As your business struggles, when is it time to call it a day?
When To Call It A Day
In the last episode, Ben Sewell of Sewell & Kettle in Sydney went through the first ten questions in a list of 19 for you to ask when your clients struggle to pay their debts.
Today let’s cover the remaining nine. 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 To Call It A Day
Just to regig your memory here are the ten questions we covered in the last episode (ep 364):
1 – What are the options?
2 – Is the Company Insolvent?
3 – How to Determine Insolvency?
4 – Is a Private Treaty Viable?
5 – What Caused Insolvency?
6 – What Type of Business?
7 – Reputational Risk?
8 – What is the size of the debt?
9 – Any All PAAPs?
10 – Angry Creditors?
So that was episode 364.
When To Call It a Day
But now to the remaining nine questions.
Question # 11 – Size of Tax Debt
How big is the tax debt?
Among your creditors, the ATO is the most likely to fund further action. The ATO doesn’t seem to like voluntary administrations. And they usually abstain from voting toward a DOCA (Deed of Company Arrangements).
No word yet on how the ATO views the small business restructuring process. They may be favourable to it in order to save businesses with employees and a history of tax compliance
The ATO is not fond of pre-packs (whether finalised through liquidation or voluntary administration). In most cases, pre-packs leave a tax debt with the old company that is wound up, so the ATO gets nothing. The ATO is the most militant creditor in taking action against phoenix activity.
Question # 12 – Employee Entitlements?
Are employee entitlements up to date, ie. lodged and paid? If not, small business restructuring is not an option. Small business restructuring requires all employee entitlements to be up-to-date and paid.
Employees are second in the order of priority for payouts – right after paying the liquidator – as per the Corporations Act 2001 (Ch).
There is a statutory scheme (the Fair Entitlements Guarantee or ‘FEG’ Scheme) in Australia which may step in for a liquidated company and pay out employees unless there is a successor company.
The FEG scheme won’t apply in a pre-pack insolvency arrangement because there is a successor company. Payments to employees are not voidable as unfair preference claims.
Question # 13 – Active Suppliers?
Suppliers might push for three actions to recover their funds.
1 – Small Business Restructuring Plan
A small business restructuring plan might be the most seamless process, leaving directors in control. You can often work out a compromise without any halt in trading.
2 – Personal Guarantees
Suppliers have often been burnt in the past and hence regularly obtain personal guarantees from the directors of debtor companies.
As unsecured creditors in a liquidation, suppliers’ returns are likely to be small. So they focus on enforcing directors’ personal guarantees instead.
3 – Personal Property Securities Register
Some suppliers register a particular type of security, a Purchase Money Security interest (‘PMSI’). This is a security interest over the goods they supply.
You register a PMSI through the Personal Property Securities Register, making you a secured creditor. This gives you a security that potentially extends to receivables and cash at bank.
In practice, PMSIs often miss out because their interest can be difficult to trace.
Question # 14 – Compromise
How hard is it to finalise a compromise with creditors?
Small Business Restructuring Plan
The process for a small business restructuring plan as such is relatively easy. You don’t need an instrument to register creditor agreement. And the vote is by majority by value only – so not by number, just by value. As this framework has just started up, there is no rule of thumb about what creditors would accept.
DOCAs
Deed of Company Arrangements (DOCAs) are harder. The DOCA — the ideal outcome of a voluntary administration — is a more formal process. It requires agreement from creditors by majority in value AND number. And it requires an instrument to be implemented and overseen by a deed administrator.
Liquidation
Liquidation is a No Compromise approach. Creditors receive whatever minuscule amount they are entitled to pari passu.
Pre-packs
Pre-packs do not require consent or compromise from anyone. A pre-pack can be implemented without a single creditor agreeing. Though, as noted before, any pre-pack will be investigated by a voluntary administrator or liquidator with any uncommercial transactions being voidable.
Question # 15 – Costs?
How much the whole process will cost you depends on what you do.
Voluntary Administration
Voluntary administration is relatively costly. This is the most expensive as the insolvency practitioner does the work on an hourly rate basis. A voluntary administration would often cost between $50-100k.
Small Business Restructuring Plan
A small business restructuring plan is relatively cheap. It is expected that the overall cost of the process will be about AUD 10,000 to AUD 20,000. This reflects the short time frames, the streamlined process, and the fact that the directors still retain responsibility for controlling and operating the business.
Pre-Pack Insolvency Arrangements
Pre-pack insolvency arrangements are difficult to price because they don’t just involve drafting an asset sale agreement. The better approach is to consider the whole business and also assess future risks of legal action by liquidators. Funds should also be allocated to pay liquidator professional costs.
Question # 16 – What kind of expertise is needed?
There is no readily accepted turnaround profession in Australia. Voluntary administrators, liquidators and Small Business Restructuring Practitioners are almost always professional accountants.
Pre-packs are developed by insolvency lawyers and insolvency practitioners. Lawyers should have a role. As should anybody who is a fiduciary.
Question # 17 – Which process is the quickest?
Pre-Packs
Pre-packs can be very quick. There is no need for creditor agreement slowing down the process. Note however, that the subsequent liquidation of the original company would go on for a couple of years.
Small Business Restructuring Plan
The process for a small business restructuring plan is quick, usually done within 20 business days plus any voting period.
VA
Voluntary administration can be quick, often within 25 business days. However, the DOCA process might pull this out.
Question # 18 – Best return to creditors?
The cold truth is that creditors don’t get much from insolvency anywhere in the world. Modern objectives aren’t moral but economic – getting capital back to work and efficient asset allocation
Voluntary administration is the worst. High hourly VA fees chew up the asset pool before the (likely) eventual liquidation and dispersal or remaining assets to creditors
Liquidation is often better. But it involves stopping business and a firesale.
The SBRP process is an unknown. One potential issue is that this process forces smaller creditors into restructuring plans that are not to their benefit.
Pre-pack is the worst for creditors. A pre-pack is designed to empower the directors of the debtor company and enable them to continue the business without prior debt hanging over them. Generally, unsecured creditors end up behind in the dust because there are no more assets to distribute.
Informal workouts/private treaties rarely occur. It is extremely difficult to get an agreement from creditors to a private treaty.
Question # 19 – Biggest risk to directors?
Insolvent trading litigation by liquidators is very rare
The biggest factors behind litigation against directors by liquidators are the size of the asset pool, or the presence of litigation funders
Pre-pack insolvency arrangements may mean less scrutiny of director action
Presence of ATO debt? Watch out for director penalty notices
SBRP process may offer a good solution to grasp a final chance
Summary
So it is never just about the numbers, but about a whole lot of issues.
The lack of an accepted business turnaround profession in Australia means that directors often seek advice from the wrong people (such as phoenix operators)
There is no restructuring option in Australia that both provides significant returns to creditors and enables directors to smoothly turn around an insolvent company
The new SBRP process could be useful for these purposes, but will only be available for small businesses.
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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.