Company distress and the new alert indeces published by the national council of the order of chartered accountants and accounting expertes

Stefano CarminiFounder and Managing Partner, Carmini e Associati Studio Legale

The Code of Company Distress and Insolvency, outlining the new system of alert and prevention, pursuant to art. 13, paragraph 2, has delegated the development of adequate indeces that may reasonably constitute a presumption of the existence of the state of crisis, that gives rise to the obligations of prompt adoption and implementation of the initiatives that the legal system provides in order to overcome the crisis and recover the business continuity, to the National Council of the Order of Chartered Accountants and Accounting Experts[1].

Therefore, the National Council of the Order of Chartered Accountants and Accounting Experts, adopting the document published on 19th October 2019, proposed a set of indeces, which are now being examined for their approval by the Ministry of Economic Development. Firstly, it appears appropriate to note that it is a hierarchical system of indeces, in compliance with which these indeces are to be applied in a particular order and one alternatively to the others. Along with the general index of crisis consisting of repeated and significant delays in payments, two indeces (applicable to all the enterprises) and five sector indeces have been developed.

The first index of crisis, applicable to all the enterprises, is integrated when net worth is negative or, for companies, below the legal limits.

In the event that the net worth is positive or higher than the legal limits, it should be ascertained, through a prognostic evaluation, the sustainability of the debt situation of the company within six months. To this end, reference should be made to debt service coverage ratio (DSCR), that is the ratio between all the cash inflows within six months and the expected cash outflows for repayments of financial debts within the same period. When that ratio is less than 1, it is reasonable to presume the state of crisis, as long as the prognostic data are believed to be reliable by the management and the supervisory bodies.

If the DSCR is not available or it is not believed to be reliable because of the inadequacy of prognostic data, five indeces, with different threshold values for each economic sector, will be applied. The combined exceeding of all these values may reasonably constitute a presumption of the existence of the state of crisis.

The abovementioned five indeces are the following:

  1. the financial burdens sustainability index, in terms of ratio between financial burdens and turnover;
  2. the capital adequacy index, in terms of ratio between net worth and total debt;
  3. the cash return of assets index, in term of ratio between cash flows and assets;
  4. the liquidity index, in terms of ratio between the short-term assets and short-term liabilities;
  5. the indebtedness deriving from social security contributions and tax liabilities index, in terms of ratio between indebtedness deriving from social security contributions and tax liabilities and assets.

Pursuant to art. 13, the National Council of the Order of Chartered Accountants and Accounting Experts has developed specific indeces of crisis for companies that are in situations which would not enable the abovementioned indeces to be applied. For example, only the negative net worth is relevant for newcos (established for less than two years).

The indeces provided for innovative start-ups are particularly interesting. Indeed, start-ups are characterized by a high rate of failures deriving from the considerable degree of risk related to the sector. Moreover, it is generally known that they are characterized by basically negative operating results and that, therefore, part of their success relies on their ability to obtain financial resources (from shareholders, banks, financial intermediaries o through new financing systems such us crowdfunding). For these reasons, the index of crisis is represented by a DSCR calculated on the basis of the ratio between the forecasted financial resources and the minimum liquidity necessary to continue studying and developing the project.

Lastly, it appears necessary to underline that the adoption of the abovementioned indeces is not mandatory. Indeed the same art. 13, par. 3 of the Code of Company Distress and Insolvency provides that if an enterprise doesn’t believe these indeces to be suited for its situation because of its own specific characteristic, it must explain the reason in the explanatory notes and, at the same time, it must indicate the indeces considered adequate to reasonably constitute a presumption of the existence of its possible state of crisis. However, in this case, an independent expert must certify the adequacy of the chosen indeces.

In the view of the above, even if the decision of the Ministry of Economic Development is pending, it is evident that, in order to implement an organizational arrangement suitable to detect the indeces of crisis and a control system monitoring the adequacy of this arrangement, specialist expertise will be crucial, also for the purpose of a  correct application and interpretation of the new indeces, which shall be applied with great care, especially during the first period of operation, in order to prevent the risk of the so-called false positives.

[1] See also the articles: https://www.carmini-law.com/en/appropriate-structures-in-the-light-of-the-code-of-company-distress-and-insolvency-and-models-under-legislative-decree-231-2002/ and https://www.carmini-law.com/en/business-crisis-and-need-for-adequate-organizational-arrangements-compatible-with-the-italy-system-the-network-contract/.

Author: Paolo Visconti