Insolvency (Part 2): Small Business Restructures, Voluntary Administration & What Happens Next

0:00
You're listening to Explain That by Velocity Legal, the podcast that keeps business owners and professional advisers ahead of the curve in an ever-changing legal landscape.

Welcome back to another episode of Explain That by Velocity Legal.

0:16
I'm joined by Director Demian Walton. Demian is a director in Velocity Legal's Disputes and Insolvency team, with more than 20 years' experience.

In Part 1, we talked about what insolvency is and what the consequences of it are.

In Part 2, we'll be talking about what formal insolvency processes are available to business owners.

0:35
Firstly, welcome back to the show, Demian.

Thank you, Andrew.

Well, there's a lot to cover here. It's sort of an interesting area because it's something that's changed in recent years.

Let's start with what steps actually, or what processes, might be available.

0:51
And just introducing those concepts. So I'm a business owner, I've got concerns about the solvency of my business. What could I consider?

What are the options available?

Essentially, there are three options.

There's what's called a Small Business Restructure, which is a relatively recent innovation.

1:11
There's what's called voluntary administration with a view to the company executing a deed of company arrangement. That is an older innovation.

And then there's a creditors' voluntary winding up, which of itself won't save a business, but it can be done in combination with essentially rescuing the business in a new entity.

1:40
Restructure.

We'll be talking about it in Part 3, that restructuring of the business and the concerns there.

Yeah. But so I've got the Small Business Restructure, so the SBR, the voluntary administration, and then the creditors' winding up.

1:56
It's funny in insolvency. I don't practice in insolvency, but there are a lot of words, buzzwords, not buzzwords, but terms of art, I guess, thrown around.

And I guess if you're not in the space, that could be confusing.

So let's start with the Small Business Restructure. I understand this was brought in, or how long ago was it?

2:17
Was it 2016, 2017?

Approximately. It might be a little bit later. It was sort of created with scepticism.

I remember at the start, there was this sort of, and you'll be better placed to answer this than me, but I remember that it was brought in and then nothing really happened. It wasn't really used to start with, right?

2:39
No one, maybe because no one knew what it was or they thought it was too restrictive.

But it's really opened up now, hasn't it?

It's opened up. Curiously, it's opened up because of the way the tax office approaches them.

2:55
I suppose I should start with what the eligibility criteria are.

Yes.

So firstly, the company needs to have unsecured creditors that don't exceed $1,000,000.

3:12
It's the magic number, the $1,000,000 of unsecured debtors.

Yeah. That includes contingent liabilities, which could be liability under a guarantee, for example.

It doesn't include accrued employee entitlements that are not yet payable.

3:34
Yep. So long service leave.

Yeah, yeah. Annual leave, personal leave, etcetera.

And this was thought to be the kicker that would make it difficult to access.

The company has to be up to date with all its tax lodgements.

3:51
So as you said in Part 1, they could put their head in the sand.

Yes, they haven't lodged.

Yes. Now, so there's that second requirement. And the third requirement is simply that the company hasn't already done one, or hasn't done some kind of external administration, in the last seven years.

4:11
I suppose the way to approach it is firstly the company should file all its tax lodgements, hopefully at the end of that the amount owing is not over $1,000,000, and when combined also with other unpaid creditors.

Coming out of COVID, for the reasons we sort of touched on in the last podcast, the ATO is often the main creditor.

4:40
Now, the benefit of that, I suppose I'll come to that.

What happens, the way you commence the procedure is the directors appoint what's called a small business restructuring practitioner, which is essentially someone who's a registered liquidator.

5:01
That person then assists the directors to prepare the restructure plan, which involves paying the company's creditors.

Yeah. It might involve paying them in full.

Where situation you start with.

But possibly in that situation where a company needs to sell an asset.

Yes.

5:18
And it needs time.

Yes, to do that, yeah.

So that might be a situation where creditors might be paid in full, but they have to wait.

5:37
More commonly, there'll be a proposal to pay creditors a certain number of cents in the dollar.

Yes. The reason for the recent popularity in Small Business Restructures is the ATO has been taking quite an accommodating response in supporting Small Business Restructure proposals.

6:05
And how those proposals work, is it that every dollar of debt gets a vote?

Yes and no.

Unrelated.

So only unrelated creditors can vote. But so long as you get a majority of creditors in value to support the plan, it goes through.

6:26
Yeah. So if you've got debts of $500,000 and you owe the ATO $300,000, if the ATO votes in favour, it's going to get up.

If they don't, then it's never going to get up.

Yeah, it's not going to get up.

If it doesn't get up, in a sense there's no harm done.

6:47
Yes.

But it would mean that you kind of need to move to one of the less favourable processes.

And you said that the ATO has taken quite an accommodating approach generally with those proposals.

7:05
I've heard figures, you know, 15, 20, 25. They're all sort of anecdotal, but yeah, it does seem like they're taking a somewhat generous or reasonable approach.

7:21
One thing that I found interesting is that you can contrast that to what we talked about earlier about payment arrangements.

Yeah, where it's not an accommodating approach.

Yes. There's also another eligibility requirement, which is that the company actually is insolvent or likely to become insolvent in the future.

7:41
So it's not available as a kind of way to get a big discount on your tax.

But as often happens in insolvency law, bad behaviour can get rewarded.

Yeah, yeah. Well, I guess maybe that's why that seven-year requirement exists, that it's not there to be used.

8:01
Yeah, every year.

And are you seeing a lot of COVID debts as part of those, mainly to the ATO, but maybe to landlords and things like that as well?

So with landlords, if they lose patience, they'll lock the company out.

8:21
Yeah.

And usually they'll go after the guarantors. With the ATO, it's usually the ATO that's the creditor that forces business owners to do something.

Yes.

To those business owners who have their head in the sand because they don't want to look at this ugly picture, there's hope.

Because if the picture's sufficiently ugly, these processes might be available to get a significant discount on debt.

9:01
$1,000,000, lodgements up to date, seven years, and there's a requirement to pay employee entitlements.

Any unpaid super, unpaid wages.

If an employee is searching for unfair dismissal and gets a compensation award, you need to pay this.

Yeah, yeah, yeah.

9:17
And in general, if it is available, is that probably where you'd start for a small business?

It's probably where you would start.

Yeah. It might be the case that the business just isn't profitable.

At the same time, it's a way of at least dealing with the debts and ultimately closing it down.

9:38
You've got a big ATO debt and then you're running up 10% interest on top of it.

Yeah, that 10% interest could be the difference which ends up being viable or not.

Could be, yeah, yeah.

Well, then let's turn to the voluntary administration or DOCA.

9:56
So how does that work? Because you just said that's sort of a more traditional mechanism that's been around for a long time. If you want to just walk us through.

Yeah, that was introduced a long time ago. It's Part 5.3A of the Corporations Act.

10:21
It's intended to provide a pathway for achieving a better outcome for creditors and saving a business if it's viable.

That's what it intends to achieve, and often it does achieve that outcome.

10:39
But there are issues with it.

But I suppose to walk you through how it works, the directors pass a resolution that the company's insolvent or likely to become insolvent in the near future.

10:55
They appoint someone who needs to be a registered liquidator to act as administrator.

The administrator takes control of the company, so the director's powers are suspended.

Yes, which is one contrasting feature from an SBR.

For the administrator to operate the company is expensive.

11:21
Yes. Well, they wouldn't want to take it on unless they're compensated for it, right?

Unless they're going to be paid.

Administrators are also personally liable for any debts that are incurred during the VA period.

11:36
Yeah.

So they're going to want to have some confidence that they're not going to personally go broke as a result of trading losses.

Sometimes they'll want indemnities from related parties to give them comfort.

11:56
But what can happen is the administrator arrives and sees the company's not going to be able to absorb the cost. There's too much risk, and they just shut down the business.

I see.

12:13
Or usually it'll be shut down the operating business.

Yeah, because selling an operating business will take weeks or months.

So they shut the business, sell up the plant and equipment, and they're going to get a haircut on the value of something.

12:29
Yeah. A lot of value is destroyed.

Yeah, yeah, a lot of value is destroyed.

That's essentially the drawback.

But what sort of happens during the VA period?

Assuming the company can absorb the cost, the directors can put up a proposal for what's called a deed of company arrangement, or a DOCA.

12:56
A DOCA is basically a deal between the company and its creditors.

Usually it involves a cash amount being provided, often by a related party, to put in a fund.

Creditors lodge their claims against the fund and they get a return proportionately, sometimes as low as 1 cent.

13:21
Yes, yeah. Or less.

Sometimes 5 cents.

But creditors get to vote.

On whether or not to accept.

On whether, yeah, yeah.

So one of the significant costs of the administration is that the administrator has to undertake an investigation into what went wrong, whether there are voidable transactions, that is unfair preferences that can be recovered, assets that were transferred out of the company not for market value, insolvent trading, and often a range of unpleasant things.

14:00
Yeah, that's what the liquidator will do if the company goes into liquidation.

Yes. So whatever's offered to creditors needs to give them a better outcome than liquidation.

Because otherwise, yeah.

14:16
Then why would people accept it?

Why would creditors accept it?

And if it's voted ahead, it then gets returned to the directors.

Yes. So the process culminates in a meeting of creditors where they decide the future of the company.

14:34
There are three possibilities. One is to end the administration. I've never seen that happen.

Another possibility is that they accept the DOCA proposal if one has been made.

And then the final possibility is that they vote to wind up the company in insolvency.

14:56
Liquidator goes in and unpleasant consequences can follow after.

For the DOCA proposal to be accepted, it needs the vote of the majority of the creditors in value and number.

15:13
And in number.

And in number, yeah, both.

Now, if the proposal is supported by a majority in number but not value, or value but not number, then the administrator has a casting vote, and that can often lead to litigation.

15:33
So the ones that have a big debt can get it up, or vice versa.

Yeah, yeah. Related parties, unlike an SBR, get to vote.

Okay.

But if the proposal only passes because of their vote, a disgruntled creditor can approach the court.

15:56
Yeah, a bit of a check and balance.

There's a check and balance. That said, litigation to set aside a deed of company arrangement is very expensive.

And does the ATO take a different approach with VAs and DOCAs compared to SBRs?

16:14
Is it similar?

I would say that it's similar. Probably with an SBR there might be more communication or negotiation between the liquidator, sorry, between the SBR practitioner and the ATO.

16:32
Yeah, to arrive at an amount that the ATO is likely to accept.

Yes, in the voluntary administration process, you don't know which way the ATO is going to go.

Until that meeting.

Until the meeting.

The consequences are higher than, I guess, if you got it wrong.

16:52
The third option or avenue is the creditors' voluntary wind up, which you were talking about as the death of the company.

Yes, the death of the company voluntarily, as opposed to a winding up action where the court appoints a liquidator.

17:12
Yes.

It can happen in one of two ways. It can happen at the end of the VA period if creditors vote for it.

It can also happen where you call the meeting of shareholders, the shareholders pass a special resolution to wind up a company and appoint a liquidator.

17:35
The advantage of that over the court appointing someone is that you get to choose.

Yeah, liquidator.

Yes. All liquidators have the same obligations to creditors, the same duties under the law.

18:01
Yes, but different approaches can be taken. Some are more aggressive, some are more conciliatory, some are more commercial.

Yeah.

So even if you know the situation is beyond rescue, it's still better to get on the front foot and do it actively, right?

18:16
Yeah, you direct your own.

And sort of choosing your own liquidation adventure.

So, Demian, we've talked about the SBR, the VA and the creditors' voluntary liquidation.

18:32
I've heard that VAs can be pretty expensive. As you said, administrators maybe have a reluctance to take it on unless there's a lot of money there to cover their own debts.

And the SBR has that $1,000,000 threshold and other criteria.

So what about a situation where you don't qualify for the SBR, but it's prohibitively expensive to do the VA?

18:54
Any other options available?

Sure. So first thing to consider is, is this business worth saving?

You know, if the market, if it's a video rental store, it's probably not worth saving.

19:14
If it's something else that can be made profitable, then there are options.

Usually what this will involve is sort of setting up a new entity and transferring the business operations over to the new entity.

19:36
Now this can be fraught if it's not done carefully.

It's not done properly.

But if it's done properly, it's a great way to avoid destruction of value.

Save a business sometimes.

Maybe get a better outcome for creditors.

19:58
Well, I know you've referred to that as the pre-pack transaction, and I'm really looking forward to going through that as part of the next part of this series.

Just to recap on this part, we've talked about SBR, Small Business Restructure, VA, voluntary administration, and creditors' voluntary liquidation.

20:16
And I've just posed the question today, what if we can't use one of those particularly well?

So thanks once again for being part of this part.

I'm looking forward to Part 3, talking about pre-pack transactions.

Thank you.