STAGING A COVID COMEBACK: Options for those struggling financially

Published on 12 November 2020

Rockhampton Regional Council SmartHub Business Manager Elize Hattin was joined by Michael Beck, the Central Queensland Partner for solvency and forensic accountants, Worrells, to talk through the options and the legislation changes which may assist with the COVID comeback

Michael’s firm, Worrells, primarily specialises in debt advisory and solutions, as well as dispute matters.

He says despite what some people think, his advice to struggling businesses is not always just to go bankrupt or to place a company into liquidation.

Whilst COVID has had a significant impact on the economy and on businesses, Michael acknowledges the significant government assistance and relief provided to date may provide an opportunity for businesses and/or their clients to get ahead.

“Whether the assistance clears up owed tax debt or provides additional funds to look at opportunities to expand.

“Please remember these are only temporary, and sooner or later things will go back to normal and debts or bills will need to be paid,” he cautions.

INSOLVENCIES

Michael has witnessed increased commentary about a tsunami of insolvency predicted in future, saying it is music to his ears.

“I don't like to see any business fail; however, such failures do provide opportunities for other businesses to expand or acquire other businesses.

“When things go back to normal, there's likely going to be a significant number of creditor payment defaults.

“This important for you and your clients to consider when you're planning cash flow,” he says.

First Mover Advantage is a concept whereby anyone owed money will get an advantage, if they start recovery action sooner rather than later.

If you are having some issues or COVID has caused or impacted your business significantly, Michael recommends starting planning now.

“Hope is not a strategy, don't leave anything to chance and it's a fairly important time for clients to seek the right advice rather than stick their heads in the sand,” he warns.

RECOVERY MODE

So, what is going to happen when Government funding and incentives stop? What should businesses be doing as part of their comeback?

The first one and the most obvious is pay debts, which might include obtaining finances by borrowing funds from family members.

“Chances are if you're talking to someone like me, it's probably not an option and all the funds that can be raised can't pay all the debts.

“Other options available may include informal debt negotiation, formal debt proposals by way of Deed of Company Arrangement or for an Individual Part X Personal Insolvency Agreement or Part IX Debt Agreement.

“There is also new proposed legislation by the Government which is meant to come into effect January 2021,” Michael explains.

Informal Debt Negotiation

Michael says an informal debt negotiation is simply putting a proposal to creditors to resolve what debts are owed to them.

“If you are required to, or want to do an informal debt negotiation, there should be a good reason why, such as licensing issues, whether it be with the Queensland Building and Construction Commission (QBCC), real estate, your real estate licensing, etcetera.

“You might have someone that owns a property that has future development potential.

“You or your client may have concerns about the effect that bankruptcy or liquidation may have on the ability to obtain credit.

“There's a whole range of reasons people wish to do informal debt negotiations a lot of the time and it can simply be a reason of pride as to why they don't want to go bankrupt, which to be honest, is just as valid a reason as any,” Michael says.

An informal debt proposal can incorporate absolutely anything if it is attractive to creditors.

Often, Michael says they involve providing a new source of funds or a proposal to make payment over time.

“One of the issues with informal debt negotiations is they generally require all creditors to agree to the proposal, which can be quite difficult when you have a large body of creditors.

“They tend to be better suited when there's a smaller number of credits involved,” he advises.

A lesson on Informal Debt Negotiation

A mum and dad client bought a franchise business for their daughter. They were directors of the company but were not really involved in the business. To purchase the business, they obtained financing from the bank and put their home up as security, and personally guaranteed the franchise agreement.

A few years down the track, the daughter decided to leave town and left mum and dad stranded with a business they had limited knowledge on how to run, and subsequent conduct by the franchisor significantly impacted on the profitability of business.

The business was shut down, family home was sold to repay the bank debt, and with a surplus of approx. $100,000, mum and dad bought a rundown house with the hopes of renovating it.

Two years on, the franchisor came chasing a debt of $386,000 for outstanding royalties, advertising fees, and was also seeking damages for the early termination of the franchise agreement.

Both mum and dad who were at retirement age had drawn out almost all of their superannuation to keep the business afloat and were now faced with the prospect of losing absolutely everything.

The franchisor was using a debt collection agency, and the mum and dad had approached our firm. So, the approach that I took was to advise the debt collection agency that there was a real threat of bankruptcy.

If bankruptcy occurs, there's chance the franchisor would have had to wait a couple of years to recover anything, if anything at all. 

The second thing I did was to set out their financial position, and the potential outcomes in bankruptcy.

The third action was the threat of negative publicity to the franchisor. It was a national franchise that really did not want to get dragged into a story on A Current Affair about how they ruined some retirees.

The fourth thing I did was I played on the heartstrings, seeing their daughter abandoned them. Mum and dad have limited assets now and must work well into their retirement age. They could also potentially be out on the street if a deal cannot be struck.

The final thing I did was remind them of the cost to actually bankrupt someone. If you want to force someone into bankruptcy, it takes the best part of 12 months and it would cost somewhere between $10,000 - $15,000 between court filing fees and legal fees.

So, what was the outcome? I originally settled the claim for $20,000. However, the client had some issues with the house, so I squeezed further, and it was settled for $15,000 with payment over time. Mum and dad kept the house, they now have somewhere to live when they retire, and they also managed to retain a small amount of funds.

Michael advises any form of informal debt negotiation needs to be in writing.

“It needs to stay in full and final satisfaction of all clients between the parties.

“I see it time and time again, people think they've actually settled on a debt by way of a phone call.

“They go and pay a lump sum amount of $10,000 or $20,000 and then the debt collection agency continues chasing balance and potentially bankrupts them,” he caveats.

While the main issue with informal debt negotiations is you typically need all creditors to agree, Michael says this does not mean there cannot be negotiation with each creditor individually.

Formal Debt Proposals

Formal debt proposals are available for individuals to be put forward under the bankruptcy act, whether it be by way of Part X Personal Insolvency Agreement or Part IX Debt Agreement.

Regardless of whether it is a company or an individual, you must provide a better return to creditors than the upcoming bankruptcy or liquidation, Michael says.

Michael explains the benefit of a formal debt proposal is they do not require all creditors to agree to the proposal to necessarily bind all creditors.

“On a corporate entity, for it to be put forward a formal proposal, what happens is the company first goes into voluntary administration, and then they put forward the proposal by way of what's called a Deed of Company Arrangement Proposal or DOCA.

“More often than not, it's put forward by the directors, but they can quite often be put forward by a third party, whether it's a creditor or a purchaser of a business,” he says.

When a company goes into voluntary administration, creditors decide the future and the options for the company which is handed back to directors.

This assumes a company can pay its debts as and when they fall due, and that the company should never be an actual voluntary administration.

The next option is the company creditors can vote that a company go into liquidation.

“That will generally occur if there is no Deed of Company Arrangement Proposal put forward or the proposal’s not agreed to.

“The third option is creditors except the Deed of Company Arrangement Proposal put forward.

“Like an informal debt negotiation, Deed of Company Arrangement can be absolutely anything.

It just needs to provide a better outcome than the upcoming liquidation,” he explains.

A case study in Formal Debt Proposals

One client we advised through this process was a long-standing family business in manufacturing, with a turnover of approximately $6-8million. The business was using an accounting system almost as old as the business itself.

It had been around for 30 - 40 years, with approximately 40 staff and secured a bank debt of $1.5 million.

The business suffered significant bad debts, but it still managed to battle on.

Over time, the tax debts and supply debts crept up to around $2 million. They subsequently received a demand from the liquidator of that bad debtor at about $400,000, and then over the Christmas period, some of the jobs they were doing didn't pan out as expected, which impacted their cash flow and the ability to trade on.

If the business had closed and terminated all the staff, it would have crystallised an employee entitlement bill of approximately $1.25 million.

They were already struggling with funds to continue to trade, so they had no chance of paying the employee entitlements if they terminated them.

Their options were do nothing; they might have been able to continue for a while, but eventually would have had to close because they did not have the working capital to continue. Plus, some of the suppliers had already started putting them on stop credit.

The next option was ceasing trading, place company into liquidation; this would have seen the company's assets auctioned off at considerably less than the book value and would have crystallised employee retirement liability of $1.25 million.

There would have been a shortfall on the secured debt to the bank, which would have caused the bank to enforce the security, either personally on family assets and there would have been absolutely no return to unsecured creditors because employee entitlements get a priority.

The third option was that they placed the company into voluntary administration with the prospect of putting forward a Deed of Company Arrangement Proposal, or an offer to creditors.

They put the company into administration with me in the role of the administrator.

The role of the administrator is to take control of the company and continue trading the business, and continue to try to secure and assess the realisable value company's assets, conduct investigations into the company's affairs to identify answers under the Corporations Act and make an assessment of any recoveries that may be available to a liquidator.

The next step was to negotiate and formulate a Deed of Company Arrangement that it wants to be proposed, and then the final step is to issue a report to creditors and provide a positive recommendation on whether creditors are better off accepting the proposal or whether they're better off having the company go into liquidation.

“In the end, the director put forward a DOCA proposal that essentially provided for a payment of $100,000 from a family member, which is going to provide an approximate dividend of five cents in the dollar to ordinary unsecured creditors, control the company was going to be headed back to the directors.

In addition to these tasks and those ordinarily associated with trading and business, Michael also conducted investigations, dealt with staff and payroll issues, liaised with debtors over their secured debt, monitored work in progress, debtors and cash flow to ensure that we had sufficient funds to trade the business.

APPEASING THE ATO

Under the DOCA, the company had to maintain its future tax lodgements and liabilities.

Employee entitlements would continue to be paid in the ordinary course of trade. Any surplus funds the administrator had were handed back to the company to assist with its working capital requirements.

“The business had 40 staff, so the payroll was about $80,000 - $90,000 a fortnight, so they were always going to need some cash to continue to be able to trade.

“There was only a return of five cents in the dollar, on what unsecured creditors were owed. The trade creditors overwhelmingly voted to accept the DOCA, because otherwise they were going to get absolutely nothing.

“There was overwhelming support by suppliers, which wasn't surprising given the long trading history that the company had with suppliers.

“Upon acceptance of the DOCA, it basically removed $2 million worth of bills that would have had to come out of cash flow at some point in time.

“At this point, the ATO are owed at about a million bucks on the matter. They abstained from voting. They did not vote against the proposal. Rather, they just allowed the local trade creditors to decide on the future of the company.

“All staff kept their jobs, and the company didn't have to stump up $1.25 million in employee entitlements in one go.

“To date we've handed back about $250,000 in surplus trading receipts and I'm expecting we will probably give them another $30,000 - $50,000 yet,” he predicts.

Even though control of the company has been headed back to the directors, Michael still maintains contact with them to ensure they are addressing the issues identified.

CHANGES TO LEGISLATION

Governments have scrambled to implement or provide relief and implement legislation to help deal with the fallout from COVID.

From an insolvency perspective, Michael says the year has ended with the government announcing new corporate insolvency regimes specifically designed for small businesses.

However for this industry, the turmoil of COVID is further exacerbated by the fact the proposed legislation has not started and will not be implemented until 1 January 2021. 

“We don't have all the laws. We have sections of the Act, but we do not have the regulations and the rules,” he explains.

Michael says the government is providing only half of what is ultimately going to be the law and that really raises more questions than it does provide answers.

The new reforms have seemingly come out of the blue not only for the insolvency profession, but for the regulators as well. And Michael says these are not minor changes.

These new proposed administrations’ will be the first few corporate insolvency regimes since the introduction of the voluntary administration process was introduced back in 1993.

So, what are the new regimes all about?

The government has said the current insolvency system is a one size fits all process with barriers of high costs and lengthy processes, Michael says.

“The government feels we need an insolvency process to better serve small businesses, their creditors and the employees with the aim of the new insolvency regimes to enable small businesses to quickly restructure and where a restructure isn't possible to be wound up faster, enabling a greater return to creditors.

“I guess the government thinks we need it now because otherwise the fallout from COVID-19 is going to cause a so called ‘tsunami of insolvencies’ that will have an even greater impact on an already fragile economy,” Michael proposes.

THREE ELEMENTS TO THE PROPOSED REGIME

Michael explains the proposed regimes are made up of three elements; the first being temporary relief for companies seeking a restructuring practitioner.

This is an opportunity for companies to have creditors debts put on hold, while it explores options to get out of its dire financial position.

According to Michael, the fact sheet on this suggests it is similar to temporary debt protection currently available under the bankruptcy act for an individual who's wanting to consider their personal insolvency options, but fears they can't do so because they're receiving too much pressure from their creditors.

“In the case of the new proposed temporary relief for anyone seeking a restructuring practitioner, there will be a hold on the creditors ability to pursue debts against company for three months.

“What does the new proposed law actually say on this? Absolutely nothing. It's just in one of the government Fact Sheets, so it will be a matter of watching this space,” he advises.

The next element is the restructuring of a company; a simplified system to arrange with creditors to avoid liquidation like the voluntary administration/deed arrangement process.

“This proposed new restructuring regime is probably at the heart of the government's proposals, because the government really wants to save as many small businesses as they possibly can.

“The logic is the economy is never going to be able to recover if most of the businesses in the country fail, so let's remove some red tape and get out of the way of debtors doing deals with their creditors,” he says.

Australia has traditionally had what is called a creditor in possession style model of insolvency.

This is because current insolvency regimes take control of the company away from the owners and give that control in turn to an insolvency practitioner whose interest is instructed by creditors.

“I suppose the reason for the creditor in possession style model that currently stands is that we shouldn't leave control of the company in the hands of the very parties who got the company into its financial problems.

“The new proposed restructuring system moves away from that, to a debtor in possession style arrangement.

“Under this new regime, whilst a restructuring practitioner is appointed, they are there to assist the directors, because control of the company and the continued trade of the company remains with the directors.

“The aim of this part of the legislation is to have a plan in place for the company to repair its existing debt problems, thereby staying in business and avoiding liquidation,” he says.

Michael says it is important to note only directors can initiate the appointment of a restructuring practitioner; not even the court can initiate that process.

Once the process is started, they must complete the process.

The third element of the new regimes is a simplified liquidation process, which is still the end of the life of the company but with reduced red tape.

It can be used for any liquidation after 1 January 2021, which means it is not retrospective, and the company does not need to go through the restructuring process.

“The simplified liquidation only applies to creditors voluntary liquidations.

“The draft legislation is written as such that once a company is in liquidation, creditors complete the relevant forms and the liquidator can give notice to creditors they are guaranteed to adopt the simplified liquidation process,” he says.

Michael maintains a company is not eligible for the simplified liquidation process if current directors have been a director of another company that has gone through either the restructuring process or simplified liquidation within the last 12 months.

“The purpose of the proposed simplified liquidation is to make it quicker and cheaper.

“Unfortunately, we are not sure whether directors or creditors are going to see a huge difference between a simplified liquidation process and a no ordinary credits volunteer ration,” he said.

WHERE TO FROM HERE?

From 1 January 2021, the simplified and regular liquidations will be available.

Following on, from 21 January 2021 its proposed voluntary administration is going to be available with the intention of doing a Deed of Company Arrangement Proposal or the new restructuring regime.

So, the big question is if you or your clients are in financial distress, should you wait until 1 January before appointing an external administrator?

Michael counsels this largely depends on the financial position of you and your clients and where they see their business heading in future.

“Whilst it is not currently in the legislation, there is an indication employee entitlements are going to need to be brought up to date.

“So, if you and your clients are well behind in superannuation, there seems little point waiting until the new regime comes into play.

“If your client is up to date with the tax lodgements, they qualify for Job Keeper now and employee entitlements are in order and there might be some benefit in waiting until the new legislation comes into effect.

“Obviously, if your clients are not in a financial position to offer any money to creditors, or unable to borrow money to pay creditors, then there is little point in considering the new proposed restructuring regime or the administration.

“If your client is a small business and the only funds they have to pay for liquidation come from personal assets, then it may be more commercial to wait until the new simplified liquidation takes effect, because it's meant to be presumably more cost effective,” he says.

Any information contained in this article is general in nature. For a no obligation discussion about the current financial circumstances and options for your business, contact Michael on 07 4923 8900.

Worrells is a firm dedicated to solvency management, insolvency administration and forensic investigation.

Michael joined the firm in May 2015 as manager of its Central Queensland office and became a partner on 1 July 2018.

Michael has over 10 years insolvency experience during which he has worked on both corporate and personal insolvency matters across various industries and has been involved in several insolvency investigations and large litigation matters.

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