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Scarp restructuring mechanism offers lifeline to struggling firms

Small Company Administrative Rescue Process a good alternative to examinership

One of the initially surprising aspects of the Covid-19 lockdowns and other restrictions has been the quite low number of insolvencies reported since the beginning of the pandemic in early 2020. That is due to a number of factors according to Hilary Larkin, insolvency and restructuring partner with Mazars, who explains that there is often a significant time lag between an economic shock and consequent business failures.

But there is more at play than a normal lag between cause and effect. She also points to the government support schemes, the support of the banks and the Revenue’s flexibility as key factors which have depressed the insolvency rate.

“The banks have been quite supportive of business customers over the last 18 months and granted forbearance or breaks on loan repayments to many businesses, which is keeping a lot of them going,” she notes.

However, with the Revenue warehousing scheme set to end this month, the remaining government supports due to be phased out by April 2022, and with the banks having to address non-performing loans sooner or later, a fairly sharp uptick in insolvencies can be anticipated in the latter part of next year.

But there is hope for many of those companies which may have good prospects of survival once they get over the shock of the withdrawal of the different supports. The new Small Company Administrative Rescue Process (Scarp) is a new addition to the range of corporate rescue tools available and offers a low-cost alternative to examinership.

Court costs cut

“It is designed to eliminate, or significantly reduce, the requirement for costly court intervention, which is a feature of examinership,” explains Mazars partner and head of advisory Tom O’Brien. “It is aimed at small and micro-companies which meet two of the following three criteria: turnover does not exceed €12 million; balance sheet does not exceed €6 million; and the average number of employees does not exceed 50.”

To put that in context, about 98 per cent of businesses in Ireland would meet the qualifying criteria.

The relative simplicity and straightforward nature make it very attractive in comparison to examinership where the entire process is overseen by the court. An examinership application requires a report from an independent expert who determines if the company has reasonable prospects of survival. A positive determination usually leads to the appointment by the court of another insolvency practitioner to act as examiner.

“Examinership has been the only real option up until now but that was too expensive for most Irish companies,” Larkin adds. “That’s why the Scarp legislation was fast-tracked earlier this year. Examinership can cost between €400,000 and €500,000 between accountancy and legal fees. That’s why it tends to be quite large companies that avail of it. We are still awaiting Scarp’s implementation, however. But it’s not mission-critical right now. We really need to have it in place when the Government supports wind-down next year.”

The Scarp process will be triggered by the appointment by a company of a process adviser who carries out an assessment to establish whether the company has a reasonable prospect of survival after a rescue plan is implemented. Once that assessment has been carried out, the company can commence the process by company resolution with the same adviser handling the rescue process. The adviser then has 49 days to agree a rescue plan acceptable to creditors who then have a further 21 days to consider it.

Potential snags

There are some disadvantages to Scarp, however. “There is no protection from creditors during the process,” O’Brien points out. “This may lead to creditors initiating debt recovery actions or objecting to the process.”

That would require court involvement to stay any proceedings and may threaten to derail the process before it is complete.

Furthermore, Revenue is defined as an excludable creditor under the legislation and can opt out of the process in certain circumstances such as where the company is deemed to have a history of non-compliance with its tax obligations.

“The expectation is that Revenue will participate whenever possible,” Larkin notes.

And then there is the property question. “The repudiation of onerous contracts, such as property leases, requires court approval and this will add cost to the process, particularly where the landlord does not consent,” says O’Brien who believes this will be a recurring theme for companies in distress given the move to online business models as well as hybrid and remote working.

Those issues shouldn’t deter companies from using Scarp, according to Larkin. “It remains to be seen what sort of uptake there will be of Scarp, but you could see many small businesses opt for it as a means to restructure debt and legacy liabilities,” she says. “A huge element is pre-planning. Early communication with creditors is essential so that companies can present a strong argument and evidence to support it that the prospect of survival is good.”

Finally, the company must ensure it can continue to trade during the process, according to O’Brien. “The company must also determine the level of working capital that will be required to get through the process to cover ongoing day-to-day running costs given that most creditors will be operating on a cash-on-delivery basis over the rescue period.”