The insolvency process in Australia can be broken down into two stages.
- Restructuring: when there is a possibility that the company can turnaround or be salvaged
- Winding Up: when the company is irretrievably insolvent and has no real possibility of a turnaround or resurrection
This article will explore Restructuring, and a following article will discuss Winding Up options.
Restructuring Options
There are many restructuring options, with some widely known and seen as part of the insolvency process, while are options are not as popularly used. Each option presents different pros and cons and these need to be carefully explored on a case by case basis.
Option 1 – Informal Workouts
An Informal Workout is a private arrangement between a company and its creditors. It can be between the company and one creditor or between the company and many creditors.
Informal Workouts can include agreements that renegotiate, reduce, delay or waive pre-existing debts or terms of trade. They can be extremely flexible and usually do not become public knowledge. This has some significant advantages when considering the company’s reputation.
While Informal Workouts can be a great tool, the risk is that, as they usually involve selected creditors rather than all creditors, they can lead to complications such as voidable transactions or directors potentially breaching their duty not to trade insolvent.
Notwithstanding the risks, Informal Workouts can be a great way for a business to restructure its affairs which can benefit all stakeholders, directors, shareholders, creditors and clients.
A common example is where a Company experiences the ‘squeeze’. They have one bad debtor and then win an expansion contract. Their key supplier may be seeking payment for the goods supplied, but the Company, due to the debtor and the contract, needs to pay the debt but also ensure they have the ability to be supplied with goods.
An Informal Workout in the case might look like the Company agreeing to a debt repayment term for the outstanding amounts, while preserving their account so goods can be supplied, and the new contract can be fulfilled.
Option 2 – Schemes of Arrangement
A Scheme of Arrangement (SoA) is an alternative which is available to companies who seek to restructure but avoid liquidation. They create a binding agreement between the company and its creditors which alters their legal rights and allows the company to continue to trade. If successful, this can lead to a better outcome for all involved.
While the terms of the scheme can be flexible, the process is rigid and needs careful attention. The process involves the following:
- A Proposal is put forward in concert with an insolvency practitioner to the company and the creditors.
- An Explanatory Statement is prepared which includes a report as to the Affairs of the company. This is also sent to the creditors together with the Proposal.
- An Applicant (creditor, company etc) can apply to the Court to have a Creditors Meeting convened.
- Following an Order made by the Court, the Creditors must be informed of the Creditors Meeting. If 50% of Creditors at the meeting, who control 75% of the debt, vote in favour of the SoA then it will be adopted.
- If the Creditors vote in favour of this SoA then a further Court Hearing is required to approve it and make orders accordingly.
- Once the court approves it then this is filed with ASIC.
One of the major benefits of a SoA is that it is not generally considered to be part of an insolvency process. However, it does not prevent creditor actions during the time the Company restructures. This means the company can be exposed.
Schemes of Arrangement are usually seen in large reconstructions as the cost and complexity involved generally prohibits smaller reconstructions.
Option 3 – Voluntary Administration & Deeds of Company Arrangements
Voluntary Administration (VA) and Deeds of Company Arrangements (DOCA) are the most common and widely known restructuring options. Many however consider a VA to be the same as a liquidation or a ‘failed business’. The overarching purpose of a VA, as per section 435a(A) of the Corporations Act 2001 (Cth) is to:
- maximises the chances of the company, or as much as possible of its business, continuing in existence; or (b) if it is not possible for the company or its business to continue in existence-results in a better return for the company's creditors and members than would result from an immediate winding up of the company.
Under a VA an administrator is appointed by the Company when the Directors form the opinion that the company is ‘insolvent or is likely to become insolvent at some future time’.
The administrator investigates the affairs of the company and reports to the creditors the best outcome. This occurs at two creditor meetings, one at the beginning and one at the end, where creditors decide on the outcome of the administration. The options include:
- That the company is wound up and the liquidation process begins;
- That the administration should end and the company given back to the management team; or
- That a DOCA is executed.
This deed is between creditors and the company and comes after a VA. An administrator of the deed is appointed, and while the deed is in place the company continues to trade. This means the company is not ‘insolvent’ while under the DOCA.
While the content of the DOCA is flexible, the Deed itself must detail all the arrangements including the circumstances in which it will terminate and the order of distributions of the company’s property to DOCA creditors. The DOCA binds the company, its creditors, officers and members. This means that the creditors are precluded from winding up the company in relation to debts that are covered by the DOCA or arose before the date specified by the DOCA.
Once the DOCA is executed, the administrator will call funds in that are relative. Usually this is from the Directors or Members but can also include external funding sources that have been arranged.
If Creditors receive the dividend as agreed under the DOCA then this is in full and final satisfaction of their claims against the company. Once all entitlements have been paid by the administrator, then the deed is fully affected and the company may continue without the threat of the claims as dealt with by the DOCA. However, if the DOCA is not fulfilled then it can be terminated, and this termination generally leads to liquidation.
Conclusion
As identified above there are a number of restructuring options that provide a real and likely chance that the company is turned around. In a later article, I will discuss Safe Harbour Provisions, which allows for the exploration of a turnaround by the directors while providing a defence for insolent trading.
The Restructuring system is like IKEA furniture. If you follow the instructions, then it is simple. If you ignore them, you do so at your own peril.
If you or your clients need expert advice regarding restructuring, please email James Frank, our Corporate Advisory, Restructuring and Litigation Lead at jfrank@franklaw.com.au or call (02) 9688 6023.
This is not legal advice.
Photo by Luke Chesser on Unsplash
