Examinerships - which can protect an insolvent company from its creditors - are increasing, writes Frank Dillon

THE OSTRICH syndrome in failing businesses, poor financial information systems and overly optimistic expectations for the performance of the business: these are among the lessons for directors gleaned from the examinership process, according to some of Ireland's leading corporate restructuring experts.

With the economy now in full-blown recession, examinerships are on the increase.

According to Declan Taite of accountants FGS, there were 70 examinerships in 2008, compared to 29 the previous year. The figure is somewhat skewed by the Thomas Read Group, who accounted for 15 companies out of that total, but underlines the increasing use of this form of restructuring vehicle as a method of trying to save ailing businesses.

Examinership is Ireland's equivalent of the US 's Chapter 11. It is used as a legal structure to protect an insolvent company from its creditors while it attempts a restructuring.

While a company must be shown to be insolvent to be afforded examinership, it must also convince the High Court that there is a reasonable prospect of a successful rescue.

Examinership was introduced in Ireland in the wake of the collapse of the Goodman beef empire in 1990.

The process has two key aims, firstly, to secure the viability of the business and to prevent job loss and secondly, to arrive at a scheme of arrangement with creditors.

Creditors are grouped into secured creditors, normally the financial institutions that have charges on the business, preferential creditors such as the Revenue, and unsecured creditors, generally comprising of the firm's suppliers.

Examinerships typically last from 70 to 100 days and provide a breathing space to sort out the company's affairs and to seek new investors. One of the main differences between examinership and administration is that the examiner effectively operates as a non-executive chairman, working with the existing management to restructure the business.

"The theory is that existing management have the best detailed knowledge of the business and the industry sector and will be best placed to assess the prospects for attracting new investment, for example," says Billy O'Riordan, partner at Corporate Recovery Services at PwC.

While it has undoubted advantages, the process of undertaking an examinership is a relatively expensive one - involving accountancy and legal fees - so it may not be a viable option for smaller firms.

The evidence of recent times suggests that in about half of cases, examinership has a successful outcome, though some of the corporate recovery specialists The Irish Times spoke to claimed much higher success rates.

So what do examiners typically find on their appointment and are there lessons that can be learnt to avoid businesses seeking High Court protection?

Inadequate and late record-keeping is a common theme from accountants.

"Out-of-date management information and poor systems for analysing the health of the business feature regularly," says Barry Lyons, corporate recovery partner at Lyons Kenny.

"If you have a business that is high volume and low margin, for example where turnover dips by 10 per cent and credit control slips from 60 to 90 days, you can quickly have a major crisis on your hands.

"A process of denial often sets in when a business starts to fail and this is the worst thing that can happen as it results in inertia," adds Taite.

For many SMEs, formal preparation of financial accounts only takes place months after the financial year-end with some making full use of the nine-month window before the Companies Registration Office begins to chase them, observes PwC's O'Riordan.

"Where a business was profitable that might not be a big problem but in a rapidly deteriorating environment, businesses need very timely information to effect change such as reducing their cost base quickly."

Another common problem is the high level of borrowing. "A lot of businesses leveraged themselves based on a certain set of presumptions which may have been perfectly valid at the time. A few years ago, businesses with large amounts of cash on their hands would be accused of being over cautious. There's a different attitude to debt now," he adds.

One of the key tasks of the examiner is to restore confidence in the firm. That's a delicate balancing act involving satisfying creditors and the requirements of the High Court while working closely with the management team.

"The examiner must successfully manage an inclusive process involving the company's key customers, suppliers, management and staff, ranging over all aspects of the business. It's management-friendly and in that regard must be distinguished from the unilateral nature of receivership and liquidation," says Lyons .

The very appointment of an examiner can trigger problems, however. According to Jim Hamilton, partner at BDO Simpson Xavier, there is a specific potential difficulty in relation to invoice discounting.

Companies experiencing cashflow problem often engage in invoice discounting by assigning their debtors to a finance company.

In theory, the debts are then owned by the invoice discounter, putting them effectively in a stronger position than any of the creditors.

"In practice, examiners tend to cover this off but there have been situations where potential schemes of arrangement have almost come unstuck because of this, so good communication is vital," says Hamilton.

In reality, invoice discount providers are aware that if they enforce their rights, the consequence will be the collapse of the company, in which case they may get nothing, he adds. The exception to this may be the construction industry where debts are generally difficult to recover and where the invoice discounter may choose to act independently.

Having said that, examinership has some very specific advantages for the directors of a firm. The process prevents the appointment of a liquidator or receiver, no goods or services can be seized or claimed by creditors or a sheriff, and personal guarantees cannot be enforced during the period of examinership.

The process of examinership is brought to an end when the examiner puts together a scheme of arrangement with creditors usually following some form of investment, so that there is a fund to share out. This is then brought to the court for approval.

According to Lyons, the key to having the scheme approved by creditors is to present it in such a way that it is clear to the creditors that they will receive a more advantageous outcome for themselves by going along with the proposal, rather than having the company wound up.

"In arriving at a scheme of arrangement, pragmatism tends to rule the way," says O'Riordan.

As a general rule of thumb, secured creditors get the open market value of any assets, preferential creditors tend to get 30 per cent, while unsecured creditors will get 10 per cent.

"Unsecured creditors are aware that in a liquidation they are unlikely to get anything so any advance on that is seen as reasonable in the circumstances," he says.