The debtor does not usually lose control over the management of the business during the period in which restructuring proceedings are ongoing. In this respect, restructuring proceedings are unlike other commercial insolvency proceedings, such as bankruptcy and receivership, in which an insolvency administrator assumes control of the business. However, it would be a grave mistake to think that this means that the debtor will simply carry on business as usual. The initiation of commercial restructuring proceedings radically alters the environment within which the debtor manages and operates the business. The debtor must work closely with insolvency professionals and expert legal advisers and must engage in a series of negotiations with claimants in order to develop an acceptable plan.
There are a multitude of decisions that must be made, and there inevitably will be parties who are unhappy about some of these decisions. The governance rules establish the legal framework within which the decision making occurs, and the recourse available to those who wish to contest the decisions that are made. In order to make properly informed decisions, the participants in the process must have accurate and timely information available to them. Therefore, it is also necessary to put mechanisms in place that provide for the free flow of reliable information.
If the debtor is an individual or a partnership, the governance issues are relatively straightforward. The individual or partner is both the owner and the manager of the business and is subject to unlimited liability for claims arising out of the operation of the business. The debtor will attempt to negotiate a deal in which the outcome for both the debtor and the creditors is better than if the debtor’s assets were liquidated in bankruptcy proceedings.
The matter is often more complex when the debtor is a corporation. In many instances, the corporation is closely held. In these corporations, a single person or a small group of persons holds a controlling interest in the corporation. The controlling shareholders manage the business and the shares they hold are not traded on an exchange. These individuals sometimes possess firm-specific knowledge and expertise, which makes it necessary to retain them as participants in the restructured business.
In other instances, the shares of the corporation are publicly traded and professional managers are responsible for the management of the business. Here, there is a division between ownership and control. The shareholders are the residual owners of the firm, but they do not actively participate in its management. It is often the case that the total value of the creditors’ claims exceeds the going-concern value of the financially distressed firm. The shareholders’ interests will usually be wiped out and they will not be participants in the restructured firm.1During the restructuring proceedings, the corporate directors must recognize that it is no longer appropriate for them to focus upon the interests of shareholders when making their decisions. It may also be advisable to replace or augment the existing management team. This may be necessary if the creditors have lost trust in the managers, if some or all of the managers have left the firm, or if the managers are thought to lack the expertise necessary to carry out a turnaround of the business.
The various stakeholders in a corporation will often have divergent views as to the preferred direction and outcome of the restructuring. Claimants such as secured creditors with higher-ranking claims may press for an immediate sale of the assets. Claimants with lower-ranking
claims who believe that a sale would result in their recovering little or nothing may push for a restructuring in which their claims are preserved in some form in the hope that the prospects for the business will improve in the future.2The corporate directors make decisions on the appropriate course of action, although the court in many instances will be called upon to review the fairness and appropriateness of these decisions. The principles of corporate governance provide the legal structure for this decision-making process by defining the nature of the obligations owed by the directors and identifying the parties to whom these obligations are owed.
The leading Canadian decision on the obligations of the directors of a financially distressed corporation is that of the Supreme Court of Canada in Peoples Department Stores Inc. (Trustee of) v. Wise.3The Court held that the corporate directors owe a duty of care to their creditors but that this does not rise to the level of a fiduciary duty. In determining the best interests of the corporation, the directors may legitimately consider the interests of shareholders, employees, suppliers, creditors, consumers, governments, and the environment.4The...