Does your business need more time to breathe?
Given the continued uncertainty surrounding the economic impacts of COVID-19, it’s likely that the Australian Government’s temporary relief measures for business may not be enough. Business owners and directors may need to look for additional options to ensure the survival of their company in the short to medium terms.
Organisations need to focus on preserving the business in the short term. In the medium term to longer term, the focus should shift to acquiring working capital and any additional financial support that might be required to reboot the business once the current trading restrictions ease.
Despite the changes to the safe harbour defence, the increased time to comply with statutory demands and the amounts under which a demand can be made; directors still need to be aware of, and adhere to, their common law and statutory duties.
One of those is the requirement to understand their obligations if the company can’t meet its debts as and when they fall due.
To that end, the voluntary administration process and the potential for the implementation of what is commonly known to insolvency professionals as a “Holding” or “Hibernation” Deed of Company Arrangement (DOCA), could be a useful mechanism under which those obligations can be met, providing further breathing space whilst the COVID-19 restrictions remain in place.
What is voluntary administration?
Voluntary administration is a formal regime that can be enacted to facilitate the survival of the business (where possible), or to administer the affairs of the company in a way that results in a better return to creditors then would have been received if the company was placed immediately into liquidation.
A company can appoint an administrator if its board is of the opinion that the company is, or is likely, to become insolvent in the future. Upon appointment of an administrator, all pre-appointment debts incurred by the company are subject to a moratorium period whilst investigations are undertaken and decisions made surrounding business conduct and survival.
There are two meetings of creditors held. The first is a formality where creditors are able to propose a replacement administrator and if so inclined, appoint a committee of inspection. Following the first meeting, a report to creditors is issued by the administrators which provides for a number of options for creditor consideration and approval. These options are generally: to accept a DOCA proposal, to end the administration; or to place the company into liquidation. Administrators are obliged to provide creditors with a recommendation as to whether any DOCA proposal should be accepted or whether the company should be placed into liquidation.
Further information can be found on the Worrells’ voluntary administration factsheet.
Whats a DOCA?
A DOCA is a binding instrument that is entered into between a proposer (usually the directors/shareholders but it can be another stakeholder), the company, the administrators and the company’s unsecured creditors.
It is a flexible tool that allows the proposer to offer a number of compromises that will result in a better return to unsecured creditors then would likely be afforded to them if the company was placed into liquidation.
It is important to note that unless a secured creditor is a party to the DOCA and/or has voted in favour of it, they are generally not bound by its terms. Landlords may not be (and are often not) bound by the terms of a DOCA.
DOCAs can be complex and may involve debt to equity swaps, replacement of shareholders and require court approval. They commonly result in a pool of funds being contributed by a stakeholder that—once paid to creditors—allows the company to emerge from insolvency and continue to trade.
They may also involve the utilisation of standstill arrangements pending a further DOCA proposal being finalised—aka the “Holding” DOCA.
Further information can be found on the Worrells’ Deeds of Company Arrangement factsheet.
So, why might a Holding DOCA be useful for a business that’s been “shutted” by COVID-19 restrictions?
A Holding DOCA’s benefits are that it:
- Provides further time for a voluntary administrator/stakeholder to develop proposals for the recapitalisation of the company without the need to seek orders from the court to extend the convening period of the administration;
- Provides an extended moratorium on pre-appointment debts and their enforcement against the company;
- Allows for continued oversight of the company and its operations by an independent party; and
- It provides stakeholders with additional updates surrounding the final DOCA proposal progress and allows for that proposal to be voted on by creditors at a further meeting of creditors once the business environment stabilises.
When considering whether a Holding DOCA is a viable option, the board needs to first ensure they have the support of creditors/stakeholders that may not be bound by the terms of a DOCA (secured creditors and landlords typically). Their support is paramount as they may enforce outside of the terms of the DOCA.
Furthermore, the costs incurred by the administrator during the administration and the Holding DOCA period are a cost of the administration and currently are not able to be compromised under the Corporations Act 2001.
While a Holding DOCA is not a ‘one size fits all’ solution to any business that is currently experiencing financial distress, there are circumstances where this may be a viable restructuring option.
Please reach out to your local Worrells partner if you would like to know more about the administration process or have any other insolvency questions.