Should you consider voluntary administration during COVID-19?

Benefits of voluntary administration for directors and creditors
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For businesses impacted by the COVID-19 crisis, voluntary administration may offer a path forward

It is fair to say that Australian businesses have had a hard time recently. Since last summer, the country has been hit with a devastating one-two punch of bushfires and COVID-19 that has left many businesses on the mat.

Little surprise, then, that so many companies are exploring the benefits of voluntary administration, although very few companies are actually appointing an administrator. Making the choice can be stressful, but it is a useful way to buy some time while a strategy is developed to move forward. This is especially true in the current volatile climate, as the Courts and legislature have introduced special measures to help directors navigate through these choppy waters.

We have previously considered the benefits of a holding DOCA, which could provide a useful mothballing mechanism for a company in administration with good post COVID-19 prospects. This article is concerned with the pre-cursor to any DOCA: taking the plunge into voluntary administration.

What are the benefits of voluntary administration?

Voluntary administration is an insolvency mechanism, which can be useful for restructuring and turning around a struggling company. It is intended to give companies time to develop a plan to restructure, and maximise the return to creditors.

By appointing a voluntary administrator as soon as you suspect your company cannot or may soon be unable to pay its debts, you will increase the options available for a positive outcome and improve the chance that your business will survive. If you leave it too late, you might find that liquidation is the only realistic option left, or that you incur personal liability for insolvent trading and or breach of your other director duties.

During voluntary administration, a company can:

  • Continue to trade
  • Receive Federal stimulus monies (including JobKeeper payments if eligibility is met)
  • Avoid new Court actions against the company (unless the Court orders otherwise or the administrator consents)
  • Suspend any existing proceedings against the company (except security interests) and enforcement of personal guarantees (see below)
  • Give creditors a voice on the future of the company

How does voluntary administration affect creditors?

Once in voluntary administration, the company benefits from a moratorium which:

  • Prevents creditors from taking action against the company (unless there is written consent from the administrator or leave of the Court)
  • Prevents any person from enforcing a charge on property of the company (unless there is written consent from the administrator or leave of the Court)
  • Prevents legal claims against a company being continued or started (unless there is written consent from the administrator or leave of the Court to do so)
  • Stays action by owners or lessors of property being used by the company

This buys the administrator time to develop a strategy, which may result in the company being successfully rescued.

Often, directors, their spouses, de facto spouses or their relatives will have provided personal guarantees to creditors of the company. Except in limited circumstances, once the company has entered administration, creditors have to obtain permission of the Court to enforce the guarantee – and such permission is rarely given.

Secured creditors

There are several exceptions to the moratorium that apply to secured creditors.

First, creditors who hold a charge on “the whole, or substantially the whole” property of a company are not bound by the moratorium if the charge is enforced:

  • before the company enters voluntary administration; or
  • within 13 days of receiving notification of the voluntary administrator’s appointment.

In practical terms, that means that the company’s secured lenders can call in the business loan as soon as it knows the company has entered voluntary administration. Ideally you should make sure that the secured lenders are supportive of the voluntary administration and are willing to work with the administrator. It may be worth engaging with secured lenders before appointing an administrator to bring them on-side – but this has to be part of a carefully crafted strategy considering all possible outcomes.

Other exceptions to the moratorium include:

  • A secured creditor who holds a charge over the company’s property and has begun to enforce that charge prior to the company entering voluntary administration
  • Owners or lessors of property used, occupied by or in the possession of the company who have enforced a right to take possession of the property prior to the company entering voluntary administration
  • A secured creditor who holds a charge over perishable property
  • An owner or lessor of perishable property

In many cases, secured creditors will recognise that they have a better chance of recovering their debt if they agree to a DOCA.

Unsecured creditors have fewer rights than secured creditors. However, voluntary administration may still be in their best interests because:

  • A DOCA might allow the company to maximise the amount that can be paid to unsecured creditors as compared to an immediate winding-up
  • Voluntary administration may allow the company to use tax losses to maximise assets and therefore returns to creditors
  • The statutory moratorium may also allow the administrator to carry on trading. Unsecured creditors who are suppliers to the business may prefer the continued trade to a winding-up
  • Employees who are unsecured creditors may be able to receive ongoing entitlements, including government stimulus packages such as JobKeeper. These are not available to companies in liquidation

How does the voluntary administration process work?

There are three routes to appointing a voluntary administrator. The most common is by the company making the appointment by majority resolution or resolution of the sole director.

Once a company has appointed a voluntary administrator, most creditors’ claims against the company are immediately suspended. That takes the pressure off temporarily so that the voluntary administrator can develop a strategy.

The voluntary administrator then comes up with a proposal for the company’s future based on its history, assets, operating position and prospects. The proposal sets out:

  • How the company will operate
  • Whether assets will be sold or retained (and which ones)
  • How much creditors can expect to receive
  • The timeline for payment

The proposal is presented at the second creditors’ meeting, which must usually be held within 25 days of the company entering administration. (Note that the Courts have been willing to extend this timeframe, and especially so during the COVID-19 pandemic.)

If creditors accept the proposal, it is formalised in a deed of company arrangement (DOCA). If they do not, the company can either be returned to its directors or placed into liquidation.

What paths can a voluntary administrator take?

There are several paths a company in voluntary administration can take.

Voluntary administration offers far more options than liquidation. If your company is in liquidation, you are already in the winding-up stage. In voluntary administration, multiple options can be explored.

Trading through

‘Trading through’ until your company starts to become profitable again is the ideal scenario, especially while creditors are kept at bay.

During the COVID-19 pandemic, however, trading through may be difficult and unrealistic. This is because, for example, footfall in shops and malls has dramatically fallen, many people have taken up online purchasing and, in the hospitality industry, the restrictions mean people are unable to dine out or go to the pub.

If your business is fundamentally sound but is unable to meet its outgoings under the current lockdown, voluntary administration may be the ideal solution. It can enable the company to be ‘mothballed’ by suspending all debt actions in the hope that the business may be able to bounce back later.

Restructuring

The voluntary administration process can be used to restructure the business.

Restructuring significantly modifies either the debt, operation or structure of the company. This might involve selling off assets, moving a retail business online and/or laying off staff to reduce outgoings. A debt restructure might see the company consolidate its debt to create a more favourable environment in which to pay liabilities.

The Arrium Group restructure is an example of a large corporate restructure. In April 2016, Arrium Group was one of Australia’s two largest steelmakers when it entered voluntary administration. The administrators first executed a holding DOCA to preserve moratoriums before undertaking a sale and restructure process.

The creditors agreed that the funds from the sale of assets across all 93 companies would go into a single fund, and distributed according to the terms of the DOCA. This allowed the administrators to sell a significant part of Arrium Group to Liberty OneSteel as a going concern, preserving hundreds of jobs.

Sale

One possible path is to explore the sale of the business to another entity. Businesses which cannot continue to trade on their own are often still an attractive prospect as acquisitions: either to expand their operations or to negate competition. The business sale can be on the basis that the liabilities stay with the company in administration, and are not transferred to the new owners.

Winding-up

Sometimes, a voluntary administration process cannot save the company. However, an administrator is able to manage the company’s affairs such that the eventual winding-up process returns a better result for creditors than immediate liquidation.

What other options do directors have if they want to avoid administration?

Directors who want to avoid appointing a voluntary administrator may be able to take advantage of the ‘safe harbour’ regime, and the temporary relaxation of personal liability for insolvent trading legislated in recognition of the COVID-19 pandemic.

In general, directors must not knowingly trade while insolvent. The law imposes heavy penalties on directors who do so, both civil and criminal. Directors who knowingly trade while the company is insolvent may be made personally liable for any losses suffered by creditors.

Safe harbour

Sometimes, directors of a troubled company need time to develop a plan of action to salvage the situation. If it is reasonably likely that their strategy will deliver a better outcome than appointing an administrator or liquidator, they may be able to use the statutory protection of ‘safe harbour’ to avoid personal liability for insolvent trading

The safe harbour protection is likely to be available where:

  • The company is paying and remains able to pay the entitlements of its employees as they fall due
  • The company is complying with disclosures required under taxation law, including the filing of notices and statements

and the director is:

  • developing courses of action that are likely to lead to an outcome that is better for the company
  • acting on advice from a qualified entity or is implementing a plan to restructure the company
  • properly informed of the company’s financial position
  • guarding against any misconduct by employees or company officers that could affect the ability of the company to pay its debts
  • keeping financial records

How has COVID-19 affected the safe harbour provisions?

On 24 March 2020, the Coronavirus Economic Response Package Omnibus Act 2020 (Cth) inserted a new section 588GAAA into the Corporations Act 2001 (Cth). This is intended as a ‘new safe harbour from the directors’ duty to prevent insolvent trading’ as per the Explanatory Memorandum.

Section 588GAAA provides a safe harbour for debts incurred:

  • During the six-month period from 25 March 2020, and excluding debts effectively incurred before that date
  • In the ordinary course of business, meaning those debts necessary to facilitate the continuation of the business during the prescribed period
  • Before the appointment of an administrator or liquidator

The safe harbour provisions may afford you some breathing room to make a decision about the future of your company without proceeding straight to administration. But, you will need to obtain expert advice first.

Many insolvency practitioners suspect that struggling businesses are not entering into voluntary administration now, or seeking safe harbour advice, because of the temporary relaxation to personal liability for insolvent trading. However, this is a questionable strategy. What happens when the temporary relaxation terminates – by then, winding-up may be the only viable option, and if courses of action to trade out of insolvency while in a safe harbour have not already been formulated, there may be no safe harbour to pull into.

What does this mean for you?

The decisions you make about your company now will determine whether it is sustainable in the future. As a director, you have a duty to act with due care, skill and diligence, and to act in the best interests of the company. These duties have not been modified by the Federal Government’s COVID-19 measures.

The COVID-19 pandemic has already shaped the standard expected of directors in discharging those duties.

In these volatile times, it is harder than ever to predict the economic landscape that awaits us. Whether Australia ‘snaps back’ to normal in a few months, experiences a slower but still stable recovery or goes through a fundamental change to the entire economy is still an unknown.

If you decide to trade through the next six months and the economic recovery is strong, your company (and your creditors) will likely be in a better position that if you had placed the company into administration. However, it is a risk. If you trade through only to find that there are not smoother waters on the other side, it may be too late to take full advantage of a voluntary administration. Remember that generally speaking, the longer you wait to appoint an administrator, the less options they have to help you.

For that reason, it is crucial that you seek advice early if your company is facing a possible insolvency. A qualified independent advisor can help you understand your company’s financial position and the options available to you going forward.

If you are trying to decide whether voluntary administration would be appropriate for your company, contact us to find out how we can help you make the right choice without breaching your duties as a company director.

Further information

For more information about how voluntary administration may help your company during the COVID-19 crisis,  please contact:
Trevor Withane: trevor.withane@blackwattlelegal.com.au, tel +61 (0)418 717 001

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