Business suffering from financial distress – What are your options?

Introduction

Business suffering from financial distress – What are your options?

If you are not worried about the impact on your staff, suppliers and customers, you can simply put the business into liquidation.

If you potentially want to lose your house and other assets, just do nothing.

But if you want to save your business from its financial distress, and protect your personal assets, you need to look at other options.  The 3 key options are:

• Voluntary administration / DOCA
• Safe Harbour
• Debtor in possession debt restructure

A brief overview of how each can deal with your financial distress, including the pros and cons, is covered below

Voluntary Administration

Introduced in the 1990’s, the purpose of voluntary administration is to attempt to turn a business with financial distress around to maximise its chances of continuing.  Or if that is not possible, to provide a better return to creditors and owners than if there was an immediate liquidation of the company.

The process

The owners of the business effectively appoint an independent third party (the “administrator”) to run and manage the business.  The administrator, not the business owner is liable for debts incurred once the business is in administration.

The administrator reviews the business to determine if it is able to continue trading or not.  They do not have to listen to the business owner and can implement different actions than what the business owner would prefer.

If the administrator believes the business can continue trading, they put to creditors a deed of company arrangement (“DOCA”) as a process of getting the business out of administration.  The typical deed will ask creditors to accept less than 100% of what is owed.

If the creditors approve the DOCA, the administrator will hand the business back to the owners and they have to work within the confines of the DOCA.

If the creditors don’t approve the DOCA, the business is effectively shut down and assets sold.  Any goodwill the business had is usually lost in this process.

This should all happen with six weeks.

Pros

• Provides protection for your personal assets in the period the business is controlled by the administrator. But no protection in the period before the administrator was appointed.
• Your DOCA may involve creditors accepting less than 100% of what is owed.

Cons

• A third party is in control of the business.
• Administrator’s job is to get the best return for creditors, not the business owner.
• As this third party is liable for debts when the business is in administration, they may take the risk adverse decision to stop trading, effectively closing your business and destroying any goodwill.
• Historically very few business’s come out of voluntary administration. Hence why new safe harbour laws (see below) were introduced in 2017.
• Public – large amount of information about your financial circumstances will be made public. Your customers may also become aware of this and get scared and source alternate suppliers.  Your competitors may also become aware of this and use this to their advantage.
• If the creditors don’t vote in favour of the DOCA, the business will be forced to close.
• You may still be found liable for trading whilst insolvent in the period before the administrator was appointed
• Can be costly.

Safe Harbour

Because so few companies were coming out of the voluntary administration process, it was not really achieving its objective of maximising the chances of a business with financial distress recovering and continuing to operate.

As a result, a different approach was required and the new Safe Harbour Laws were introduced in 2017.

These Safe Harbour laws allow eligible business owners to take reasonable steps to restructure and / or allow the business to trade out of its difficulties, without being personally liable for debts that the business runs up in the period you are trying to improve the financial position of the business.

In other words, if you are eligible for these Safe Harbour laws, you, as the business owner, without placing the business into voluntary administration, can buy some time to fix the financial problems of your business without putting your personal assets such as your house at risk.

It is important to remember Safe Harbour covers you for debts that are “incurred directly or indirectly in connection with” developing and taking the course of action.   Safe Harbour does not protect you for any other debts incurred where they are not for a proper purpose.  For example, you take on a debt to pay yourself a dividend, or pay for personal expenses.

The process

The business with financial distress needs to:

• obtain advice from an appropriately qualified entity to determine if it is eligible to use the Safe Harbour laws; and,
• be developing one or more courses of action that are reasonably likely to lead to a better outcomefor the company within a reasonable time frame.

You do not need to communicate this with creditors, customers or staff

Eligibility rules

To be able to use the Safe Harbour laws there are two key areas that the business and business owner need to comply.

The first part is very factual.  Is your business:

1. Paying all entitlements to your staff by the time they fall due. For example, paying superannuation on time.
2. Meeting all your tax reporting obligations to the Australian Taxation Office.
3. Taking appropriate steps to ensure you have appropriate financial records.
4. Taking appropriate steps to prevent any fraud or misconduct by officers or employees of the company.
5. Obtaining advice from an appropriately qualified entity.
6. Developing or implementing a plan for restructuring the company to improve its financial position.

And are you, as a business owner, properly informing yourself of the company’s financial position.

These are all factual questions and you as the business owner need to support these statements with some form of reasonable evidence.

The other area is less factual and more subjective.

You, as the business owner, must be developing one or more courses of action that are reasonably likely to lead to a better outcome for the company within a reasonable time frame.  In other words, a business rehabilitation plan.

What is a Better Outcome?

The Safe Harbour law defines a better outcome as one that is better for the company than the immediate appointment of an administrator, or liquidator.

Some of the things that you as the business owner need to consider to determine if you can achieve a better outcome include:

1. Are the financial difficulties facing the business from short term issues or a longer term irreversible decline? If it is a long term decline, then will a rehabilitation plan be reasonably able to improve the business outcome in an appropriate time frame?  Maybe in this situation you have no choice but to appoint an administrator.
2. Are the financial difficulties facing the business a result of factors outside your control? If the factors are outside you control, will you be able to implement changes for the better?  If not, maybe you have no choice but to appoint an administrator.
3. Can any rehabilitation plan be implemented in a reasonable time frame?

Pros

• Provides protection for your personal assets against properly incurred business debts (as long as you meet all other director duties).
• You, as the business owner are in control of the restructuring process.
• No defined time period, just needs to be undertaken in a reasonable time frame.
• Private – customers, creditors and suppliers don’t need to be notified.
• Flexibility in what you are doing as not just limited to a debt restructure.
• Available to you right now so can start to protect your personal assets straight away.
• Businesses today are using these laws to save their business.

Cons

• You need to meet the eligibility criteria which includes making sure all staff payments including superannuation are up to date.

Debtor in Possession Debt Restructure

As a result of the adverse impact on businesses of the shutdowns from COVID-19, the Federal Government introduced new laws, effective 1 January 2021.  The aim of the process is to have a debt restructuring plan in place for the company to repay its existing debts, thereby enabling the company to stay in business and avoid being wound up.  I have called these the “Debtor in Possession Debt Restructuring” laws.

The Debtor in Possession Debt Restructuring laws, allows eligible business owners with liabilities of less than $1 million, to trade in the ordinary course of business whilst they are taking steps to restructure their debts.  They can do this without being personally liable for debts incurred in the ordinary course of business, in the period you are trying to implement this debt restructure

The process

It is important to note that only the directors of the business can commence this debt restructuring process.  Creditors and other third parties cannot commence the process or force the company to enter the process.

The very first step is for the directors to have reasonable grounds for suspecting that the company is insolvent, or is likely to become insolvent at some future time.  And this will need to be documented by way of board resolution.

The next step is to determine if the business meets the eligibility requirements (see below).  Note the determination of the eligibility requirements would usually be done with the assistance of a small business restructuring practitioner” (“SBRP”), but at this stage they are not formally appointed as such.

The third step is to formally appoint the SBRP.  The SBRP must be a registered liquidator..

This appointment is announced to creditors.

This announcement then prevents unsecured and some secured creditors from taking action against the company.

The business and the SBRP then have 20 business days to prepare a debt restructuring plan to be sent to creditors.  Associated with the debt restructuring plan is sufficient information about the business’s financial affairs to allow the creditors to make an appropriate assessment of the debt restructuring plan.

Once the debt restructuring plan and associated information is provided to creditors, the creditors have 15 business days to vote on the plan (after proof of debt is confirmed).  Related party creditors can’t vote on the plan and secured creditors can only vote to the extent their debt exceeds the recoverable amount of their security.

If more than 50% of the creditors who voted, vote in favour of the debt restructuring plan, then the debt restructuring plan can proceed under the control of the business owners and they can do this without being personally liable for debts incurred in the ordinary course of business.

If this is not achieved, the business owner has limited options.  Either place the business into voluntary administration or use the proposed simplified liquidation process.

Eligibility rules

The key eligibility criteria as currently proposed include:

• The business must be insolvent, or likely to become insolvent. But it can’t already be under administration, in liquidation or operating under a deed of company arrangement
• Business must have liabilities of less than $1 million on the day that the small business restructuring practitioner” (“SBRP”) is appointed.
• You must retain a “small business restructuring practitioner” (“SBRP”).
• Paying all entitlements currently due and payable to your staff by the time they fall due. For example, paying superannuation on time.  This does not mean you have paid unused annual leave for example.
• Your tax lodgements are up to date, but does not mean they have to be paid if you have a payment arrangement with the ATO
• You can’t have used these laws previously (may be some flexibility in the regulations when finally issued).
• You have taken appropriate steps to ensure you have appropriate financial records and you are properly informing yourself of the company’s financial position.
• The restructuring plan can only deal with debts incurred by the company prior to entering debt restructuring

Pros

• Provides protection for your personal assets against properly incurred business debts (as long as you meet all other director duties).
• You as the business owner are in control of the restructuring process, providing the creditors vote in favour.
• Your debt repayment plan may involve creditors accepting less than 100% of what is owed.
• A simpler, cheaper and possibly quicker option than voluntary administration.

Cons

• Your business is taken to be insolvent if it proposes a restructuring plan to its creditors.
• Your business liabilities must be below $1 million to access this.
• Public process where creditors, staff, customers and competitors can see your financial information. Also, on all business paperwork such as invoices, you need to disclose “restructuring practitioner appointed”.
• You need to meet the eligibility criteria which includes making sure all staff payments including superannuation are up to date.
• Fixed time frames

Summary – what to do if your business is suffering from financial distress

If your business is suffering from financial distress and you want to try and save your business, without putting your personal assets at risk, what should you do?

You could consider voluntary administration.  But very few businesses actually come out the other side of this and continue to trade.  You may be lucky and be like Virgin Airlines and have a white knight come and save your business.  What are the chances of this for your business?  And my personal view is that if you know of a white knight, why do this in the public arena?  You could achieve the same object through the Safe Harbour laws.

You could consider a Debtor in Possession Debt Restructure, but you are still beholden to the views of creditors.  And if your business liabilities are over $1 million, you can’t use these anyway.

This leaves for many businesses the Safe Harbour laws.  But it takes time to ensure you comply with the eligibility criteria..

If you are thinking about utilising the Safe Harbour Laws, contact us for a confidential and obligation free initial assessment.

Contact Wayne Wanders for to see if you can access the Safe Harbour Laws

To ensure I help your business specifically, the best approach I have found is to have an obligation free session with you.  In this session we will review your current business in a factual and objective manner, to better understand the challenges that you face.  And this session does not need to be face to face.

At the end of this session, you will have some clarity around whether you can access the Safe Harbour Laws..

Simply fill in the contact form below or email me at wayne@aRealCFO.com.au or call me on 0412 227 052 to organise one of these obligation free sessions.

To get help you successfully navigate your way through your financial challenges so your business can survive and thrive in these uncertain times, simply use the contact form on the left to email Wayne or call him on 0412 227 052.

Let Wayne Wanders, a fully qualified and experienced CFO, help you successfully navigate your way through your financial challenges so your business can survive and thrive in these uncertain times.

Wayne Wanders, A Real CFO

wayne@aRealCFO.com.au