General guidelines in reconstruction
For a reconstruction to be successful the following principles are to be followed:
Creditors must be better off under reconstruction than under liquidation.
If this is not the case they will not accept the reconstruction as their agreement is a requirement for the scheme to take place.
The company must have a good chance of being financially viable and profitable after the reconstruction.
The reconstruction scheme must be fair to all the parties involved, for example preference shareholders should have preferential treatment over ordinary shareholders.
Adequate finance is provided for the company’s needs.
In solving reconstruction questions the following steps can be followed:
State the above principles of reconstruction.
Check what each party will get if the company were to go on liquidation.
This can be done by adding up the break-up values of the assets.
Note the sequence of creditor priorities as followings:
- taxes and unpaid wages
- secured debts, including unpaid interest – fixed charge
- secured debt – floating charge
- unsecured creditors
- preference shareholders including unpaid dividend
- ordinary shareholders.
Check the sufficiency of the amount of finance that will be raised from the scheme.
This includes proceeds from the sale of investment, existing assets when new assets are to be bought to replace them, and reduction in working capital.
Check if the parties will be better off under the proposed scheme than under liquidation.
Assess the fairness of the scheme.
Assess the post-reconstruction financial viability and profitability of the company by calculating post-reconstruction EPS and P/E ratio.
Come to a conclusion.