Help, my company is insolvent! Who should I call?
When a company becomes insolvent, the directors have a difficult challenge ahead if they want to salvage it. The first task company directors have is to work out who is going to be their trusted adviser.
If a director “starts developing” a restructuring plan they can take advantage of the new safe harbour from the insolvent trading prohibition. On the other hand, appointing a voluntary administrator puts in place a moratorium from creditor claims and winding up petitions that might be necessary to stop legal action.
So who does a director consult to make a decision?
- An insolvency practitioner who could become a liquidator or voluntary administrator or advise on a safe harbour restructure (but not both);
- An accountant, lawyer or consultant who specialises in offering restructuring and safe harbour protection advice (but who doesn’t take on formal appointments as liquidator or voluntary administrator).
What are the benefits and shortcomings of each type of adviser?
- Day-to-day experience administering formal appointments
- Up-to-date knowledge of restructuring techniques
- Not likely to have an entrepreneurial flair
- May not be interested in accounting and finance advice because formal appointments (e.g. voluntary administration) are more profitable
- Could later be under a conflict of interest if they take a formal appointment because they would be obliged to act in the interests of the creditors
- Likely to have good contacts in finance and accounting
- All communications are privileged
- May have good knowledge of insolvency law if they are a specialist insolvency lawyer
- May have up-to-date knowledge of restructuring techniques
- Very unlikely to have an entrepreneurial flair
- If the restructure falls apart they can continue to support the directors personally
- Likely to have good contacts in finance and accounting
- Some experience in real small-to-medium-sized enterprise turnarounds
- Not likely to be on top of insolvency law and restructuring techniques (because they do lots of other things like tax)
- May have good contacts to help implement a turnaround
- May have an entrepreneurial flair
- Not likely to be on top of insolvency law and restructuring techniques
- To understand what phoenix activity is read our blog post: What is phoenix activity?
- May be a failed liquidator or lawyer
- Usually, run a “bait and switch” model that takes advantage of the director’s weak circumstances and implements a plan that is doomed to fail
How do you pick a suitable turnaround adviser?
Answer: Shop around, ask for evidence about their expertise and think about whether you’re comfortable working with them.
- Ask the adviser to describe the last 2 matters that have been involved in and how they added value
- Ask to speak to 2 directors of companies they have assisted
- Think about whether you could work with this person in a high-pressure situation (personal chemistry)
- Read some of their written materials or case studies
- Ask for a reference from another experienced professional they have worked with such as a partner of an accounting firm, judge, barrister, head of a professional association, etc.
The take-away is that company directors should combine both an objective evaluation of the experience of the adviser and also think about personal chemistry.
What are the techniques that could be implemented?
Option 1: Informal restructure through the safe harbour
Up until the end of 2017 companies that were insolvent were prohibited from continuing to trade (via the director’s duty to prevent insolvent trading). Australia’s insolvent trading laws were then significantly watered down by the passing of the safe harbour from insolvent trading (section 588GA of the Corporations Act).
The key requirement to obtaining safe harbour protection is that the directors start to develop a restructuring plan. To do this it is likely that they’ll need an “appropriately qualified entity” to advise them and document the informal restructuring process.
Option 2: Formal restructure through a voluntary administration
Voluntary administration is a formal process where the voluntary administrator takes over control of the company from the directors. The focus is to put an offer of compromise to creditors whilst continuing to trade the business and investigate the conduct of directors. If the voluntary administrator isn’t able to convince creditors to accept an offer of compromise from directors, the company is put into liquidation.
There is a potential conflict of interest so the voluntary administrator is prohibited from providing substantial pre-insolvency advice to the directors about restructuring pre-appointment. The position of the voluntary administrator is a difficult one and directors often accuse them of being “Jekyll and Hyde”. The directors appoint the voluntary administrator so before their appointment, they’ll be friendly and give assurances of a smooth process. But after their appointment (when under statutory obligation to act in the best interests of creditors) the friendliness ends and the cold reality of the actual voluntary administration process is realised.
The insolvency industry is not a place for new players to try without support. The usual process of appointment of an insolvency practitioner, through the company’s external accountant, is unlikely to be optimal. There may be a paid referral relationship in place or some other incentive that the external accountant receives in consideration for the referral. Directors are better off appointing an independent expert who acts solely in the interests of the directors and owners and has sufficient experience with insolvency to give robust and uninhibited advice.
Option 3: Shut down or break up the business through a liquidation
This is the last option that is only utilised when it becomes clear to directors that the salvage of the business entity (i.e. the company itself) isn’t possible.
When a company is wound up due to insolvency the process is commenced because the company has no chance of financial recovery. This may not mean that the business itself is terminated because a director can transfer business assets through a pre-pack insolvency arrangement before the commencement of liquidation. See a lawyer if you want to do this legally or you may find yourself inadvertently involved in phoenix activity.
When the company is in liquidation the liquidator has a duty to act in the business interests of creditors and this includes investigating any pre-pack insolvency arrangement and other pre-appointment transactions.