implication does that involve, and how can this problem be addressed?

 This is also called the domino effect of insolvencies and brings us back to my starting point about the merits of corporate rescue. Lawmakers and policymakers, in general, should be aware of and alert about this possibility. For example, suppliers provide credit by deferring the time of repayment for the goods/services. When the debtor company falters, and no going concern is achieved, the creditors will receive just a part of their stakes, at best. This negatively impacts their accounting position, which may further deteriorate, making payments more difficult and affecting then, through the same mechanism, the whole existing chain of credit.

Creating a preventive culture, enhancing cooperation, and improving business mentality are very important for businesses to face the pandemic’s consequences successfully and also achieve growth and profitability. The pressing need now is to implement a comprehensive framework of policies to alleviate solvency strains and prevent bankruptcies of companies with good prospects of viability in the long term.

Preventive restructuring tools, like examinership, should be used systematically. Special attention must be paid to early signs of distress by all interested parties (i.e., directors, creditors and stakeholders, in general) to make these procedures as efficient as possible. Adequate business recovery plans must be put in place promptly, safeguarding the interests of all parties involved. As far as banks are concerned, they must obtain a thorough understanding of their customers’ activities and structures, gain deep insights into the needs of particular sectors and sub-sectors, and also assess the nature of operations of individual borrowers; business models can be pretty diverse from one company to another within the same industry.

 *Ioannis Sidiropoulos is an associate at Elias Neocleous & Co LLC, in the Financial Services department of the firm.  He has obtained two LL.M titles, one from the London School of Economics (Corporate and Commercial Law, 2015) and one from the University of Amsterdam (International Trade and Investment, 2017), after graduating from his undergraduate studies at the Democritus University of Thrace in 2014.  He has also received certifications from the University of Oxford (History of Economic Thought) and the Athens University for Economics and Business (Accounting).  Ioannis was admitted to the Athens Bar Association in 2017 and to the Cyprus Bar Association in 2019.  He has experience in commercial, corporate, insolvency and investment law.  He is also a guest staff member at the Law Faculty of the University of Leiden, with a research focus on the alternative rescue methods that can be utilized to turn companies around under conditions of macroeconomic adversities.