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Corporate Rescue Under the Companies Act 2016 (Part 1)

Insolvency and Going Concern: The Precursor to Corporate Rescue
Dato' Adam Primus
March 21, 2024
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Every company' is conceived and created by entrepreneurs; from defining its purpose or raison d'être, coming up with its guiding principles and values for its existence right down to its operating structures. The company has a life of its own in the eyes of the law quite distinct from the entrepreneur that conceived and created it. Its life can only be ended in the same manner it was created; through the operation of the law. Technically, companies can exist forever. However, its fate rests entirely in the hands of directors who operate and run the organization in accordance with the constitutions of the company. In order to meet the purpose of the company, the company will need to face all the challenges that may come in its path, whether that may be from internal or external sources. The company either succumbs to these challenges or prevails over them.

A company does not operate in a vacuum but operates in a dynamic environment where there are many moving parts or variables - both internal and external. At the macro level, it consists of 'global forces' i.e. economical developments, demographics, politics, technological developments and social developments. The transactional level is the macro level and consists of 'market forces' such as suppliers, supply and demand, distribution, competitors and strategic alliances. And finally at the micro level - the organizational level involves forces that address the internal environment of the firm; vision, mission, strategy, resources, processes, products and services. A graphic representation of the complexity of this dynamic environment is shown in Figure 1.

A company is required to adapt to this environment and the fast paced changes that take place within this environment. A product or service that was proven successful in the past can be replaced or even eliminated from the market place with the introduction of new ways of doing business, technology or competitors. Companies that were household names in the past have been replaced with new names and some have even ceased to exist.

Causes of Failure

There have been numerous studies, analysis and theories over the years expounding the success or failure of companies. These studies have been researched by different disciplines be it accounting and finance, leadership, economics, strategy, management, organizational, sociology and entrepreneurship amongst others. However, from these studies, it is apparent that there are four major causes of failure namely failure at the top (leaderships and management), customer and marketing failure, financial management failure and system and structural failure?

One of main outcomes from these studies has, been the use of signs of decline and the development of predictive tools, quantitative and qualitative or a combination of both. Quantitative models® generally use financial data including ratios over a period and mathematical formulas
to predict failure. Financial institutions, venture capitalists and government agencies generally use these quantitative models as they wish to be protected against risks of failure when funding ventures. On the other hand, qualitative prediction models uses a number of non-financial
(subjective) factors arising from existing conditions in a company resulting in mistakes or defects and signs of failure. The financial signs are declining profitability, declining sales and margins all of which lead to liquidity pressure, inventory build-up and collection and aging problems on receivables, missing forecasts, both profit and cash, funding covenants coming under threat, delayed supplier payments and production scheduling amongst others. An understanding of the key markers or determinants used in these models may be used by management as preventive mechanisms against failure by ensuring that the company remains within the acceptable levels of these models.

Each field of study is able to provide theories for the reasons or causes for success or failure and the leadership/management of a company must take cognizance of these theories and predictive tools to assist them in managing the business and company in its dynamic business setting.

Insolvency and Going Concern

Invariably, financial failure can be said to be the ultimate cause of failure i.e. the inability of the company to pay all its debts on a timely basis. This may arise from various causes in the business environment, which influences the company's performance. The main measure of the performance of the company is its liquidity or cash position as it moves from a solvent to an insolvent position as presented in Figure 2 below:

There are four major financial conditions a company may experience as it deteriorates from solvency to failure i.e. winding up of said company. In the first condition, the company is a going concern and solvent10, where its current assets exceed its current liabilities and the company should
have cash reserves, annual surpluses, minimal levels of debt, and be able to invest in its future operations.

In the second condition, the company is underperforming and experiencing financial distress with deteriorating conditions such as minimal cash reserves, marginal surpluses, increasing debt, and an inability to invest in future operations. This can be called the zone of insolvency. In the third condition, insolvent zone, there is a worsening of company's economic conditions that causes the company to become insolvent.

A company "is unable to pay its debts" when it satisfies the definition of "inability to pay debts"; the test used by the Courts in deciding to wind up a company and appoint a liquidator to administer it. The Courts presumes that a company satisfies the test of insolvency when a company cannot meet a statutory demand for payment ("commercially insolvent*) or when a company does not act on a court judgment or order to the satisfaction of the creditor ("unsatisfied execution process"). In all other circumstances, this presumption is met where the Court is satisfied that a company is unable to pay the debts or where the Courts determine that the liabilities (including contingent and prospective liabilities) exceed the assets of the company.

The company is in crisis as customers may be pulling out their orders and creditors and financiers scrambling for payment leading to difficulty in making payments. Directors of the company should thread carefully in the zone of insolvency and insolvent zone as transactions during this period may be open to claw back provisions, personal liability, fines and imprisonment for offences committee, falsification of books18, false representations to creditors, material omissions relating to the company affairs, misfeasance, not keeping proper books of accounts and breach by directors of general law duties.

Finally, in the fourth condition, the company either voluntarily files for winding up or is woundup by its creditors. In this instance, the business ceases and assets are sold to pay its creditors.

Going Concern and Importance of Financial Statements

All parties dealing with a company or whomever that is interested in dealing with the company, which may include bankers, suppliers, customers, investors and analysts, use financial statements as the primary source of information to determine the health of the company. When financial statements are prepared on a going concern basis, assets and liabilities are recorded on the basis that an entity will be able to realise its assets and discharge its liabilities in the normal course of business, as it is assumed that the entity will continue its business in the foreseeable future.

The directors of the company and its auditors are required by both the law and professional bodies to ensure that all the necessary information and explanations are made in the financial statements. The overall performance of the company is manifested in the financial statements of the
company, which must be prepared in accordance with approved accounting standards. The Board of Directors must approve both the financial statements and directors' report. The financial statements must be audited before it is presented to the shareholders at their Annual General Meeting and filed as a public document at the Companies Commission of Malaysia (CCM).

One of the underlying principles in the preparation and reporting of financial statements is the concept of "going concern"? In order to appreciate the going concern concept, The Malaysian Accounting Standards Board 1 (MASB 1) is reproduced as below:

"When preparing financial statements, management should make an assessment of an enterprise's ability to continue as a going concern. Financial statements should be prepared on a going concern basis unless management either intends to liquidate the enterprise or to cease trading, or has no realistic alternative but to do so. When management is aware, in making its assessment, of material uncertainties related to events or conditions, which may cast significant doubt upon the enterprise's ability to continue as a going concern, those uncertainties should be disclosed. When the financial statements are not prepared on a going concern basis, that fact should be disclosed, together with the basis on which the financial statements have been prepared and the reason why the enterprise is not considered to be a going concern.

In assessing whether the going concern assumption is appropriate, management takes into account all available information for the foreseeable future, which should be at least, but not limited to, twelve months from the balance sheet date. The degree of consideration depends on the facts in each case. When an enterprise has a history of profitable operations and ready access to financial resources, a conclusion that the going concern basis of accounting is appropriate may be reached without detailed analysis. In other cases, management may need to consider a wide range of factors surrounding current and expected profitability, debt repayment schedules and potential sources of replacement financing before it can satisfy itself that the going concern basis is appropriate."

And insofar as the auditors are concerned, this is reproduced as follows:

"The auditor's responsibilities are to obtain sufficient appropriate audit evidence regarding, and conclude on, the appropriateness of management's use of the going concern basis of accounting in the preparation of the financial statements, and to conclude, based on the audit evidence obtained, whether a material uncertainty exists about the entity's ability to continue as a going concern. These responsibilities exist even if the financial reporting framework used in the preparation of the financial statements does not include an explicit requirement for management to make a specific assessment of the entity's ability to continue as a going concern.

However, as described in ISA 200 the potential effects of inherent limitations on the auditor's ability to detect material misstatements are greater for future events or conditions that may cause an entity to cease to continue as a going concern. The auditor cannot predict such future events or conditions. Accordingly, the absence of any reference to a material uncertainty about the entity's ability to continue as a going concern in an auditor's report cannot be viewed as a guarantee as to the entity's ability to continue as a going concern."


The Companies Act 2016 has recognised that companies with going concern businesses that encounter financial problems should be provided additional avenues to reorganize the company and its stakeholders with the aim, to return to solvency. This is based on the recommendation of the
Corporate Law Reform Committee (CLRC). By allowing these additional corporate rescue mechanisms, it is anticipated that these businesses would avoid a premature winding up of the company. Creditors and shareholders will tend to lose much more in a forced closure of businesses than a situation where value of the assets of the company can be maximized as a going concern.