Even the best of operators can face financial struggles and at such times a wounded business loses friends quickly.
When a business starts to look shaky, creditors will often tighten their trading terms for fear of suffering losses themselves. Assertive creditors may choose to seek liquidation of a company or bankruptcy of an individual. These options can lead to very poor outcomes. The result can be staggering liquidation costs, lost jobs for employees, lost owners’ equity, disruption for customers and losses to other creditors.
Sometimes it makes no sense for creditors to shut down a business. In these instances there are legal mechanisms available to companies and business owners to make compromises with creditors possible and, to an extent, put the fate of the company or the business owner/s in the hands of common sense.
In the case of companies, voluntary administrations are intended to be a fast and inexpensive alternative to a liquidation. The voluntary administration regime’s purpose is to maximize the chances of a struggling company to continue trading.
An administrator may be appointed by the company’s board, a liquidator, a secured creditor or the court where a company is, or is likely to become, insolvent.
A meeting of creditors must be held within 20 working days of appointment of the administrator. The creditors then decide (by a 75% majority in value of debt owed) the future of the company. The creditors may decide to specify the terms on which the company will continue trading and what protection the company will have from existing creditors in a ‘deed of company arrangement’. Alternatively, the creditors may decide to do nothing and return the company to the control of its directors, or to put the company into liquidation.
A deed of company arrangement will bind the company’s directors, shareholders and unsecured creditors, and all secured creditors and lessors of property who have voted in favour of it. It may also suspend the ability of creditors to enforce personal guarantees.
Another real strength of this process for the struggling company is that after the creditors have decided that the company will enter into a deed of company arrangement, the court may order that a secured creditor may not exercise its rights, or a lessor may not retake possession of leased premises or chattels.
Such orders may be made only if the interests of the secured creditor or lessor will be adequately protected.
Adequate protection doesn’t necessarily mean equal treatment. In Australia, where the rules are similar, the courts have allowed a company to walk away from its lease commitments, paying the landlord only the amount it would have received in a liquidation of the company. The other creditors were paid in full from funds contributed by a parent company.
There’s a similar procedure in the case of individuals who are unable to meet their financial commitments. Insolvent people can apply to the court to have a trustee appointed to convene a meeting of creditors to reach a compromise short of bankruptcy. The content of the proposal is flexible but must be accepted by both a majority of the creditors voting and a 75% majority of the creditors in value of debt owed. It must also be approved by the court.
There are very clear benefits for a person to avoid bankruptcy: this includes being able to continue in business, to continue to hold directorships of companies, freedom to travel overseas and avoiding the stigma of bankruptcy.
For any looming company or personal insolvency situation where the business owner has the ability to achieve a better outcome for creditors than they would otherwise achieve, these alternative processes should be considered. This might require a contribution of funds from an external source but, in the right circumstances, creditors may also be convinced that the best outcome will come from supporting continued trading.
Such compromises can also give directors protection from personal claims, and creditors a degree of control, with the real prospect of a better financial outcome than they might otherwise achieve using the more severe liquidation or bankruptcy remedies.
Voluntary administration and insolvency proposal procedures give business owners and creditors the opportunity to work together to achieve an outcome, which is mutually beneficial and has wider positive spinoffs.