The internet contains a lot of information about the various insolvency options, but sometimes it’s difficult to understand how the different options work together.
In our recent Worrells breakfast seminar series, we talked through the corporate insolvency options available through our case study on Fork in the Road Civil Pty Ltd. I thought it was worthwhile summarising the options for those who couldn’t make the seminar, and hopefully at the same time show that there are options that suit every corporate client suffering from solvency issues.
This article is all about companies that are in financial trouble. So, if it's a person (not a company) that’s in trouble, then look out for our future article on the personal insolvency options. If it’s a trust, then you need to establish who the trustee is and go from there.
There are three main corporate insolvency options:
Repayment Arrangements / Informal Workouts
Formal Restructuring
Liquidation
1. Repayment Arrangements / Informal Workouts
Repayment arrangements are agreements exclusively between the company and its creditors that don’t need to be supervised by a licensed external administrator. Most are simple repayment arrangements with one creditor (e.g., ATO) where the company agrees to pay the total debt a little later than when it is due, or over an extended period of time. They are negotiated over the phone or in person, and no written agreement is necessary, but for larger and/or more complicated debts, it would be wise to document the arrangement.
Repayment arrangements can be used to negotiate deals with multiple creditors at the same time. However, they are best used when you have a minimal number of creditors (e.g., three to five). If you have a larger number of creditors to contend with, it can become unwieldy to negotiate multiple deals at once.
One key point is that the creditor must agree to the repayment arrangement; you can’t force a creditor to accept.
2. Formal Restructuring
The Small Business Restructuring (SBR) and Voluntary Administration (VA) processes are designed to assist a company to come to a formal agreement with all creditors to pay all or part of its debts. Whilst the director may personally do some of the negotiation with creditors, the processes have to be conducted through a licensed registered liquidator.
The SBR and VA processes are powerful tools to deal with large numbers of unsecured creditors at one time. Secured creditors (i.e. those who can foreclose on an asset if you don’t pay) generally sit outside the arrangement. The processes are generally about 4–6 weeks long (but can be extended in special circumstances), culminating in a meeting of creditors where the creditors vote on whether to accept or reject the deal put to them.
Unlike repayment arrangements, where you need the consent of each individual creditor to the repayment, under the SBR and VA processes, acceptance or rejection of the deal is based upon creditor votes. So, you can have some creditors outvoting other creditors to get the arrangement accepted (or rejected).
The major differences between the SBR and the VA processes are:
There are eligibility criteria for the SBR.
Under the SBR, the directors remain in control of the trading of the company's business, whereas under the VA the administrator takes control of the company’s business, property, and financial affairs. (i.e., the directors and other officers lose all their powers and can only deal with the company with the permission of the voluntary administrator.)
Under the SBR, related party creditors can’t vote on the proposed arrangement.
Both processes are best used when you want to save your company. Whilst the deal can be just about anything the company can afford and creditors are prepared to accept, including making payments over a period of time from profits generated by the company, creditors are more likely to accept the certainty of a lump sum payment. Therefore, it is good to have some external funding (e.g., borrowings from your house or family) available to offer to creditors.
It is important to be aware that the SBR and VA processes are to allow a company to do a deal with its creditors. Guarantors will generally continue to be liable for the whole amount of the debt. For example, the company may do a deal to pay creditors 30% of their debts, but creditors may still be able to pursue the guarantors for the other remaining 70% of their debts.
You can read more about SBR and VA on our fact sheets.
Small Business Restructuring (SBR) Explained | Worrells
Voluntary administration: What is the process? | Worrells
3. Liquidation
Liquidation is the end of the life of the company. The role of the liquidator is to realise the company’s assets and any other recoveries, and then to pay that money to the company’s creditors and shareholders. Where the company is unable to pay all its debts, the liquidator reviews the company’s affairs to get an understanding of why the company is in its current financial position and to determine if there are any transactions the company has entered into that can be overturned, so as to realise more money for the stakeholders.
A liquidation can be commenced by the court on an application of a creditor (court liquidation), or by resolutions of the directors and shareholders (members’ voluntary liquidation and creditors’ voluntary liquidation). Liquidations of insolvent companies (court liquidations and creditors voluntary liquidations) can only be administered by licensed liquidators, but solvent liquidations (members’ voluntary liquidations) can be administered by just about anybody. There are, however, specific responsibilities and ASIC lodgement requirements, so I recommend that even with a member’s voluntary liquidation, you should consult a licensed liquidator.
The main effects on directors of companies that go into liquidation are:
Creditors with personal guarantees will pursue the guarantors for payment of the company’s debts.
The Australian Securities & Investments Commission conducts an investigation into the conduct of directors. They don’t always investigate, but will if the director was the director of two or more companies that go into liquidation in a seven-year period. In essence, they are trying to determine if the director has willingly steered the company into its financial plight and, therefore, should be banned from being a director for a period of time.
In some cases, the liquidation is recorded on the director’s personal credit file. This may be an issue if the director applies for finance, because the lender may request a letter from the liquidator confirming the liquidator has no claim against the director.
You can read more or watch a video about liquidations at Liquidation Process: What It Is & How It Works | Worrells
I hope that helps explain how the insolvency options work together, but of course reach out to your local Worrells principal (we are everywhere) if you need some more help.