The writer’s view is that 95% of voluntary administrations fail to meet the stated objective of the regime, being saving goodwill value of insolvent businesses, saving jobs and repaying a decent percentage of unsecured creditor debts (in double digits). Unfortunately, there is currently no conclusive empirical evidence to prove or disprove this proposition. This blog post is a warning to company directors to carefully consider the prospects of success before jumping into a voluntary administration.
What we know about voluntary administration success rates in 2019 (as a rough estimate):
|Stage of insolvency process||%|
|Insolvent companies that use voluntary administration||13%|
|Voluntary administrations that enter into DOCAs||28.5%|
|DOCAs that are successfully completed and deliver a trading enterprise within a year||~25% (writer’s estimate)|
|Overall result: estimate of percentage of insolvent companies that use voluntary administration to successfully restructure business (0.13*0.285*0.25)%||1%|
What is a successful voluntary administration?
When a company in Australia gets into financial difficulties, the term ‘voluntary administration’ often arises. This is the process whereby an independent specialist is appointed to take full control of the business for a limited period of time while at the same time providing a ‘moratorium’ on legal actions by creditors (i.e. breathing space). The Corporations Act 2001 declares the purpose of voluntary administration as maximising “the chances of the company, or as much as possible of its business, continuing in existence”. Only where this primary goal cannot be achieved is it the goal of voluntary administration to get a better deal for creditors of the company than liquidation.
The three elements of a successful voluntary administration process are:
- Goodwill value of business saved: Goodwill is an intangible asset that represents the value of a business over the total value of assets (e.g. plant and equipment). This is the X factor of business valuation and it is usually related to a ‘multiple of maintainable earnings’. Every business owner, at some time in their career, faces the issue of developing an exit strategy. At the end of the day if they don’t create goodwill value in a business (that gives them a sale value) they won’t receive any fruits of entrepreneurship.
- Jobs saved: Australia, unlike many other countries, genuinely cares about the protection of workers and their entitlements in the insolvency process. The government foots the bill for a large portion of unpaid entitlements through the Fair Entitlement Guarantee. This means that one of the key elements of insolvency law policy (and a key justification for business restructures) is the protection of jobs.
- Unsecured creditor debt payments: The payment of unsecured creditor claims is a key element of a successful voluntary administration. Over time the returns to unsecured creditors from voluntary administration have deteriorated but a decent return to unsecured creditors would be in the double digits of a percentage. For example, a deed of company arrangement that delivers a dividend to creditors of 20c in the dollar for their debts would be preferable to receiving no return in a liquidation scenario.
The key question that all directors ask: how successful is the voluntary administration process?
The answer is that it is unlikely to be at all successful for directors or their company’s creditors.
The creditors can expect returns from a deed of company arrangement (DOCA) in the order of 5-7c in the dollar*. Directors should not expect to trade through the voluntary administration, or for deed of company arrangement periods to result in a company that is free and clear of legacy debt (10% chance or less). In the market, other businesses view voluntary administration as the equal of liquidation and it carries a stigma that results in the ultimate destruction of goodwill value.
The winners are the administrators with the average fees being in the order of $97,000* in small voluntary administration processes.
Why is there a lack of empirical research on the topic?
There are very few empirical reports in Australia that can be drawn upon to educate us about the effectiveness of voluntary administration. In the United States of America there is a wealth of research into Chapter 11 of the Bankruptcy Code generated through universities. Empirical research into voluntary administration is important because if you can’t measure it, you can’t manage it.
The problem that Australia has is that without in-depth insolvency research we are “walking blind”. Insolvency in Australia is at risk of being hijacked by industry groups or fraudsters (i.e. phoenix operators) rather than good policymakers.
Australia is a much smaller market and unlike the United States, the historical focus of bankruptcy and insolvency law has been to punish debtors rather than restructure insolvent businesses. It may be that there is also a bias in the insolvency industry against undertaking empirical research because it would undermine the professional fees that the process generates.
For the company director considering voluntary administration, they should exercise extreme scepticism about the prospects of success unless a detailed review is undertaken by experienced professional advisers.
What is voluntary administration?
It is important to understand the distinction between voluntary administration and a range of other legal concepts that it is sometimes confused with:
- ‘Insolvency’ occurs when an individual or business cannot pay their debts as they fall due. In making the decision to enter into voluntary administration, directors are often guided by an awareness of their duty to prevent the company trading while insolvent.
- ‘Receivership’ occurs when a secured creditor (or occasionally, the court) appoints an independent specialist (‘the Receiver’) to have control of the company’s assets. The receiver’s task is to sell enough of the company’s secured assets to repay the debt owed. This process does not affect the existence of the company.
- ‘Liquidation’ means the winding up of a company including an investigation into the company and the distribution of assets to creditors.
- ‘Bankruptcy’ is the process where individuals (rather than companies) are declared unable to pay their debts as they fall due and an independent person is appointed to assess tax liabilities and if there are assets remaining, distribute them to creditors.
Voluntary administration and the last three terms are sometimes referred to as different types of ‘external administration’.
On appointment, the voluntary administrator gains control of the company, its business affairs and its property. The company’s directors are then required to assist the voluntary administrator.
The voluntary administrator’s key outputs are a set of recommendations to creditors as to what should be done with the company and its property as well as accompanying reports.
The appointment decision, usually made by a majority vote of the company’s directors, can be made when the directors are of the view that the company either is insolvent or is likely to become insolvent at some time in the future. However, the decision can also be made by liquidators/provisional liquidators and some secured creditors.
How is a voluntary administration executed? Through two meetings of creditors
Within five business days of being appointed, the voluntary administrator must call a ‘first meeting’ of the creditors.
The creditors will determine:
- whether to replace the voluntary administrator with someone else; or
- whether a committee of creditors should be appointed to correspond with the voluntary administrator throughout the course of the voluntary administration.
Within 28 to 35 days, the voluntary administrator will need to call a ‘second meeting’ to determine the company’s future. The voluntary administrator will release a range of information for the meeting and offer an opinion on three options:
- whether it is in creditors’ interests to execute a deed of company arrangement (DOCA). A DOCA is a binding arrangement between a company and its creditors resolving how the company’s affairs will be dealt with and what proceeds they will see. It binds all unsecured creditors whether they voted for the DOCA or not;
- whether it is in creditors’ interests for the administration to end and give the company back to the directors; and
- whether it is in creditors’ interests for the company to be wound up through a liquidation.
In response, the creditors must make a decision to do one of the following:
- execute a DOCA;
- end the administration;
- have the company wound up; or
- adjourn the meeting for up to 60 days.
What is the main benefit of a voluntary administration? A moratorium from creditors
The most important effect of voluntary administration is the moratorium from the enforcement of creditor claims. This means that a range of actions against the company that would be adverse to its continued operation is temporarily frozen in order to give the company ‘breathing space’. The moratorium means:
- The company cannot be wound up;
- Securities cannot be enforced (with some exceptions);
- An owner or lessor cannot recover property used by the company (with some exceptions);
- Legal proceedings cannot be commenced against the company (with some exceptions);
- A company director’s guarantee cannot be enforced.
The objective of the regime is to give directors a process to protect the goodwill value in an insolvent business from winding up by creditors.
Other typical objectives behind directors appointing a voluntary administrator include:
- Delay creditors: using the process to delay creditor action
- Litigation tactic: staying winding up applications or other causes of action
- Director’s escape valve: avoiding investigations that may follow a liquidation
- Control of the company: resolution of internal disputes
- Employees: stifle enterprise bargaining
- Future complaints: avoid compensating future claimants
- Relation-back period deferred for unfair preference claims
What is the typical outcome of a voluntary administration? It isn’t a DOCA being fulfilled
There is enough empirical evidence to support concern about the voluntary administration process. In its submissions to a parliamentary inquiry the ASIC reported that between 1993 and 1997 of the 5760 companies that entered into voluntary administration, only 10% resumed “normal trading”. (Source: Parliamentary Joint Committee on Corporations and Financial Services, Corporate Insolvency Laws: a Stocktake (June 2004))
In considering the possibility of voluntary administration this is an essential, but a very difficult, question to answer. It is difficult because there is little agreement as to what the ‘correct’ measure of success is for voluntary administration. Is it the successful completion of DOCAs? What if those DOCAs provide a poor return for creditors? Or, might it be the proportion of businesses that continue to trade (in some form) after voluntary administration?
Voluntary administration is becoming a less popular option for company directors. In 2003, approximately 41 per cent of insolvency appointments were voluntary administrators (See Parliamentary Joint Committee on Corporations and Financial Services Corporate Insolvency Laws: a Stocktake (2004)). In an analysis of ASIC insolvency statistics for the 2015 year, Jason Harris estimated that the proportion of voluntary administrations occurring in insolvency appointments dropped to around 13% of companies that enter formal insolvency. Creditors’ voluntary liquidations are a much more common insolvency tool at 49%. Declining popularity, however, does not tell us whether voluntary administration is a useful tool, but it is a negative indicator.
As the DOCA is the tailored outcome of the voluntary administration process, it is important to look at how common the DOCA outcome is as a proportion of voluntary administration outcomes. In the years 1992-2001, 25 to 50 percent of voluntary administrations ended with DOCAs. Recent analysis by Jason Harris shows that this proportion has remained relatively stable over the years. For the 2017 year, DOCAs made up 28.5% of all insolvency appointments.
To summarise, we know that voluntary administrations are decreasing in popularity but that DOCAs remain a stable outcome of voluntary administrations at around a third. What we still need to determine is whether the outcomes of the voluntary administration process and DOCAs satisfy the goals of voluntary administration as set out in the Corporations Act 2001.
In a 2014 study, Mark Wellard looked at a cross-section of DOCAs in depth to see the quality of the outcomes that they provide for companies and creditors. His study demonstrated that:
- Creditors received, on average, 5-8 cents on the dollar;
- 72 per cent of DOCAs were ‘compromises’ which might be thought of as ‘glorified liquidations’. In the remaining 28 per cent there was some substantial carrying on of the company’s business through the DOCA.
In 2015 the Productivity Commission reinforced this point showing that, again on the basis of ASIC statistics:
- 37 per cent are deregistered within two years of the commencement of a voluntary administration;
- 57 percent are deregistered within three years;
- 70 per cent are deregistered within four years; and
- 78 per cent are deregistered within five years.
All-things-considered, there is not very strong empirical evidence to suggest that voluntary administration is meeting the goals of the process as set out in the Corporations Act 2001. Only a small proportion of companies are continuing to substantially trade after voluntary administration and the average proceeds available for creditors are meagre. While it is possible to argue that many of these businesses would have been wound up anyway, and the distributions to creditors may have been less than from a straightforward liquidation, the continued decline in popularity of voluntary administrations suggests that companies themselves are seeing it as less desirable than other insolvency options.
The typical outcome of a voluntary administration may be described as a “glorified liquidation”.* The voluntary administration process is subject to a vote of creditors at the second meeting of creditors that decides the fate of the company (i.e. liquidation or deed of company arrangement). Most voluntary administrations today result in a liquidation rather than a DOCA.
Further, of the companies that do enter into a DOCA, the majority (49/72*) are non-trading and therefore the company that is subject to the DOCA becomes a shell. The purposes of this DOCA may be to stall litigation, resolve a directorship dispute, obtain breathing space from tax liabilities and/or discharge liability for unfair preference claims or director claw-back actions. One of the main benefits of a DOCA compared to a liquidation is that the directors are protected from claw-back actions because the company does not go into liquidation.
What would an exceptional outcome of a voluntary administration look like?
- Trading on the business through a DOCA and beyond
- Third party contribution to the DOCA fund
- Arrangements with continuing creditors to ensure ongoing support outside the DOCA
- Motivated management and staff (good culture)
- Some return for non-continuing creditors (e.g. 10c in dollar)
*Wellard describes this as a “creative alternative DOCA” in comparison to the standard DOCA which is a “Quasi-liquidation DOCA”.
What are the potential negative impacts of voluntary administration?
Putting to one side the low success rates of voluntary administration, we think there are other reasons to think twice before using this process. Negative potential impacts of voluntary administration include:
- Reputational damage. Not only is voluntary administration likely to damage the company’s relationship with suppliers, it can also negatively impact on the relationship with customers. The differences between distinct insolvency appointments like voluntary administration and receivership are sometimes not understood by the broader public. As Jason Harris put it:“the public perception of formal restructuring procedures is one of failure. Voluntary administration is reported in the press as the end of a company, with corporate undertakers sent in to sell the business, often in conjunction with a receivership.”
- In some industries, voluntary administration has become synonymous in people’s minds with misconduct. For example, the widely publicised Independent Inquiry into Construction Industry Insolvency in NSW in 2012 found that widespread financial mismanagement in the construction industry had led to a multitude of voluntary administrations.
- Another significant potential negative effect is the impact on any licenses held by the company. For example, for energy retailers, special provisions of the National Energy Retail Law kick in upon voluntary administration and in the building industry, depending on the jurisdiction, licences may be cancelled immediately;
- Secured creditors might decide to appoint a receiver.
What are the alternatives to voluntary administration?
- Informal arrangements: See our podcast and interview on the safe harbour from insolvent trading
- Pre-pack insolvency arrangement: Read our whitepaper
- Obtaining further finance (debt or equity)
- Putting the company into liquidation
Other than the writer’s opinion, parts of this blog post are based upon the empirical research carried out by Mark Wellard in the 19 May 2014 report:
Wellard, Mark Norman (2014) A sample review of Deeds of Company Arrangement under Part 5.3A of the Corporations Act. ARITA Terry Taylor Scholarship. Australian Restructuring Insolvency and Turnaround Association.