Regulator's Column

Impact on shareholders when firms are in financial distress

The possibility of a trading halt, suspension or delisting applies to companies in financial difficulty, regardless of where they are incorporated.
The possibility of a trading halt, suspension or delisting applies to companies in financial difficulty, regardless of where they are incorporated.ST FILE PHOTO

Most issuers listed on the Singapore Exchange are Singapore-incorporated limited companies, though a number are incorporated in other jurisdictions. An investor who subscribes to shares in an IPO or buys shares on the Singapore stock market would become a part owner of a limited company listed on the SGX.

Shareholders are generally aware of the risks and rewards of share investing. What may be less well-understood is the impact on shareholders when a listed company is in financial distress.

Shareholders enjoy rights Shareholders have a bundle of rights, which usually includes the power to vote on major issues concerning the company.

When companies grow, shareholders may enjoy benefits such as dividends, bonus shares and/or capital gains from the rise in the prices of their shares.

Shareholders are not personally responsible for the debts of the company due to the limited liability structure of limited companies. Nevertheless, shareholders should be aware that their rights will rank behind the rights of creditors, such as the company's employees who are owed wages, holders of the company's bonds, lenders to the company and its trade creditors.

This awareness is important when a company is in financial distress, which could mean that the company is, or is threatening to be, insolvent. Insolvency is a situation where the company is unable to pay its creditors when debts are due, or where it has more liabilities than assets.

Options for financially distressed companies When a company is in financial distress, a free-for-all scramble for the firm's assets among creditors may result. Many jurisdictions have legal frameworks in place to address this to ensure that claims on the company are settled in a fair and orderly manner, and for the company's finances to be restructured, if possible, such that it may recover.

How the claims settlement and financial restructuring are carried out depends on the place of incorporation of the company. For example, a company established in Bermuda would be subject to processes under Bermudian law.

Nevertheless, the underlying key principles of the processes in most jurisdictions will largely be similar. This column focuses on the Singapore regime, which is relevant to most issuers listed on the SGX.

The Singapore regime provides for several routes that a company may take to try to revive its fortunes, restructure its finances, or to otherwise find a solution that best serves its creditors and shareholders. These include:

PRIVATE ARRANGEMENT

A company could privately agree with its creditors to ease its finances. This could be by restructuring the debts that the company owes into manageable parts or by extending payment deadlines, for example.

If a private arrangement is successful and the company continues operating as a business, shareholder rights are unlikely to change.

SCHEME OF ARRANGEMENT

A scheme of arrangement is a court-approved restructuring of the debts owed by the company to its creditors.

Although similar to the private arrangement, it avoids the difficulty of obtaining every creditor's agreement. If a simple majority (and 75 per cent in value) of creditors agree and the court approves, the scheme is binding on the company and all of its creditors.

The company would retain its existing management and can continue its business. By allowing the company to continue operating, creditors may get a better return on their claims as opposed to immediately closing down the company.

JUDICIAL MANAGEMENT

Judicial management is another court-supervised process that seeks to rehabilitate potentially viable companies.

The court can order the process if certain criteria are satisfied:

• The company must be unable to pay its debts and a simple majority (and 50 per cent in value) of creditors must agree to the process.

• The process has to be likely to achieve the company's revival, or a compromise with its creditors, or to better realise the company's assets than in a winding-up.

A court-appointed official (called the judicial manager) would take over the duties of the directors. All claims against the company would be frozen once an application for judicial management is filed with the courts. This allows the judicial manager breathing room to revamp the company's affairs without the risk of assets being depleted.

WINDING UP

If attempts to rescue the company fail, the company might look towards cutting its losses and closing down as a final resort. Winding up (or liquidation) is the process by which a company seeks to realise its assets and pay its creditors and, if possible, shareholders. At the end of this process is the closure of the company, also called dissolution.

There are several ways that a company can be wound up:

•If the company is still solvent, shareholders could seek to do so by a special resolution. A declaration of solvency must be filed by the company's board. A provisional liquidator will be appointed by the board to ensure that no creditor benefits unfairly in the interim. A liquidator would subsequently be appointed by a shareholders' ordinary resolution.

•If the company is insolvent, the creditors can voluntarily wind up the company through a creditors' meeting. In such a case, the liquidator may be appointed by the creditors instead.

•A creditor can also petition a court to compulsorily wind up the company in certain circumstances, the most common of which being the company's insolvency. The liquidator is then appointed by the court.

The liquidator takes over the functions of the company's board and seeks to close out the company's affairs and distribute its assets in a fair and efficient manner. Claims over the company's assets are frozen during this period to prevent a depletion of the assets. If the company has any residual assets after paying creditors, they would be distributed among the shareholders.

Impact of financial restructuring processes on shareholders' rights

TRADING HALT, SUSPENSION AND DELISTING

In the midst of any of these financial restructuring processes:

•The company could voluntarily request for trading to be halted or suspended for a longer period of time to afford it time to put its finances in order. If any of the financial restructuring processes successfully resuscitates the company, the business would continue as usual. Share trading can resume if the company shows that it can function as a going concern.

•The SGX could also suspend trading of the company. This could be where the company is, among other things, in significant debt or being placed under judicial management, or where the SGX deems appropriate. Share trading can resume only if the company demonstrates that it can again function as a going concern.

There is also a risk of the company delisting. The likelihood of delisting varies, depending on the company's financial state. For instance, if the company is implementing a scheme of arrangement, a trading halt or longer suspension may suffice to allow it some time to settle matters and disclose material information. On the other hand, if the company is being wound up, delisting (whether at the liquidators' request or by the SGX) is likely inevitable.

The possibility of a trading halt, suspension or delisting applies to companies in financial difficulty, regardless of whether they are incorporated in Singapore or abroad. This is because these are processes governed by the Listing Rules which apply to all SGX-listed companies, and do not fall under Singapore's insolvency regime.

WHAT SHAREHOLDERS SHOULD EXPECT

It is possible that a company may not recover even after restructuring. In such cases, shareholders' expectations would have to be tempered. Shareholders should expect the following:

•When a company is insolvent, creditors' claims rank ahead of those of shareholders. The company's assets are, therefore, first given to its creditors. A shareholder is entitled to his pro-rated share of the remainder only after all creditors have been paid. If the assets are insufficient to satisfy all creditors, shareholders may lose the money they paid for their shares.

•The company may be delisted. Although a listed company is required to make an exit offer to shareholders before delisting, this may not be possible if the company does not have enough assets to satisfy its creditors. The SGX will only allow a delisting without an exit offer in such a scenario.

•Dividends are unlikely to be declared as the company may not have any profits. Further, the shareholder's right to appoint management may in some cases be overridden by a court-appointed official.

Conclusion The limited company structure limits shareholders' liability so that shareholders are not personally responsible for the company's debts. However, in return for this and other benefits, shareholders face the risk that their investment may be lost if the company becomes insolvent.

Shareholders must be aware of such risks when they hold shares in companies that show signs of financial distress. They must be aware of the possible outcomes for the company when making decisions on their investment, including the worst-case scenario where the company has insufficient assets to satisfy its creditors, therefore leading to a delisting without an exit offer.

Tan Boon Gin
Chief regulatory officer
Singapore Exchange

•This is an edited version of the Regulator's Column on the Singapore Exchange website. The column aims to communicate the SGX's views, comment on listing and governance issues, and highlight emerging regulatory issues.

A version of this article appeared in the print edition of The Straits Times on May 23, 2016, with the headline 'Impact on shareholders when firms are in financial distress'. Print Edition | Subscribe