Directors shouldn’t appoint a voluntary administrator:
- When they don’t have any idea about how key suppliers, employees and other stakeholders will react
- If they don’t already have a plan in place for a compromise to offer to creditors
- If a pre-pack insolvency arrangement or some other informal restructure through the safe harbour hasn’t been looked into first
- If they haven’t thought about the consequences of failure and the liquidation of the company
|Essential pre-planning for voluntary administration||The potential result of poor planning and analysis|
|You need to have a good idea about how key suppliers, employees and other stakeholders will react||A voluntary administration could be the kiss of death for the business|
|You need a written compromise to offer to creditors||You’ll be swept up with the process and lose influence over the outcome because you haven’t worked out a strategy|
|You should consider whether an informal restructure through the safe harbour would be more effective||You’ll pay a lot more in professional fees and put your business in the hands of others|
|You should also plan for a liquidation (at least 95% overall chance of failure of voluntary administration)||If the business isn’t viable it won’t be saved by a voluntary administration and it will be sold in a fire-sale at some point|
What’s it all about? The purpose of voluntary administration
The voluntary administration regime was introduced into the Corporations Law in 1993 to provide an alternative to liquidation and the immediate closure of insolvent businesses. The intention was to protect the going-concern value of insolvent businesses by creating a flexible process of implementing a compromise with creditors with minimal Court involvement. The consensus in the insolvency industry is that it basically failed in its purpose because it gets bogged down in litigation and angry creditors have control of the outcome. The bad news for directors is that there is no plan to change voluntary administration in the near future.
The process of voluntary administration is controlled by an independent insolvency practitioner who is appointed by the directors. If a compromise offered by the directors is not accepted by a vote of the creditors then the company goes into liquidation nevertheless.
For more information about voluntary administration, appointments read our blog post: Who appoints a voluntary administrator?
For information about the low success rates of voluntary administration read our blog post: What are the success rates of voluntary administration?
For more information about the shortcomings of voluntary administration read our blog post: What are the shortcomings of voluntary administration?
What are the alternatives to voluntary administration?
The key alternatives to voluntary administration are:
- An informal restructure through the safe harbour from insolvent trading (watch our interview and listen to our podcast)
- An informal restructure through a pre-pack insolvency arrangement (read our whitepaper)
It should be noted that voluntary administration can be used in conjunction with other informal restructuring techniques. The big end of town is now focusing its restructuring efforts towards using pre-packs and voluntary administrations together. However, businesses with less than 200 employees (i.e. small-to-medium sized enterprises) usually can’t find the right lawyers and accountants to help them put together an effective pre-pack insolvency arrangement.
In 2017, Channel 10 was successfully restructured using both a pre-pack insolvency arrangement and a voluntary administration. ASIC objected to the process of using the same insolvency practitioner for the pre-pack and voluntary administration but the Federal Court allowed it: see Re Korda, in the matter of Ten Network Holdings Pty Ltd (Administrators Appointed)(Receivers and Managers Appointed)  FCA 914.
Summary of voluntary administration
|How is a voluntary administration commenced?||Usually by directors of the insolvent company|
|What criteria needs to be met for a voluntary administrator to be appointed?||The company must be insolvent (or about to become insolvent)|
|What happens when the voluntary administrator is appointed?||The voluntary administrator assumes control and the powers of directors are suspended. The voluntary administrator then decides whether the business trades day-to-day.|
|How long does a voluntary administration last?||Usually about 6 weeks in total|
|What is a successful voluntary administration?||Occurs when the creditors vote in favour of a deed of company arrangement (DOCA) proposal and the business of the company survives to complete its obligations under the DOCA|
|What is an unsuccessful voluntary administration?||The directors expect that a DOCA will succeed but it is voted down by creditors and the assets of the company are sold in a fire-sale after liquidation|
How does voluntary administration actually work? Directors lose control of the business
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, 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.
Key take-away for directors: The voluntary administrator doesn’t work for the directors, they work for the creditors.
Do you need time? Voluntary administration could be a quick death
The main benefit of the voluntary administration process is that it gives directors ‘breathing time’ to work on a restructure. However, this isn’t very long: the time frames show that directors have about 6 weeks to finalise the restructure. The short time frame is both a blessing and a curse. Australia’s short time frames are in contrast to Chapter 11 in the United States where a formal restructure is given on average 180 days to be put together.
Within five business days of being appointed, the voluntary administrator must call a ‘first meeting’ of the creditors. At that meeting, the creditors decide whether to replace the voluntary administrator with someone else.
Within 28 or 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 for the creditors to vote on:
- Whether to accept the director’s compromise proposal and formalise it through a deed of company arrangement (DOCA);
- Whether to reject the compromise and put the company into liquidation; or
- Whether to stop the process completely and give the company back to directors (an extremely unlikely outcome in the writer’s view)
Given the short time frame and the requirement that creditors vote favourably to accept the DOCA proposal some key questions need to be asked by directors, including:
- Do my creditors hate me? This is not such a dumb question for anyone who has been to a creditors meeting where there is screaming and swearing. It is unlikely that you’ll be able to change their mind in 6 weeks if you’re only offering them a small dividend and they feel injustice.
- Are you going to rely on the ATO to vote in favour? The ATO usually doesn’t vote in favour of DOCAs so you should probably expect them to abstain. Secured creditors are also going to abstain.
- Will your vote be relying on subcontractors and suppliers? If anyone is going to be unhappy about the process it is likely to be subcontractors and suppliers because they are likely to receive very little by way of dividend.
- Will the voluntary administrator exercise their casting vote? It would be wise for directors to read about this further. It is a backup in case the majority of creditors (in value) vote against your proposal but you have a majority in number through employee votes.
- Are there any winding up applications on foot? The Court could make orders to appoint a liquidator over the top of your voluntary administrator if the Judge isn’t convinced that the voluntary administration is the right way to go.
Typical reactions of key suppliers, employees and other stakeholders
- By industry: Some industries have stakeholders that react aggressively to the voluntary administration process, such as building and construction. Subcontractors are aware that they are likely to get no returns and they are usually very angry.
- Landlords: Rarely compromise on rent that is overdue and this may result in a lock-out from trading premises after a voluntary administration commences (look into the new ipso facto prohibitions for post-1 July 2018 leases that may assist)
- Sub-contractors: Will not expect a return from a deed of company arrangement and will, therefore, be likely to react aggressively if they don’t get a tangible benefit
- Employees: It is a requirement that they are paid in full during the process and they should receive entitlements from FEG and/or the DOCA but they are unlikely to enjoy being managed by the voluntary administrator
- ATO: The Australian Tax Office deals with liquidations and voluntary administrations every day. Unless there is phoenix activity or some other fraud they are unlikely to be very concerned about what happens in small-to-medium-sized enterprises going into voluntary administration.
- Media: If you’re in a business that has lots of small creditors and lots of employees (such as retail) then you’ll get some media attention. Otherwise your voluntary administration will only attract the attention of creditors and your employees.
Take-away for directors: ask yourselves, are you liked by creditors? This is a funny question and it calls for reflection but the more successful voluntary administrations tend to have an entrepreneur who is well-regarded by creditors. If you are a director who has avoided and infuriated creditors during the spiral of insolvency then serious thought needs to be put into what can be done to obtain a favourable vote through a voluntary administration.
Issue 1: 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 (see section 415D of the Corporations Act).
The differences between distinct insolvency appointments like voluntary administration and receivership aren’t understood by the public. As Professor 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.”
The media conflate voluntary administration, liquidation and receivership together so you can’t expect the creditors to avoid the feeling of complete loss as soon as you start the process. To put it another way, there is no public discourse about any successful voluntary administrations – every voluntary administration reported in the media has unhappy people that ultimately lose out.
Australia isn’t a friendly place for entrepreneurs that need to restructure and historically the focus of insolvency law (e.g. the insolvent trading prohibition) is to punish entrepreneurs who attempt informal restructures. A lot has changed, however, since the days of Alan Bond and Bell Resources and John Elliott and Elders IXL. The focus of policy-makers is now to ‘create an ecosystem of entrepreneurship’. The Australian Government report in 2016 titled ‘Improving bankruptcy and insolvency laws’ stated the new focus of policy:
“More often than not, entrepreneurs will fail several times before they achieve success. To create an ecosystem that enables these entrepreneurs to succeed will require a cultural shift. Our current insolvency laws put too much focus on penalising and stigmatising the failures. With these measures in place, bankruptcy and insolvency laws will strike a better balance between encouraging entrepreneurship and protecting creditors. Over time, these changes will help reduce the stigma associated with business failure.”
The Australian culture, however, is pretty hardwired against insolvent entrepreneurs (as a result of the cowboy culture of the 1980s and the bottom of the harbour schemes of the 1970s) so it may take some time for us to shift our cultural attitudes. In the United States, for example, President Trump used Chapter 11 bankruptcy six times for his businesses and this didn’t cast much shadow upon his 2016 political campaign. The New York times reported on 11 June 2016:
“As all of his ventures neared collapse, Mr. Trump’s lenders insisted that he submit a business plan, appoint a chief financial officer for the Trump Organization and sell, among other things, the Trump Shuttle airline, his yacht and his stake in New York City’s Plaza Hotel, which also filed for bankruptcy protection. They also put him on a $450,000-a-month budget for personal and household expenses.”
The focus of media reporting wasn’t criticism of using Chapter 11 protections to restructure but mismanagement. This is in complete contrast to Australian media reporting that rarely takes a sympathetic view of entrepreneurship and insolvency. This harsh coverage undoubtedly has deep cultural roots in Australia.
Take-away for directors: Expect reputational damage from appointing voluntary administrators.
Issue 2: Stigma of misconduct
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. The media reports create the sense in the community that voluntary administration part of the ‘dodgy’ directors playbook.
This is a problem for entrepreneurs in Australia because they are going to be adversely affected by publicity from the appointment of voluntary administrators. There is also a real chance that it will follow them throughout their career.
Take-away for directors: Most creditors will think that “something dodgy” has happened where a voluntary administration has occurred.
Issue 3: Exercise of termination clauses by counterparties
Another significant potential negative effect is the impact on any licenses and contracts held by the company. For example, in the building and construction industry, head contractors usually find their construction contracts terminated by developers immediately after they enter into voluntary administration.
There is a new law that has been implemented to stop the enforcement of ‘ipso facto’ clauses in contracts being enforced in voluntary administration. As a consequence, the contractual counterparties will be ‘locked-in’ and required to continue to perform contractual obligations, at least for the period that the voluntary administration is on foot.
‘Locking-in’ suppliers and other contractual counterparties during voluntary administration is intended to assist in maintaining ‘business as usual’ conditions for the company’s trading during these insolvency processes. This should help prevent the unnecessary destruction of valuable and viable businesses, and thereby create a better opportunity for a successful restructuring.
Caveat: The new law on ipso facto clauses does not apply to contracts entered into before 1 July 2018.
Issue 4: Employees lose confidence and depart
Employees are keenly aware that during voluntary administration, everything has changed and their tenure depends on the voluntary administrator.
Voluntary administration is often seen as a good way to terminate non-performing staff but it may also have a chilling effect on productive staff. Not only will the productive staff be worried about whether the company will ultimately fail but you can expect that they will immediately start looking for new jobs because they will realise that the company could be placed in liquidation.
Issue 5: A DOCA probably won’t work as a restructuring technique
The terms of the director’s offer of compromise are put to creditors by the voluntary administrator in a report along with a recommendation about whether the creditors should accept it. Whether the voluntary administrator recommends that creditors accept the proposal is a matter for their professional judgment. The vote requires both a majority in number and a majority in value of the creditors to support the proposal for it to succeed.
The proposal terms should be prepared in advance of the appointment and thoroughly considered before a voluntary administrator is appointed. Directors need to ask themselves: can I afford it and are creditors likely to accept it?
The chances of a successful DOCA are low and our estimate is that 95% of voluntary administrations fail: Read our blog post What are the success rates of voluntary administration?
Alternative: Pre-pack insolvency arrangement
The key objective of a pre-pack insolvency arrangement is to ensure that the business of the company is preserved whilst the company itself goes into liquidation. It is an alternative to formal restructuring through a voluntary administration process.
A pre-pack insolvency arrangement has the following elements:
- A company (Oldco) is insolvent;
- Oldco’s business is transferred for commercial consideration to a related entity (Newco); and
- The transaction between Oldco and Newco results an optimal outcome for stakeholders.
The two key characteristics of an insolvent company that may be suitable for a pre-pack insolvency arrangement are:
- That there is a serious risk the goodwill in a business will be damaged by a formal appointment scenario (such as a voluntary administration); and
- The costs of a voluntary administration are uncommercial.
The benefits of a pre-pack insolvency arrangement are that directors maintain control of the insolvency process and can forward plan costings before executing a plan. On the other hand, directors will need to make sure they have a good lawyer and accountant to put it together.
Phoenix activity occurs when a business is transferred for ‘inadequate consideration” before or during insolvency. The liquidator can take action against the directors for phoenix activity and they are obliged to report it to ASIC. For more information about phoenix activity watch our interview: What is phoenix activity and how does the law (attempt to) regulate it?
To learn more about a pre-pack insolvency arrangement read our whitepaper: What you need to know before you pre-pack (to avoid phoenix activity)
If the DOCA doesn’t work: consequences of failure and the liquidation of the company
If there is a vote by creditors against the DOCA proposed by the directors then the company will be placed in liquidation at the conclusion of the meeting. The liquidation will result in the fire-sale of any remaining assets of the company unless a satisfactory offer to purchase the assets is put to the liquidator. It is very unlikely that a voluntary administrator will sell business assets to the directors during the voluntary administration period because it would expose them to criticism from the creditors (i.e. doing a dodgy deal with directors).
One key issue to consider is the incentivisation of the insolvency practitioner and understanding the limitations of what directors should expect. Directors should be aware that:
- If insolvency practitioners don’t get paid they won’t do the work – the insolvency practitioner won’t work above and beyond what they get paid for. This goes against their professional obligations but more realistically, it’s primarily because they aren’t running a charity.
- Insolvency practitioners are paid hourly so they won’t take any personal risk – why should they take any risk when they don’t share in the rewards? If you expect a voluntary administrator to take an action for your benefit that puts them at risk of a court action or public criticism, you’re being unrealistic.
- The insolvency practitioner will probably be paid more if the voluntary administration fails and they have a long liquidation process to attend to. The value from recovering voidable transactions, selling assets and other recoveries will be greater than a short voluntary administration.
- Insolvency practitioners are trained in compliance processes. They aren’t entrepreneurs – so if you expect them to rally your sales team? Forget about it.
Take-away for directors: insolvency practitioners aren’t incentivised to take personal risk or move out of their comfort zone so don’t expect them to be entrepreneurs.