Sponsored By 
When your business can’t pay its bills, there are 19 questions to ask.
When Your Business Can’t Pay Its Bills
What should you do when your business is struggling? There are 19 questions to ask – Ben Sewell of Sewell and Kettle in Sydney will walk you through the answers. Let’s cover the first ten in this episode and then cover the other nine in the next episode.
Here is what we learned but please listen in as Ben explains all this much better than we ever could.
To listen while you drive, walk or work, just access the episode through a free podcast app on your mobile phone.
When Your Business Can’t Pay Its Bills
Everybody is unique. Every business is unique. Every insolvent business is unique. But there are similarities.
Based on a survey by Prof. Jason Harris, companies going into a liquidation and voluntary administration, often:
- are smaller: 78% of companies had less than 20 employees; 62% had 5 or less
- have less assets: 78% had $50k or less; 85% had $100k or less
- owe less: 38% owed $250k or less; 62% owed less than $250k to unsecured creditors
- owe related parties: 20% of related parties were owed 50% or more of the debts
- have shoddy records: Only 82% had records, and of those only 45% were adequate
Source of Prof Harris: ASIC Report 647 for FY18-19 (released Dec 2019) based on EX01 Sch B reports from IPs (92% by liq, only 7% by VA)
Taking those trends into consideration, there are 19 questions to ask when your business can’t pay its bills. Here are the first ten. The remaining nine we will cover in the next episode.
Question # 1 – What are the options?
You have seven options to consider.
1 – Rescue Finance
Somebody is coming to your rescue with a quick injection of cash. Be it loan sharks or family or somebody else. Getting quick cash will protect you from insolvent trading.
2 – Private Treaties
You come to some understanding with your creditors. Like a payment plan. That includes a payment arrangement with the ATO. This will also give you a safe harbour from insolvent trading
3 – Pre-Pack Insolvency Arrangements
Pre-pack insolvency arrangements have a dodgy reputation. Even among insolvency professionals. Pre-packs are seen as bolting before the cops arrive. So to speak.
You sell the business and its assets prior to the appointment of a liquidator. That often means selling to related parties (directors, shareholders, and their associates), trying to get your goodies into the dry before the rain comes in. But if this means saving the company from insolvency and paying all creditors, all is forgiven.
But beware of phoenix activity.
The big plus of pre-pack insolvency arrangements is that you don’t air your underwear in public. Nobody will know that you are hitting rough waters.
4 – Voluntary Administration
The business community perceives voluntary administration (VA) and liquidation as the same. So VAs have a chilling effect rather than being seen as a rescue mechanism.
In a voluntary administration, an independent professional, the voluntary administrator (or ‘VA’), is appointed to take control of the company.
While in control of the company there is a moratorium on creditor claims and the VA can continue to trade if they wish. The VA aims to reach a binding agreement with creditors, a ‘Deed of Company Arrangement’ (or ‘DOCA’) to settle existing debts. Once the DOCA is complete the business will either continue trading or be liquidated.
A voluntary administration is often used as a delay tactic for creditors, litigation tactic, and shareholder deadlock resolution process. Some see this as abuse, others as a clever tactic. Any spirit of compromise that was envisioned by policymakers in 1988 has deteriorated.
5 – Small Business Restructuring
This new mechanism, referred to simply as ‘restructuring’ in the Corporations Act 2001 (Cth), applies only to businesses with total debts of less than $1 million.
A small business restructuring practitioner is appointed to develop a restructuring plan, which when agreed to by a majority of creditors by value, permits the company to restructure and continue trading. Crucially, the directors remain in control of the debtor company throughout.
Safe harbour restructures also have the advantage of secrecy. But they won’t buy you time. Creditors can still proceed to wind up and the ATO can still issue DPNs.
6 – Liquidation
Everything gets sold. An insolvency professional, a registered liquidator, is appointed to realise the assets of the company and oversee its final winding up. This is usually an option of last resort, though delaying it can ‘prolong the pain’ and make eventual pay-outs lower than they would otherwise be.
7 – Strike-off
A strike-off is just letting ASIC deregister your company. You basically abandon your company.We will cover this in episode 366. This is by far the most common way for small insolvent companies to get out. At a mind-boggling ratio of 5:1.
Question # 2 – Is the Company Insolvent?
To qualify for a voluntary administration or small business restructuring, you actually need to be insolvent. Not just a temporary cash squeeze, but endemic shortage of working capital.
Question # 3 – How to Determine Insolvency?
It starts with a cash flow test. Cash-flow test. Can you pay debts as and when they fall due? Yes – you are not insolvent. No – you are insolvent.
If insolvent, any restructuring is now subject to review as a potential creditor-defeating disposition during liquidation
Question # 4 – Is a Private Treaty Viable?
Is a private treaty viable or an impossible dream?
If there are large numbers of creditors that aren’t connected to directors, then a private treaty is probably an impossible dream.
In an SME insolvency likely creditors include the ATO, State Revenue, financiers, last resort lenders, landlords, suppliers, employees (including trade union representatives) and equipment financiers. They are unlikely to enter a private treaty.
Question # 5 – What Caused the Insolvency?
A lot what is written about SME insolvency is really just about the symptoms of insolvency. Such symptoms are often poor controls, failure to keep records, and inadequate cashflow But you need to look beyond the symptoms and look at what actually caused the insolvency. You can’t fix a problem if you don’t know what caused it.
In Australia the typical SME owner facing insolvency is a 45 – 55-year-old overworked male, who has worked in the industry for 20 years and rarely takes a holiday.
Take the construction and transport industries as an example, where you find a lot of SME insolvencies. Businesses in these industries are often in a weak bargaining position, in subcontracting relationships and have low margins, high overheads and significant capital outlay.
Only when you identify these root causes can you do something about it, for example, downsizing and expense reduction, terminating unproductive staff and contractors, managing by objectives, focusing on profitable product and service lines (80/20 rule), and forgetting about vanity marketing. But of course, all easier said than done.
Question # 6 – What Type of Business?
Some businesses can just walk away and start afresh. Whether you can depend on – among others:
Does the business have secured creditors?
How big is the asset base?
How difficult is it to run the business?
How simple or complex are the business’s products and services?
Question # 7 – Reputational Risk?
What kind of reputational risks can the business withstand?
Would you burn bridges with crucial suppliers in the industry? How will your customers react to the news?
Question # 8 – What is the size of the debt?
For small business restructuring, the overall debts must be below AUD 1n. This is a total liabilities test.
“You owe the banks $10,000 they own you, you owe the banks $10m and you own them” – Maynard Keynes
There are no debt limits for voluntary administration or safe harbour from insolvent trading.
However, voluntary administration is not cost-effective for smaller debt totals. It has become too expensive for most SME insolvencies
Question # 9 – Any All PAAPs?
An ‘All PAAP’ stands for ‘all present and after-acquired property’ – new terminology for what was once called a fixed and floating charge
A general security agreement with an All PAAP means a secured party has a veto right to any balance sheet restructure: the debtor company cannot transfer non-circulating assets – like plant and equipment, without consent of the secured party.
With an ALL PAPP, a pre-pack is usually dead in the water
If there is an All PAAP the secured creditor would probably prefer a VA process. But if the secured party really doesn’t trust the process proposed they can appoint a receiver. They may do it anyway if there is real property involved that needs to be sold.
Question # 10 – Angry Creditors?
How angry are the creditors? Landlords, trade unions, and equipment financiers are often among the group of ‘angry’ creditors.
For some solutions, you need their buy-in, for others you don’t. For example, angry creditors can replace voluntary administrators but not small business restructuring appointees. So for that reason, small business restructuring is often easier than a voluntary administration when you have angry creditors.
Pre-packs also do not require a creditor vote, and hence an option when creditors are angry.
MORE
Disclaimer: Tax Talks does not provide financial or tax advice. All information on Tax Talks is of a general nature only and might no longer be up to date or correct. You should seek professional accredited tax and financial advice when considering whether the information is suitable to your or your client’s circumstances.
Last Updated on 10 October 2022
Tax Talks spoke to Ben Sewell - Principal at Sewell & Kettle - for more details.
