Insight - Of white knights and super priorities


Medical providers nationwide are working against the clock to curb Covid-19. -Art Chen/The Star.

THE global economic tumult due to Covid-19 has brought into sharp focus the need for a more robust corporate restructuring and rescue framework to tackle financial distress threatening companies.

The Consultative Document on the proposed Companies (Amendment) Bill 2020 issued by the Companies Commission of Malaysia (CCM) in August proposes major reforms to Malaysia’s corporate rescue regime, and is a timely and welcomed development.

This is the first of our two-part series on the proposed reforms:

Super-priority for white knights

The proposed bill introduces the concept of “super-priority” which allows courts to give preferential treatment to the security and return of a white knight’s funds before executing the rescue exercise.

In the event of liquidation, should the rescued business fail despite the attempt to save it, priority is given to the return of the white knight’s funds ahead of unsecured debts, and if necessary, even secured assets. The implications of super-priority are immense.

We share below our thoughts on how the business community may take advantage of this change and how others affected by this initiative may respond to it.

What is super-priority?

The proposed bill provides that a company applying to court for a compromise or arrangement with its creditors, or for judicial management of its business, may also apply for an order that the debt arising from the rescue financing obtained is treated in any one of four priorities.

How may struggling companies benefit?

Super-priority allows the borrower to change the risk profile of a debt facility or rescue investment which would otherwise be a high risk venture.

The benefits to companies are two-fold: First, a lower risk-profile broadens the pool of lenders and investors a company can reasonably approach, and secondly, it puts the company in a better position to negotiate lower financing cost for the rescue operation either with a lower debt yield or equity dilution, or a combination of both.

The threshold for a successful application is reasonable:

In order to obtain Level 2 or 3 priority, the company must show that it would not have been able to obtain rescue financing from any person unless the rescue debt is secured with the requested priority. In practical terms, the company will have to demonstrate that it has undertaken reasonable efforts to explore other less disruptive types of financing. Nonetheless, this does not mean that every potential avenue of funds must be first exhausted.

For Level 4 priority, the company must also convince the courts that there is adequate protection for the interest of the existing secured creditors. We anticipate our courts will be persuaded by the jurisprudence of the United States bankruptcy courts on this matter. They will likely consider

(i) the valuation of the security to assess if a sufficient “cushion” exist, especially if the property is eroding in value,

(ii) proposed payments to creditors and available liquidity, and

(iii) the likelihood of a successful reorganisation.

Additionally, the proposed bill provides the courts the power to order the reduction of debt, allocate security or grant relief to ensure adequate protection to existing secured creditors.

New opportunities for private equity

The possibility of super-priority in insolvency restructuring also brings into play a class of funds with a different appetite for risk compared to traditional lenders: private equity. At the risk of oversimplification, the strategy of a private equity fund is to arbitrage between risk and reward. A successful fund is one that has, on average, invested in businesses with a higher reward potential than its risk of loss.

In the context of rescue financing, white knights may come to the rescue of companies in the form of super-priority debt with the option to convert its debt to equity in the future, effectively giving up its priority in return for the full upside of the business should the turnaround strategy prove successful or more. Rationally, this action is taken where the value of the agreed equity has become certain and outweighs the debt’s yield.

How should creditors respond?

Naturally, there will be apprehension among creditors as super-priority is disruptive of their rights. That said, in our opinion, there should not be cause for anxiety as safeguards are put into place to prevent abuse in these uncharted waters.

We have discussed above how companies must first make efforts for less disruptive financing and, in the context of any priority ahead of secured creditors, must ensure adequate protection of their interest. In fact, from the viewpoint of trade creditors (who are generally unsecured), a genuine rescue scheme may be the only realistic avenue for a positive outcome of their debts as, often, rescue funds must also be allocated towards working capital to present a reasonable turnaround plan.

For an example close to home, Singapore’s experience has shown that companies will neither succeed on bare assertions for the need for super-priority nor with insufficiently formulated rationale for the level of priority they are seeking (Re Attilan Group Ltd [2017] SGHC 283).

Expansion of corporate voluntary arrangements and judicial management

The proposed bill also seeks to expand the application of the existing corporate rescue mechanisms, namely, corporate voluntary arrangements (CVAs) and judicial management (JM).

At present, CVAs are regarded as having extremely limited application since they do not apply to, among others, public companies and companies having created a charge over their property or undertaking. The amendments seek to expand and increase the accessibility of CVAs by removing these two limiting factors.

Thus, CVAs will apply to all companies except those that are:

> a licensed institution or an operator of a designated payment system regulated by Bank Negara; and

> approved or licensed by Securities Commission under the Capital Markets and Services Act 2007 or Securities Industry (Central Depository) Act 1991 or prescribed by the Finance Ministry.

In addition, the proposed bill seeks to clarify that JMs are available as a rescue mechanism for listed companies. This therefore puts to rest previous uncertainty on whether listed companies were restricted from applying for JM.

The proposed amendments align the application of JMs and CVAs, in that only those two categories of companies are excluded from applying for either a JM or CVA.

Conclusion

We are confident that the introduction of super-priority will prove to be an extremely valuable addition to our insolvency regime. The proposed reforms will modernise Malaysia’s rescue financing framework in line with trends in other jurisdictions, such as US and Singapore.

One also welcomes the extension of accessibility for CVAs and JMs under the proposed bill. There was little logic or basis for excluding public companies or companies having created a charge from undertaking a CVA.

Similarly, there was also a pressing need to clarify whether listed companies can apply for JM. The amendments have quite clearly addressed all these criticisms and concerns of the current legislative provisions.

Stay tuned for Part 2 of this series which will explore further reforms under the proposed bill. This includes the proposed cross-class cramdown (restructuring of debt) mechanism allowing courts to allow cramdown of a dissenting class of creditors, and how reforms will supercharge corporate debt restructurings in Malaysia.

Alvin Julian, Ang Siak Keng, and Tan Wooi Hong are partners of Zaid Ibrahim & Co (a member of ZICO Law) who advise on mergers and acquisitions and corporate restructuring. Judson Lim is a senior associate of the firm doing special research. The views expressed here are the writers’ own. This article is for general information only and is not a substitute for legal advice.

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