Informal restructure – breathing space needed for competitive advantage

An informal restructure can give your distressed business the breathing space it needs to gain a competitive advantage.

Insolvency Academic Professor Jason Harris said in 2015:

The corporate insolvency landscape is changing. The methods to address financial distress have moved away from formal insolvency appointments to restructuring and turnaround before financial distress becomes insolvency.

With the new Safe Harbour provisions coming into effect in 2017, under Section 588GA of the Corporations Act, directors can now undertake restructuring and turnaround initiatives without risking personal liability for insolvent trading. Better still, Safe Harbour is a defence against a creditor defeating disposition in a Safe Harbour restructure (for example, a pre-pack or pre-positioned sale) as per the Treasury Laws Amendment (Combating Illegal Phoenixing) Bill passed in February 2020. Whilst directors still have an evidential burden in ensuring fair market value is achieved, Safe Harbour provides an additional protective layer (avoiding potential criticism of, or actual, illegal phoenix activity).

In this article, you’ll learn what an informal restructure is, what it involves, and the risks that it brings. At the end of the article, I’ll show you what the outcome of your informal restructure ought to be.

What is an informal restructure?

Perhaps obviously, an informal restructure is the opposite of a formal restructure. The key difference between the two is that the methods of informal restructuring are not set out in the Corporations Act 2001.

The Act sets out formal restructure by appointing liquidators and receivers, or voluntary administrators. Voluntary Administration and a Deed of Company Arrangement (DOCA) was originally designed as a formal rescue regime. However, the average fees charged by a liquidator for even a small voluntary administration were found to be $97,000 AUD and their success rate has been argued to be less than 2% – creditors receive on average 5-7c in the dollar…! (See Wellard, Mark 2014 A sample review of Deeds of Company Arrangement under Part 5.3A of the Corporations Act. ARITA Terry Taylor Scholarship. Australian Restructuring Insolvency and Turnaround Association).

In contrast, informal restructures may draw on any number of methods. Importantly, it’s private and directors retain control of the business and operations. In an industry where trading is affected by public knowledge of insolvency, informal restructures can help directors to avoid the real crisis. After all, the media doesn’t distinguish between the formal rescue regime ‘voluntary administration’ or any other type of insolvency process or term (such as liquidation, receivership, bankruptcy etc).

Insolvency proceedings, such as receivership, liquidation and even voluntary administration (which has a stated purpose of trying to save businesses) carry a stigma of failure, which makes trading on as a business more difficult and reduces creditor confidence in the potential to save the business through a formal restructuring.

Jason Harris – Insolvency Academic 

What is involved in an informal restructure?

Informal restructures may involve:

• refinancing
• improved credit management or debt collection (ie reducing day sales outstanding)
• changing the way operations are conducted, particularly to gain efficiencies
• downsizing
• enacting crisis management protocols
• terminating non-performing or under-performing contracts, whether those are customers or employees
• gaining further equity funding for the company
• renegotiating supplier contracts, which may also include seeking extended payment terms.

If your company is a small or medium-sized enterprise, you must negotiate with your secured financiers first. This is because your bank may cover a range of securities, including a home loan.

The risk of not gaining your financier’s consent is that you might lose your home. This happens as a result of your bank enforcing mortgages or personal guarantees.

Are there any risks of informal restructures?

There are two key risks in the process of informal restructuring.

The first is in payments to the Australian Taxation Office. The ATO is perhaps the largest creditor of any business. Therefore, it’s wise to negotiate extended terms of payment for any tax debt.

Note that this won’t reduce the amount of debt owed, but it will grant more time in which it can be paid. If you are facing this situation, make sure that you are familiar with the ATO’s policy concerning your company’s circumstances. This will help you to make the most appropriate arrangements.

Communication with the ATO is critical otherwise directors may find themselves in receipt of a directors penalty notice. Even more critical is to ensure directors continue to make lodgements with the ATO – otherwise, they may find themselves in receipt of a lockdown directors penalty notice.

The second risk of an informal restructure is in facing a creditor who refuses to compromise on payment terms. That creditor may instead seek court assistance in winding up the debt. Such a creditor is known as a ‘holdout’ creditor. The process can destroy an informal restructure, even if all other interested parties have given their consent to the requested change. Dissatisfaction could result in the company receiving a statutory demand.

Mitigating these risks means seeking creditors’ consent to the process. If you can gain consent from all parties, then you are more likely to achieve a successful outcome.

The outcome of an informal restructure ought to be an improved financial position

You must understand that improving your company’s financial position, through the use of an informal restructure, is not necessarily the same as just selling off your company’s assets. That is what you might encounter in an illegal phoenix, deliberate pre-pack or pre-positioned insolvency arrangement.

Rather, an informal restructure seeks to keep the company in place, but in a new shape, so that it can find its way back to positive financial health. This should be the primary motive anyway – restructuring shouldn’t be a balance sheet re-engineering process based on merely suspected insolvency rather than genuine concern over insolvency risk. If the company’s restructuring plans fail, then it is much better placed to justify an asset sale or a legal pre-pack or pre-positioned sale (and the Safe Harbour process acts as a defence to allegations of illegal phoenix activity under the new legislation).

This is why it’s important to document plans for an informal restructure ahead of taking any action. Documenting plans also allow you to gain external advice about whether the actions are likely to achieve a better outcome than liquidation. You may recall from one of my previous articles that this is also the critical first step in seeking Safe Harbour provisions.

The moral of the story is that financial distress doesn’t have to mean financial disaster

With the right knowledge, advisors, and processes, a company in financial distress can often be saved. When you focus on restructuring, you may find yourself not only saving your business but making it stronger in the process.

This is why I created Turnabout. We thrive on seeing companies turnaround, renew, and grow.

If your company is in distress, give me a call. I will help you to regain control and provide the breathing space that is to desperately needed to turn your company around.

For a confidential discussion email eddie@turnabout.com.au or phone 1300 877 329.