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Restructuring A Bankrupt Global Company

An issues checklist from an Asia-Pacific perspective for questions of insolvency and bankruptcy

Imagine if you were the in-house legal counsel for a company with global operations, including subsidiaries or offices in the Asia-Pacific region. Your company's finance department has just confirmed the company's (and your) worst fears - the company is insolvent, creditors are beating on the doors and the company will have to act fast to restructure or file for bankruptcy.

What should you do? What are the implications on the Asian subsidiaries' operations resulting from a restructuring or a filing for bankruptcy of the parent company in a foreign jurisdiction?

This article presents a preliminary checklist of legal and practical issues for legal counsel with responsibility for foreign operations to consider in the event the ultimate parent company encounters severe financial difficulties and must undertake restructuring efforts affecting foreign operations.

Now imagine further (OK, maybe it is a nightmare) that you have been put in charge of analyzing for your company's Asia-Pacific operations the effects, from a legal perspective, of the parent company's pending or actual insolvency or filing for protection from creditors (say, for example, under Chapter 11 of the United States Bankruptcy Code). The following preliminary issues at the early stages of insolvency, restructuring or bankruptcy should be considered:

1. Will the local subsidiaries become "insolvent" as a result of the parent company's financial troubles?

2. Could the directors, officers and shareholders of the local subsidiaries face any liability if their company is insolvent?

3. Can the insolvent or bankrupt parent company receive dividends and debt repayments from its foreign subsidiaries?

4. What does it mean when the parent or subsidiary's auditor gives a "going concern qualification?"

5. What is the best way to deal with parent company guarantees and cross-default provisions in contracts?

6. What are the best ways to manage information gathering to assist the parent company and to effectively work with local counsel?

Understanding and addressing these preliminary issues will assist legal counsel and restructuring and bankruptcy advisors in assessing the client's options and drawing up an action plan for restructuring of the Asia-Pacific operations.

1. Will the local subsidiaries become "insolvent" as a result of the parent company's financial troubles?

A company's overseas subsidiaries are often, at least during the initial start-up period, heavily dependent on the parent company for capital contributions or loans. If the parent company is unable to provide financial support to its Asia-Pacific subsidiaries, the subsidiaries could become insolvent and in some jurisdictions run afoul of a prohibition against trading while insolvent.  Although many jurisdictions in the Asia-Pacific Region, including Hong Kong, Japan, Korea and Taiwan, do not prohibit trading while insolvent, one important jurisdiction that does have this prohibition is Australia. In Australia, although there is no duty to keep a company solvent, it is against the law to allow an insolvent subsidiary to trade or incur debts.

What does it mean to be "insolvent?" The standards for determining insolvency vary from one Asia-Pacific country to another: some define insolvency as the inability to pay debts as they become due (a cash flow standard, e.g. Australia and Philippines), others adopt an undesirable ratio of assets to liabilities (a balance sheet standard, e.g. Taiwan), and still others appear to have a combination of both standards (e.g. Hong Kong). One of the consequences of these varying standards is that the mere insolvency or bankruptcy of the parent company does not necessarily deem its subsidiaries insolvent, although insolvency may result from a lack of financial support from the parent company.

2. Could the directors, officers and shareholders of the local subsidiaries face any liability if their company is insolvent?

What are the duties imposed on directors and officers by the insolvency of the subsidiaries or the parent company? Will directors and officers be held liable if they permit their companies to continue trading while insolvent? In many jurisdictions in the Asia-Pacific region, the mere insolvency of a company does not give rise to any civil or criminal liability for directors and officers. However, in Australia (where, as mentioned above, insolvent trading is prohibited), directors and officers of Australian companies have a duty of care to prevent their companies from trading while insolvent. Directors and officers who permit their Australian companies to continue trading while insolvent may be held civilly and criminally liable and the directors may also be disqualified by the courts from managing a corporation for a specified period of time.

Another special case is Taiwan. In Taiwan, directors have a duty to report company losses to the shareholders and file for bankruptcy when the company is insolvent, and the failure of a director to do so can result in civil or criminal liability. As a practical matter, creditors in Taiwan have been known to file for an injunction in court to prevent a company's directors from leaving the country if it has unpaid debts. In Japan, although there is no prohibition against insolvent trading, representative directors of a Japanese company that has filed for bankruptcy have a duty to explain the circumstances of insolvency of their company to the court.

To cover the risk of this potential liability, directors and officers often ask for an indemnity or liability insurance coverage ("D & O Indemnity"). Legal counsel should verify if there are existing undertakings by the Asia-Pacific subsidiaries or the parent company to indemnify the Asia-Pacific directors and officers either directly through a contract of indemnity or through coverage by an insurance company. Thereafter, it is necessary to assess whether or not the D & O Indemnity for the directors and officers provides adequate coverage for the potential liability they are exposed to.

Can the shareholders ever be held liable if their company is insolvent or for the insolvent trading by their company? Most of the Asia-Pacific countries adopt the legal concept of a limited liability company and, therefore, generally any shareholder liability is limited to the amount of capital investment. Certain jurisdictions, however, notably Australia and Taiwan, impose liability on corporate shareholders in certain limited circumstances. A corporate shareholder of an Australian company which is in turn a holding company may be held liable for the insolvent trading of its Australian subsidiary. In Taiwan, a corporate shareholder may be jointly liable together with directors for claims from third parties if the directors fail to declare their insolvent company bankrupt.

3. Can the insolvent or bankrupt parent company receive dividends and debt repayments from its foreign subsidiaries?

If the parent company files a petition for bankruptcy, its creditors may look to the bankrupt parent company's estate for satisfaction of debts, such as inter-company loans and dividends that may be owed by a subsidiary to its parent. What if the parent company's Asia-Pacific subsidiaries also become insolvent, how can the parent company get paid? Will the parent company be entitled to cause its subsidiaries to make debt repayments or declare dividends in its favor to remit to the parent company/shareholder?

The answers to these questions depend on whether the subsidiaries can legally declare dividends or repay legitimate debts owed to the parent company. Whether the subsidiaries can declare dividends depends on the rules in their relevant jurisdictions. In certain jurisdictions, legal and accounting rules allow for the declaration of dividends based on the net assets on the balance sheet; other jurisdictions allow dividends to be declared depending on the amount of the subsidiary's unrestricted retained earnings or legal reserve. It may also be possible for a subsidi-ary's balance sheet to show surplus profit or positive net assets but still unable to pay dividends because the subsidiary is insolvent under an applicable cash flow standard. In that case, the relevant jurisdiction's rules of preference of payments could affect whether the dividends may be paid to the parent company. 

Once dividends are declared, they are generally treated as general debts and restricted under rules against unfair preferences in the event the subsidiary is liquidated or files for bankruptcy. The payment of dividends could later be nullified by a court on grounds of unfair preference. The same principle holds for repayment of debts owed by a subsidiary to its parent. As long as the debt is a legitimate debt owed by a subsidiary to its parent, there is generally no prohibition against the subsidiary repaying its parent pursuant to an inter-company loan agreement.

4. What does it mean when the parent company's or local company's auditor gives a "going concern qualification?"

As a consequence of the "dot.com" failures in the United States, some accounting firms have recently been qualifying auditors' reports and opinions for large multinational companies with statements known as "going concern qualifications." Some have even extended this practice to include going concern qualifications in the financial statements of foreign subsidiaries located in the Asia-Pacific region, even when these companies are themselves solvent and the auditors are under no duty to include a going concern qualification in the financial statements of these subsidiary companies.

In most cases, the inclusion of a going concern qualification in the parent company's financial statements should not by itself affect the solvency and continued operations of its subsidiaries because solvency is determined based on each subsidiary's financial statements and in accordance with the legal and accounting rules of each jurisdiction. However, the inclusion of a going concern qualification in a subsidiary's financial statement could compound the financial problems of the subsidiary and the group companies by affecting the reputation of the subsidiary. It is possible that the business community could lose confidence in the subsidiary's financial condition as a result of an overly conservative auditor's opinion and this could lead to further loss of business.

5. What is the best way to deal with parent company guarantees and cross-default provisions in contracts?

When a parent company faces financial troubles or considers filing for bankruptcy, it is necessary to review all parent company guarantees for subsidiary companies to determine if they contain provisions triggering a default of the subsidiary in the event of insolvency or restructuring by the parent company. Parent guarantees and cross-default provisions (i.e. contractual undertakings which provide that a default under one operative contract triggers an event of default by the same company or other companies under separate related or unrelated agreements) may be conditions to government licenses, performance bonds, or loan and security documents. Is the insolvency of the parent company an event of default for the subsidiary, or a condition for the acceleration of debt repayments by the subsidiary? Depending on the circumstances, it may be necessary or advisable to re-negotiate guarantees and other contracts prior to any filings by the parent company so that subsidiary operations are not adversely affected.

6. What are the best ways to manage information gathering to assist the parent company and to effectively work with local counsel?

When a parent company prepares its restructuring plan or its petition for bankruptcy, there are many legal issues to consider in connection with its foreign subsidiaries. What are the best ways for in-house legal departments located at headquarters or bankruptcy counsel to deal with the myriad legal issues affecting the company's operations in far flung foreign countries? It is often helpful for the company to engage regional or coordinating counsel in the foreign region to coordinate and work closely with local counsel in the various relevant jurisdictions to provide timely and accurate summaries of information, legal advice and opinions. Regional and local counsel should be familiar with the operations of the parent company's subsidiaries and able to provide competent general and practical advice on corporate insolvency and bankruptcy in each relevant jurisdiction.

It is also often helpful for in-house and bankruptcy counsel to gather as much information as early as possible about the foreign subsidiaries and their operations. A useful tool to collect this information for each jurisdiction is for counsel to develop a form document highlighting all the relevant issues and questions to be filled in for each subsidiary. Counsel may fill in on the form (e.g. using one form for each subsidiary) relevant information about each subsidiary such as its corporate structure and capitalization information, income statement and balance sheet, description of business, marketable assets, potential buyers, significant customers and suppliers, existing and potential liabilities and material litigation, tax and regulatory issues, liquidation and winding up costs, company guarantees and funding requirements and identification of any particular legal issues that should be flagged, such as potential director liabilities for insolvent trading. Once the forms are filled out, counsel will have at its fingertips relevant information that will be needed to properly advise the parent company with respect to managing its subsidiary operations.