Possible Issues when a company is in financial difficulties

English

A bona fide creditor may attempt to take one of the following actions to enable them to take security over assets in Cyprus:

1) Mortgage – the property under mortgage is transferred into the creditor’s ownership with a right of redemption in the case of default. The property will be worth a similar amount to or equal to the amount of the mortgage.
2) Pledge – gives the lender the right to sell the asset but does not confer ownership of the asset.
3) Charge over immovable property – a fixed charge gives legal rights as security without any actual transfer of ownership.
4) Impose a floating charge on any immovable property – a floating charge ‘floats’ over all of the assets of the debtor, in the event of a default, the floating charge crystallises and becomes a fixed charge over the asset.
5) A lien – gives the right to the debtor to possess the assets until the debtor pays its debts but does not give the creditor the right to sell the asset.

Duty of the Directors of the Company:
The Directors of the company have a duty to the company to act in the best interests of the company and its beneficiaries, not only when the company is in financial difficulties but from the moment that they are appointed as directors until the time that they resign.

Cyprus Companies Law Caps 113:
Section 301 of the Companies Law, Cap 113 states that ‘any conveyance, mortgage, delivery of goods, payment, execution, or other act relating to property made or done by or against a company, within six months before the commencement of its winding up will, in the event of the company being wound up, be deemed as fraudulent preference of its creditors and be invalid accordingly’. The Court will look at the dominant or real intention and not at the result in order to determine whether or not fraudulent preference has occurred.
Section 303 of the Companies Law, Cap 113 states that where a company is being wound up, a floating charge on the undertaking or property of the company created within 12 months of the commencement of the winding up shall, unless it is proved that immediately after the creation of the charge the company was solvent, be invalid, except to the extent of any cash paid to the company at the time of or subsequent to the creation of and in consideration for the charge.

Introduction of Fraudulent Trading:
Further to the above situations, Section 311 of the Companies Law, Cap 113 introduced the concept of fraudulent trading into the insolvency proceedings in Cyprus. If a liquidator can prove that fraudulent trading has occurred, the court may find the person responsible, for example, the director or other such officer of the company, personally liable for the debt incurred.
Transactions at an undervalue:
Any transactions which can be proven to have been carried out at an undervalue, with the intention of putting the assets in a position that makes them unavailable or unreachable to the companies’ creditors will be classed as transactions carried out with the intention to defraud the creditors and they are then vulnerable to being declared null and void by the court.

Transactions which fall under the Fraudulent Transfers Avoidance Law:
Under the Fraudulent Transfers Avoidance Law, Cap 62 Section 3, every pledge, mortgage, gift, sale or other transfer or disposal of a movable or immovable property made by any person with the intent to hinder or delay his creditors or any of them in recovering their debts from him will be deemed to be fraudulent and will be invalid against such creditors.
In this situation, the property or asset purported to be transferred or dealt with in another manner but for the same reason may be seized and sold to satisfy any judgment debt due from the person who made the pledge, mortgage, gift, sale or other attempted or actual transfer or disposal. This was shown in the case of Adamou v Kitchiou (1978) 1 JSC 12 and Lymperopoulou v Christodoulou and Others (1957) 22 CLR 184.

A transaction which falls into the category of a fraudulent transfer avoidance is one of the ways in which a party can proceed against company directors, taking them to Court under the Common Law Principles and where the Court may lift or pierce the so-called ‘Corporate Veil’ to protect the party’s interests.
Liabilities of a company director
The concept of fraudulent trading was introduced into insolvency proceedings in Cyprus by Section 311 of the Companies Law, Cap 113, creating a civil liability for persons who can be shown to be abusing the status of limited liability and it also created a criminal offence. The provision allows an action to be taken against persons who are knowingly parties to the carrying on of the business, but if the person cannot be shown to have been a knowing party, then they will not be liable. Although the provision can apply to directors, and often does, it is not limited to directors only and can be brought against other parties who knowingly take part in the carrying on of the business.

As discussed above, a Director may face personal liability in the event that it can be shown that they have continued to trade with the intent to defraud the company’s creditors, Sections 307-311 of the Companies Law cover the situations where a company officer may be liable. These offences can carry a conviction; under Section 307 (m) (n) (o), the term of imprisonment for which can be up to five years and in the case of all other offences, it shall not exceed two years.
The Companies Law states it shall be a good defence to some of the possible charges if the accused director can prove that he had no intent to defraud. For some of the other offences, he must prove that he had no intent to conceal the state of affairs of the company or to defeat the law (Section 307 (1)).

Formal Procedures

A company in financial difficulties in Cyprus may find itself facing one of several different formal procedures which are provided for under the Cyprus Law.
According to the Cyprus Companies Law, Cap 113, Section 203, there are two main methods of winding up a company, these being:
a) compulsory winding up order which is made by the Courts; or
b) voluntary winding up, which can be instigated either by the members of the company or the creditors of the company.
Winding up by the court:
In this situation, the court may issue a liquidation order for the company This may result from the presentation of a petition by a creditor, the company itself, the Official Receiver or the Attorney General. The Court will examine the petition for liquidation and if it believes that the company is unable to pay its debts (this test is discussed in detail below), it will then issue a liquidation order.
Voluntarily winding up:
In this situation, the directors make a decision that the company has no future and agree that that the company should be wound up and therefore proceed to terminate the company’s existence. For this to happen, a special or an extraordinary resolution will be passed by the company in a general meeting, unless the articles of association for the company provide for another procedure, stating that the company is unable to continue business due to its liabilities (Cyprus Companies Law). This is governed by Section 261, Cap 113.
Re-organisation Plan:
A third option that a company in financial difficulties may decide to take is that of a reorganisation plan. Such a plan may involve the merger of two companies or it may involve the incorporation of a totally new company. This action is taken in order to improve the future possibilities of the company and to resolve the financial difficulties. Once the directors have approved the measures, a petition to the court will be made for the approval of the plan and usually, an order will be issued to that effect. This method of restructuring a company is not always suitable and will depend upon the severity of the financial difficulties that the company faces. It will be a decision for the directors to make as to whether this option would be suitable under the circumstances. This is the most flexible and informal option available to a company.
The Process of being Under Management:
Under Section 250 (1) Caps Law, where in any proceedings the official receiver becomes the liquidator of a company, whether provisionally or otherwise, he has the power , if he is satisfied that the nature of the business of the company or the interests of the creditors require the appointment of a special manager of the business of the company, other than himself, to make an application to the Court. The application by the official receiver shall be supported by a report by the Official Receiver, which shall be placed in the file of the proceedings. The report shall either state the amount of the remuneration which, in the official receiver’s opinion, the special manager ought to be allowed or that the Official Receiver’s opinion is that it is desirable that the determination of such remuneration should be deferred, Rule 50 (1) of The Companies (Winding-Up) Rules 1949. The Court, upon receiving such an application, may appoint a special manager of the business to act during such a time as the Court may direct, with such powers as the Court believes necessary. The special manager will give security and account in a manner as directed by the Court and shall receive remuneration in a manner that the Court sees fit.

Tests for Insolvency

The test for insolvency in Cyprus is based on the company’s ability to pay its debts. If the company is unable to pay its debts, then it is likely to go into insolvency through one of the procedures discussed below and become a formally insolvent company.
The Cyprus Companies Law, Cap 113, Section 212 stipulates the situations where a company will be considered under Cyprus law as being unable to pay its debts. These are as follows:
a) The company owes more than 855 Euros to a creditor. The creditor may claim the debt by sending a formal letter to the registered office of the company and the company then has 21 days in which to send the creditor his money. If the company does not send the creditor his money, then the creditor may apply to the Court requesting that the Court issue a liquidation order against the company.
b) If execution or any other process issued with regard to a judgment, decree or order of any court in favour of a creditor of the company is returned unsatisfied in whole or in part.
c) The court will consider the company’s debts/liabilities, both those that it presently has and those which it is likely to have in the future. If it is proven that the company is unable to pay its debts, the company will be officially considered incapable of paying its debts and will officially enter the procedure of insolvency.
Grounds for being placed into each procedure
Winding up by the Court:
The court will issue an order to wind up a company in the following situations;
a) A special resolution is made resolving that the company be wound up by the court.
b) The company is unable to pay its debts (Cyprus Companies, Section 212, Cap. 113).
c) The court believes that it is just and equitable to wind up the company (Cyprus Companies Law, Cap. 113, Section 211, as amended by Law 2 (1) of 2000).
d) The company does not commence business within 1 year of its incorporation or suspends its business for a year without giving notice of this intention or submitting a plan for the business to be restored.
Voluntary winding up:
This is a very common action taken by companies that may be encountering difficulties. It occurs because the directors decide that the company has no future and agree that it is in the best interests of the company for it to be wound up. A resolution will be passed stating that the company is unable to continue conducting its business due to its liabilities and that it has been decided that it is best to wind the company up, Cyprus Companies Law, Cap. 113, Section 261. The company should give notice of the passing of the resolution in the Official Gazette for the Republic of Cyprus within 14 days of the passing of the said resolution.
Re-organisation Plan:
A reorganisation of the company will also begin with a meeting of the company, a resolution being passed and a petition being sent to the court requesting that the relevant order be issued. This must occur before the reorganisation can take place.
Required Notifications
Winding up by the Court:
The court will serve a liquidation order to the company and inform the Registrar and the Official Receiver that the company is in the process of being wound up. The company also has a duty, for every invoice, order for goods or business letter that it issues or that is issued by or on behalf of the company or a liquidator of the company, or by a receiver or manager of the property of the company, to include a statement informing the receiver that the company is being wound up. Failure to do so may incur a fine, Section 317 (1) and (2) Caps Law.
Voluntarily winding up:
If it takes place due to the members of the company, a declaration must be given to the Registrar by the directors five weeks before the general meeting of the company During the meeting, a resolution will take place in which it will be resolved that the company should be wound up and that an administrator should be appointed. If it takes place due to the company’s creditors, a meeting of the creditors will take place on the same day as the general meeting of the company. A notice of the creditors’ meeting must be published in the Official Gazette of the Republic of Cyprus and in two newspapers in the town where the company’s registered office is situated. The same provisions apply regarding Section 317 (1) and (2) Caps Law to a voluntary winding up.
Re-organisation Plan:
With regard to the reorganisation of the company, a relevant decision will be made at a general meeting and a resolution passed based on the decision. A petition will need to be sent to court requesting that the relevant order be issued. Further provisions will depend upon what decision the company makes, for example the procedures with a merger will be very different from the disolution of an old company and the incorporation of a new company. Legal advice should be sought depending on the outcome of the meeting.

Creditors

The same principles apply to liquidation procedures and winding up as well as to reorganisation procedures.
The Companies Law, Cap 113, Section 300, as amended by Law 198/86 and Law 19/1990, lays down the order for the distribution of the assets of a company in a compulsory winding up or administration.
Under the above section, unsecured creditors are ranked below the costs of winding up, preferential debts and charges secured by a floating charge. An unsecured creditor has the lowest priority in the rank of priorities for settlements. They will only be satisfied once secured creditors have been satisfied and can only be satisfied if any surplus credit or assets remain.
Accordingly, unsecured creditors have no real freedom to enforce their rights under liquidation and must therefore wait until the liquidator has made all other distributions before they will receive anything towards the repayment of the debts owed to them. However, unsecured creditors are entitled to repossess assets which are not owned by the company, for example goods which may be the subject of a retention of title clause.
A further point to make would be that an unsecured creditor who had been awarded a judgment before the liquidation proceedings were commenced is able to have the judgment served to the liquidator who must then execute the judgment and ensure it is enforced like any other civil judgment. In this sense, an unsecured creditor therefore becomes a secured creditor.
The general rule is that secured creditors may enforce their security in a situation where the company is to be liquidated. The extent to which secured creditors can enforce their security is dependent upon the value of their security in the first place. The question will be: Does the value of the security cover the debt which is owed to the creditor? If so, then they will be fully satisfied and any remaining balance will be credited to the assets of the company and will be used by the administrator to satisfy any other liabilities that the company has. If, however, the security does not cover the full amount of the debt, then they will join the ranks of the unsecured creditors and have the remaining amount of the debt settled to the extent possible in such a way.
The procedure of setting off sums owed by the company’s creditors against amounts owed by the company to the creditors is regulated in Cyprus by Sections 198-200 Caps Law 113.
Section 198 enables the creditors to achieve a set off with the company disregarding the fact that the company may be or is under the process of liquidation. The company, creditor or the administrator or shareholders may make an application to the court with the intention of convening a meeting for the class of creditors that would be participating in the set off. During the meeting, if ¾ of the creditors present accept the proposal for the set off, the court will give its approval of the set off taking place. If approval is given, the proposal is binding on the company and all of the creditors in the said class.
Section 199 explains the procedures relating to the notices which must be given of the meeting and gives information regarding compromises with the company’s creditors and members.
Under Section 246 (3) Caps Law, when all creditors have been paid in full, any money which is due on any account whatsoever to a contributory, (contributories are defined by Section 205 Caps Law as ‘every person liable to contribute to the assets of a company in the event of its being wound up’) from the company may be allowed to be given to him by way of a set off against any subsequent call.
The continuing of business after entering a procedure
In a situation where a liquidator has been appointed, they take the control of the company. The ultimate aim is the completion of the task for which he has been appointed. In this situation, the directors are no longer in control of the company for the majority of matters. The shareholders are in the same situation as the directors and have no exercise of their control powers over the company. All the powers of control are taken over by the liquidator.
If, however, the company decides to create a reorganisation plan in order to attempt to solve the company’s financial issues, the directors remain in control of the company. The shareholders’ rights are also unaffected as no third party has been appointed to handle the situation that, for example, a liquidator, administrator or a receiver would control.
Financing each procedure
In a situation whereby liquidation is taking place, the costs of the liquidation process are covered by the liquidation of the assets of the company and are paid out as the first priority in the hierarchy of creditors, as set out in the Cyprus Companies Law, Cap 113, Section 300, as amended by Law 198/86 and Law 19/1990.
If a company decides to undergo a process of reorganisation or restructuring, it will find funds from lenders or current support networks to fund any plans and procedures agreed upon. The funding of such measures will most likely be one of the factors that are taken into consideration when the company’s directors are making a decision as to whether such a measure would be suitable.
The effect on company employees
When a company goes through the process of winding up, the company’s employees are automatically dismissed, though the liquidator can re-employ some of the staff to assist in the business, but this will only be the case until the winding up is fully completed. The purpose of their re-employment is to assist the liquidator in finalising the duties that he has been appointed to complete, Companies Law, Cap 113, Sections 219-221 and 264-265.
In the case of a reorganisation, the effect on the employees is difficult to determine and legal advice should be sought with regard to the effects in each individual situation.
The effect on contractual obligations
Contracts entered into by a company that goes into liquidation are not necessary terminated merely as a result of the company entering into the procedure. The liquidator has the right to cancel unilaterally an onerous contract in order to fulfil his duties and ensure that the liquidation of the company goes ahead, which he has been appointed to arrange.
A company which is entering into a reorganisation plan or restructuring does not necessarily directly have any impact on contracts that company has already entered into. The directors of the company should ultimately take these pre-existing contracts into consideration when discussing and planning for the re-organisation.

Claims

In the case of a company reorganisation, the creditors will claim their debts in the way that is prescribed in the reorganisation agreement/order. There is no way to state definitively how this will occur, as each case will be different.
In a case whereby a liquidator is appointed, the creditors will send the company a formal claim in order to prove their debts. The creditors must send the liquidator proof of their claims. It is the liquidator’s job to consider each of these and decide which claims:
a) he will accept;
b) he will reject; and
c) he is in a position to ask for more information about and evidence of if he believes that he needs further information before he will be in a position to decide whether or not to accept or reject the claim. If a claim is rejected, the liquidator must give the reasons to the creditor in writing why he has rejected the claim. If the creditor is dissatisfied with the liquidator’s decision, he may apply to the court to request that the court consider the situation with regard to why the liquidator did not accept the proof of his claim and ask them to reconsider his claim.
d) The Companies Law, Cap 113, Section 300, as amended by Law 198/86 and Law 19/1990, lays down the order for the distribution of the assets of a company in a compulsory (court) winding up.
e) In a compulsory winding up, the order is as follows;
f) 1) Costs of the winding up - this covers the costs of getting the assets, the petition and drawing up the statements of affairs as well as the liquidator’s remuneration and the Inspection Committee’s expenses.
g) 2) Preferential debts - these debts are ranked equally so if the company’s property is not sufficient to make full payments for each, they will have to be paid proportionally.
h) 3) Charges secured by a floating charge.
i) 4) Unsecured ordinary creditors.
j) 5) Any deferred debts.
k) Lastly, any remaining surplus will be distributed among the members in proportions based on their rights under the articles.
l) If the company has decided to enter into a voluntary arrangement or a reorganisation plan, the creditors will be paid according to the terms that have been agreed upon. The rights of secured and preferential creditors remain and will not rank lower than those of the company’s unsecured creditors.

Tax liabilities

The main point to note here is that the company will not be liable to pay tax for entering into each procedure; however, the company will be liable to pay tax on any profits which are gained whilst the company is involved in any of the procedures.
The area of tax in such proceedings is too detailed and complex for a full and sufficient discussion here, however, the Establishment and Recovery Tax Law, L4/78, as amended, governs in part this topic here in Cyprus. In particular, Section 8 of the Law states that the receiver is liable to arrange the tax liabilities of the company during each of the procedures and should advise the company accordingly of the relevant taxes and amounts due as an expense of the liquidation.
Under Section 183 of the Companies (Winding up) Rules, 1949, every solicitor, manager, accountant, auctioneer, broker or other person employed by an official receiver or liquidator in a winding up by the Court shall, at the official receiver’s or liquidator’s request, deliver his bill of costs or charges to the official receiver or liquidator for the purpose of taxation.
Due to the depth and complexity of this area, we advise that all companies undergoing such procedures seek professional advice, in particular regarding their potential tax liabilities.

Ending the formal procedure

The process of cramming down is a term that is used in Bankruptcy Law where individuals are concerned and in Insolvency Law where companies are being considered when referring to the courts’ enforcement of a procedure, for example, a reorganisation plan, despite objections which may be raised by some of the company’s creditors.
We can therefore say that the process of cramming down creditors is only really relevant in voluntary arrangements and where a reconstruction/re-organisation plan is being implemented, the reasons for this being that the approval of these arrangements depends on majority voting. During these procedures, the dissenting minority are obliged to accept the arrangement which has been voted for by the majority and dissenting creditors are bound by the vote as if they had indeed agreed to the terms themselves.
It should, however, be borne in mind that the minority are often protected by principles that are intended, through the Companies Law, to protect the minority’s interests. Therefore, it must be appreciated that the scope of these procedures can be limited by such minority protections.
It is always advisable for the parties to seek legal advice in such circumstances.

Winding up by the Court:
If the Court has ordered liquidation, the liquidator, once he has completed the winding up, will request that a meeting be held for all of the creditors so that he can produce his report on the winding up. The attendants at the meeting will consider the report and its contents and whether or not it should be released. After the meeting, the liquidator must notify the court and the Registrar that the meeting did in fact take place and also what the outcome was. The Registrar will register the notice once he receives it and at the end of a three-month period after the registration, the company will be officially dissolved.

Voluntary winding up:
The liquidator will send what is known as the final account and return to the Registrar. After this, a period of three months will follow and after this period, after the registration of the final account and return, the company will be considered to be dissolved unless the court, by way of an application by the liquidators or another interested party, orders the deferment of the dissolution date.
Re-organisation plan:
If the directors of the company decide to reorganise or restructure the company, the outcome will be dependent upon the particular decisions that have been taken. It may be that the result is that two companies merge or that they undertake a joint venture. The desired outcome of such procedures will ultimately be that the financial difficulties that the company was facing are solved or at the very least, that a plan is implemented which sets out a time frame for various steps to be taken to begin working on the financial difficulties.

Alternative forms of restructuring

It may be possible to avoid liquidation if the company is still in a position to be able to pay its debts. There are various ways in which a company’s members can be advised regarding restructuring in order to avoid a formal procedure for liquidation/winding up. One such way to enter into a restructuring plan is to appoint a Receiver Manager. Any creditor of a company can request that a Receiver Manager be appointed. The appointment of a Receiver Manager is an alternative to the formal winding up procedures and is governed by the Companies Law, Cap 113 Part VI. It is also possible for the company and all of its creditors to enter into an unofficial restructuring agreement, which involves all of the creditors of the company and the members meeting and discussing and coming to an agreement on a solution.
In recent years, it has become noticeable that more attempts are being made to move away from formal insolvency proceedings and preference is being shown for corporate recovery via the restructuring of the company’s finances by means of negotiations between the company that is in difficulty and its creditors. We believe that there are numerous reasons for the shift in preference. However, it can be said that one of the main reasons may be the inflexibility of formal proceedings. A restructuring is not a statutory remedy and therefore gives an amount of flexibility, however, it does have some limitations. For example, there are no statutory mechanisms in such a restructure which will compel a dissenting creditor to participate. This may then lead to a formal procedure being initiated.

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