The public and the media do not differentiate between liquidation and voluntary administration. Australia’s stigmatising of corporate failure and the favouring creditors over debtors has given little incentive for directors to attempt a restructuring and turnaround of their companies. On the emergence on financial troubles, directors face an immediate decision as to whether they must place the company into administration. This has been labelled the ‘twilight zone’ and is where directors can face significant risk.
Section 588G(2) of the Corporations Act 2001 (Cth) states that a director risks liability at the time the company incurs a debt, and the company is insolvent or becomes insolvent by incurring the debt, and there are reasonable grounds for suspecting the company is either insolvent or reasonably likely to become insolvent.
Acting early and obtaining advice during the ‘twilight zone’ is the pivotal point that sets the company up for successful turnaround rather than catastrophic failure.
Voluntary Administration – Challenging for Directors of Smaller or Family-Owned Businesses
In brutal honesty, directors immediately lose their powers when a company enters voluntary administration. All powers to trade the company and deal with its affairs go to the administrator. On appointment, directors are not automatically terminated or resigned – they still remain on the records and must still comply with the administrators’ requests.
Realising that all control has been lost can obviously be extremely difficult for a director to come to terms with. In addition to meeting and reporting to the administrator, directors’ statutory obligations remain. They must actively assist in the delivery of all books and records, produce a written report within five business days and provide ongoing co-operation.
Any failure on a director’s part to cooperate with the administrator can result in the matter being referred to ASIC.
Voluntary Administration and Deed of Company Arrangement (DOCA)
Following the appointment of administrators, the company’s fate is determined at meetings of creditors. Two most likely outcomes include liquidation or DOCA.
The administrator will consider any restructuring plan that is put forward and present this to the creditors at meetings. Directors of small and family operated businesses are often the first to propose a DOCA. However, early action in this scenario is, once again, the key to a successful turnaround of the business. Quick action means greater options and typically financiers, investors and other sources for injections of funds can be built into management’s proposed DOCA (to salvage the business).
Directors who have taken pro-active steps in the pre-appointment stage have a much greater chance of a ‘rolling start’ once the decision has been made to appoint administrators. Early recognition, strategic planning and sufficient business performance information effectively means directors not only salvage the business but are able to maximise preservation of the business’s goodwill. Given the stigma, the speedier the resolution of an administration, the better the likelihood of recovery.
Twilight Zone – directors can now enter a ‘Safe Harbour’ protection
On 11 September 2017, Parliament passed the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill 2017 introducing a new ‘safe harbour’ protection for directors from insolvent trading personal liability. The company can undertake a restructure outside of formal insolvency processes, in a rescue attempt.
A stay provision is also introduced which affects the enforceability of “ipso facto” clauses during an administration or scheme of arrangement.
The purpose of the reforms is to encourage directors to maintain compliance, engage early with financial hardship, keep control of their companies and take reasonable steps to pursue genuine restructuring and turnaround strategies. The Safe Harbour reform came into effect on 19 September 2017 and the ‘ipso facto’ stay becomes effective 6 months after this date, in March 2018.
What is the Significance to Directors?
As stated earlier, section 588G(2) CA 2001 states that a director risks liability at the time the company incurs a debt, and the company is insolvent or becomes insolvent by incurring the debt, and there are reasonable grounds for suspecting the company is either insolvent or reasonably likely to become insolvent.
As the legislation has been focused on “reasonable grounds for suspecting” insolvency, directors have been forced to place the company into administration prematurely, even where there were goods prospects for longer term recovery, sustainability and prosperity. The early stage appointment of a registered liquidator has been the cause of significant capital loss and unemployment rates.
Honest and diligent directors may pursue an active turnaround or recovery strategy – it is an opportunity to remain in control of the company; whilst implementing reasonable innovative and entrepreneurial measures to solve financial crisis.
Early Intervention – Speaking with a Turnaround Practitioner provides reassurance
Under the legislative reform, directors are incentivised to seek advice early. Safe Harbour creates a breathing space for directors to ‘take stock’ of the company’s circumstances and consider turnaround as a genuine option; without the pressure or threat of insolvent trading hanging over their heads.
The business community and economic landscape within Australia has evolved. Companies formally held tangible ‘hard’ assets; such as property, land & buildings, plant machinery and equipment. Smaller companies, family businesses and start-ups now predominantly consist of intangibles – such as reputation & brand, patents & trademarks, software & systems, capital knowledge & talent, intellectual property and supply chain networks. It is logical to expect a trend towards less formal insolvency procedures and an increase in informal workouts, restructures and turnaround initiatives.
As a turnaround practitioner, it is always disappointing to realise you have been called in to give advice at the last minute. Early engagement always means a greater range of options and strategies are available to directors to rescue their company. Even where administration might be inevitable, a turnaround practitioner is ideally placed to assist in the formulation of strategies to maximise the goodwill of a business.
Safe Harbour Protection for Directors – Twilight Zone (illustration)
Australia Embraces a ‘Rescue Culture’
Action within the twilight zone is the single most important factor in determining whether a rescue of the business can be achieved.
The corporate insolvency landscape is changing.
While the numbers of formal insolvency appointments have not increased dramatically since the Global Financial Crisis, the dialogue surrounding financial distress and the methods to address it have moved away from formal insolvency appointments to restructuring and turnaround before financial distress becomes insolvency.
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.