How accountants can support their clients via the new insolvency reforms
It’s no secret that clients rely on their accountant to keep up to date with the latest tax rules. As their most trusted professional advisor, client’s will also frequently turn to their accountant first when facing financial struggles. In order to better serve them, you need to remain on top of new laws and reforms that affect and can benefit them. They might not be aware of opportunities designed to help them through any cash flow challenges they may be facing in the current climate.
The new insolvency reforms are an excellent example.
The new processes recently introduced are intended to help small businesses by providing additional options for those businesses facing financial difficulties. The new reforms aim to reduce the complexity and cost of a formal insolvency appointment. Small businesses may be able to restructure as a strategy to address the challenges posed by COVID-19. If restructuring is not a viable option, a simplified liquidation process has been introduced.
Here we look at the new insolvency reforms and the opportunities the reforms present to address COVID-related financial challenges your clients may be experiencing.
Key Elements
The reforms provide two new options for companies facing financial distress:.
Small Business Restructuring:
This formalized restructuring process makes it easier for struggling small businesses to undertake a process to restructure their existing debts so they have a higher chance of remaining in business. The company can continue to trade during the restructuring process with the company’s directors remaining in control of the business while a restructuring plan is formulated.
Simplified Liquidation:
Should the business not be in a position to restructure its debt, the simplified liquidation process makes it easier and more cost-effective to wind up a company, increasing the potential for a return to employees and other creditors.
Together these measures provide additional options to the usual formal insolvency processes, opening up the possibility for more small businesses to survive.
The New Small Business Restructuring Process
As mentioned above, the goal for the new small business restructuring process is to make it easier for companies to restructure their existing debts. During the restructuring period the Company can continue to trade with the directors remaining in control. In essence, the process involves:
- Determination of a company’s eligibility
- Formulation of a restructuring plan by directors and Restructuring Practitioner
- Voting by creditors on the proposed restructuring plan
- If approved by creditors, implementation of the restructuring plan with Restructuring Practitioner overseeing the disbursement of funds
Small Business Restructuring vs Voluntary Administration
Voluntary Administration:
When a business owner opts for voluntary administration and appoints an external administrator, the administrator takes control of the business during the administration period, with all decisions concerning the company including whether it should continue to trade and how to deal with company assets, being made by the administrator.
Creditors are not able to commence or continue recovery action against the company during the administration period.
If the directors wish to put a proposal to creditors, they must submit the proposal to the administrator, who prepares a report for creditors detailing the directors’ proposal and its comparison to a liquidation scenario plus the administrator’s investigations into the company and his recommendation regarding the directors’ proposal.
Simplified Liquidation:
When a business owner opts for voluntary administration and appoints an external administrator, the administrator takes control of the business during the administration period, with all decisions concerning the company including whether it should continue to trade and how to deal with company assets, being made by the administrator.
Creditors are not able to commence or continue recovery action against the company during the administration period.
If the directors wish to put a proposal to creditors, they must submit the proposal to the administrator, who prepares a report for creditors detailing the directors’ proposal and its comparison to a liquidation scenario plus the administrator’s investigations into the company and his recommendation regarding the directors’ proposal.
A meeting is then held where creditors vote on the proposal. If a majority of creditors (in value and number) vote in favour, the company enters into a Deed of Company Arrangement, otherwise creditors may reject the proposal and vote to place the company into liquidation.
If the directors’ proposal is accepted, control of the company returns to the directors who can then continue to trade the business. The administrator becomes the deed administrator who then receives and distributes funds pursuant to the terms of the Deed of Company Arrangement.
Due to the obligations placed on external administrators, including the need to conduct detailed investigations, hold meetings of creditors and comply with other statutory responsibilities, the voluntary administration process often involves significant costs. Whether those costs are paid out of company assets or directly by the business owners, they can result in reducing the funds available for distribution to the company’s creditors.
In many cases, the potential cost of the voluntary administration process has forced business owners to simply liquidate their companies, leading to the possibly unnecessary closure of some businesses and lost jobs for employees. Creditors often end up receiving little, if any, of what was owed to them. These outcomes also have a negative impact on the economy./p>
The advantages of putting forward a proposal to creditors
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.
Creditors vote on the directors’ proposal at a meeting of creditors
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.
The role of the Deed 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.
The advantages of voluntary administration over liquidation
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.
Case study: Advantages of a voluntary administration for a non-profit
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.
Case study: Advantages of a voluntary administration for a construction business
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.
