One of the biggest challenges any company can face is the prospect of insolvency.
Often companies keep plugging away, getting further and further into debt hoping business will pick up and their finances will improve. However, the longer directors wait to take action to correct their circumstances, the more likely it becomes that an adverse outcome will eventuate.
The good news is there is a way to increase the odds of a business remaining operational despite experiencing financial stress: Voluntary Administration.
A voluntary administration provides an opportunity for a business to continue while offering a way for directors to pay down outstanding debt in a more manageable fashion. If creditors accept the directors’ offer, a company can continue to trade under the control of the directors. A voluntary administration has the potential to increase the chances of a company overcoming a temporary bump in the road.
Here we explain how voluntary administration occurs and some advantages of pursuing this option.
A voluntary administration commences when, after deciding their company is or is about to become insolvent, company directors appoint an ‘external administrator’ to take control of their company and its assets.
After his appointment, the administrator will consider the company’s financial position to determine whether or not it makes sense for the company to continue to trade, or if it has reached the point where it will have to shut down. While this might not sound so appealing, it’s prudent to involve an experienced professional prior to the appointment who can help directors make the right decision as to whether or not it is the right path in the circumstances.
Where it does make sense to appoint an administrator, the sooner you proceed with an appointment, the more likely it is that the company can remain viable and continue to trade.
As soon as the administrator is appointed, they take control of the company and its assets. If the administrator considers it to be in the interests of creditors to continue trading the business during the administration period, all ongoing trading is then conducted under his control.
The administrator will take action to cease all recovery steps creditors might be taking and will assess the company’s situation, conduct an investigation into its trading activity and financial performance and will prepare a report for the company’s creditors.
An external administrator will also work with the company’s directors in the event the directors wish to put forward a proposal to the creditors to repay some or all of the company’s existing debt.
The directors’ proposal and the potential return to creditors is included in the administrator’s report to creditors together with a comparison of the potential return to creditors if the company was wound up. This is an important element of the report, as in addition to comparing the potential outcome of the proposal to that expected in a liquidation, it contains the administrator’s opinion regarding the outcome he believes is likely to be in the best interests of creditors.
A meeting of creditors is then held in which creditors vote on their preferred course of action - that is, whether to accept the directors’ proposal or to reject it and simply wind up the company. If there is no proposal, the company will end up in liquidation.
In most cases, as long as the proposal is reasonable and provides a better return than is expected in a liquidation, the creditors will find the proposal more attractive.
The purpose of putting forward a proposal to creditors is to provide creditors with an alternative to simply liquidating the company and give the company a chance to survive. It provides a way for directors to deal with current unmanageable debt and continue to trade the business while potentially enabling creditors to be repaid some or all of their debt.
Creditors ultimately vote to accept or reject any offer put forward by directors. Because of this, it is up to the directors to come up with a proposal that is both manageable for the business and attractive to creditors.
The directors’ proposal should provide a better return to creditors than is expected in the event of a liquidation. This is important because if creditors are not in favour of the proposal, they can instead vote to place the company into liquidation.
It is important to note that it is a requirement for proposals in an administration to provide for the payment of priority debts such as employee entitlements and superannuation in full (unless priority creditors agree otherwise). The fees and costs of the administration also need to be paid.
Therefore, directors will need to be able to access - or generate - sufficient funds to enable them to put forward a proposal that will ensure those priority amounts are paid in full while also providing a return to creditors that is better than expected in a liquidation.
There is no specific requirement for the terms of a proposal, and they can take different forms including the payment of a lump sum amount or instalments over time or even the assignment of the proceeds from the sale of an asset or assets. At the end of the day, it simply needs to be a proposal that a majority of the company’s creditors will vote to accept.
Often a company may be operating a viable business that is, however, on the verge of insolvency - possibly due to unfortunate circumstances such as bad debts, directors’ ill health, accidents or any other reason. When these unforeseen events occur, it can lead to a company carrying unsecured liabilities that make ongoing trading increasingly difficult.
Sometimes it is just not possible for the company to generate sufficient revenue for the outstanding debt to be repaid.
Putting forward a proposal to creditors in an administration enables the company to avoid liquidation and to continue operating. It enables the business to keep employing and generating income as well as to continue to service its customers. A proposal also demonstrates to creditors the directors willingness to repay the debt.
Once a proposal is accepted, a Deed of Company Arrangement is executed, and the directors regain control of the company. At that stage, they can continue trading without the burden of a backlog of unsecured debt, subject to contributing the funds as required under their proposal.
The directors’ proposal is considered by creditors at a meeting that is usually held approximately four to six weeks after the administrator is appointed.
The proposal is provided to the company’s creditors when the external administrator sends his report to creditors with the notice of the meeting of creditors.
It is at the creditors’ meeting that creditors vote to either accept or reject the directors’ proposal. If creditors are not in favour of the proposal, they can vote to place the company into liquidation.
In order for the resolution to pass there must be a majority of creditors voting in favour - in both the number of creditors and dollar value of their debts.
If the proposal is accepted, a Deed of Company Arrangement is prepared in order to formalise the proposal into a legal agreement. The deed is then executed by both the directors and the administrator.
After execution of the Deed of Company Arrangement, control of the company returns to the company’s directors and the business can resume trading normally.
The administrator takes on the role of Deed administrator whose role is to oversee compliance with the Deed of Company Arrangement and ensure that funds due under the deed are received and distributed to creditors according to the terms of the deed.
A voluntary administration is often more appealing to creditors as they may see a better return than they would in the event the company was wound up.
While a liquidation results in the winding down of a company, a voluntary administration provides an opportunity for a business to survive.
It provides a chance for a ‘win-win’ situation for both directors and creditors, as creditors may potentially receive more than they would have received in a liquidation while the directors can regain control of their company and can then continue to move forward and grow the business without having to deal with the backlog of debt.
A voluntary administration may enable a company to continue employing its workers, providing business to its suppliers, and contributing to the health of the community’s economy as well as provide the directors’ with an income and the potential for a return to shareholders.
As a bonus, customers may also continue to enjoy receiving the company’s goods and services!
The catch of course is that directors need to have access to, or be able to generate, sufficient funds - whether paid upfront or over time - in order to pay priority debts and put forward an offer to creditors that will provide a better outcome to that expected if the business was simply wound up.
As administrators, we were approached by a non-profit that was experiencing financial difficulties due previous poor accounting practices.
This had caused the entity to suffer from a lack of financial control and resulted in unpaid (and underpaid) employee entitlements and superannuation for their team as well as an increasing tax liability and liabilities to other creditors that the entity was unable to manage. The directors knew their organization was in trouble and appointed us as administrators.
We performed a detailed review of the entity’s affairs to prepare a report to creditors and also held discussions with the directors about putting forward a proposal to creditors. The directors came up with a proposal to pay a lump sum after a period of time that would enable payment of outstanding employee entitlements and superannuation in full and provide a return to unsecured creditors of over 20 cents on the dollar on their debts. This compared to a likely outcome of no return to creditors in the event of the entity’s liquidation.
Creditors subsequently voted to accept the directors’ proposal and control returned to directors.
After payment of the funds required under the directors’ proposal, all parties were paid their entitlements under the deed, with employee entitlements and superannuation paid in full and unsecured creditors receiving a dividend of 21.7 cents on the dollar. In addition to providing a better outcome for creditors, the entity was also able to remain operational and continue providing its services.
We were approached by a construction company that had been operating for over 25 years. The company had been experiencing some financial difficulties due to some recent bad debts and had a substantial tax liability plus liabilities to other creditors.
The directors had previously sold personal assets to pay company tax debts and were at the stage where they were about to make a further lump sum payment out of personal funds to the tax office or alternatively, to wind up their company.
After initial discussions with the directors, we concluded that despite some cashflow issues, the business remained viable. We negotiated with the directors to provide some working capital and as a result, were able to continue to trade the business during the administration.
As the directors had been considering payment of a lump sum to the tax office, we suggested the directors propose payment of that lump sum via a Deed of Company Arrangement instead as that would deal with all of the company’s outstanding liabilities at once rather than dealing with each creditor’s debt individually.
The directors’ subsequently put forward a proposal to the company’s creditors which was accepted.
The directors were able to resume trading the business under their control, and outstanding employee entitlements and superannuation were paid in full while unsecured creditors received over 15 cents on the dollar on their debts.
Rather than simply wind up the company, by putting forward a proposal for a Deed of Company Arrangement and contributing funds that they were intending to pay to a creditor anyway, the directors were able to ensure their company continued trading and that employee entitlements were paid while their creditors received a better return.
This outcome also ensured that the company’s employees kept their jobs, its suppliers didn’t lose a customer and the company would be in a position to pay taxes as well as generate an income for the directors in the future.