Voluntary Administration is a process that allows for an independent insolvency expert to take control of a distressed business and assess its current situation for the best chance of survival.
Voluntary Administration is an intense process of approximately six weeks, designed to provide immediate breathing room to struggling companies by temporarily freezing all business and personal liabilities related to those companies. During this period a restructuring plan is formulated, enabling the Administrator to gather an intimate understanding of the business and provide a recommendation to creditors on the best course of action.
The Voluntary Administration process allows creditors of a company to vote on three options. These options are:
- To execute a Deed of Company Arrangement (‘DOCA’)
- To return control to the director/s
- To wind up the company and place it into liquidation
Why appoint a Voluntary Administrator?
1. Avoid trading while the company is Insolvent
Directors have a duty under the Corporations Act to prevent a company from trading whilst insolvent. Directors can be held personally liable for the debt incurred while the company is deemed to be insolvent and can face civil and criminal charges. A director can stop a company from trading while insolvent once they discharge their duties and appoint a Voluntary Administrator.
2. Allow for a restructure to occur through a DOCA
One of the three options of the Voluntary Administration process is to execute a restructure for ongoing trading through a DOCA.
The key benefits of a DOCA include:
- debt reduction agreement with creditors to give the company a manageable balance sheet and a chance for survival and success
- a cash dividend to creditors that may otherwise not be available in a liquidation
- ongoing trading of the business that may benefit suppliers of the company
- release for the director/s from any future insolvent trading claims with the company, and
- settlement of legal disputes (except for personal guarantees).
In order to be effectuated, a DOCA generally requires more than 50% of the creditor vote in value and number and binds all unsecured creditors to the arrangement (even if they haven’t voted for it).
3. Provide temporary statutory relief from legal actions
During the Voluntary Administration, legal proceedings can’t commence or continue against a company (unless otherwise agreed or by an order of the Court). Where a director has been issued a Non-Lockdown Director Penalty Notice (DPN) by the Australian Taxation Office (ATO), one of the options available is to appoint a Voluntary Administrator to avoid becoming personally liable. The enforcement of any personal guarantees against a director is restricted during the Voluntary Administration. You can read more about the Director Penalty Regime in our article here.
4. Allow for a review of creditor and cash flow issues
The Voluntary Administrator will review the company’s viability by assessing the available assets and the outlook for future trading. The Administrator will look to maximise the business’ chance of survival, and can choose to continue to trade the business, put the business up for sale and facilitate a sales process, or restructure the company in the existing structure.
The Administrator will investigate the company’s trading history and performance and review whether any cashflow issues are temporary or permanent.
For contracts entered into post 1 July 2018, there is additional protection as there is a restriction on the reliance on Ipso facto clauses to terminate contracts due to the appointment of a Voluntary Administrator (as long as they are still paid). This can be crucial in maintaining business critical income earning contracts or lease premises and asset contracts that a company may have.
Ultimately, it is up to the creditors to vote on the future of the company once in Voluntary Administration however, the Administrator is required to provide a recommendation to creditors on what they believe is in their best interests.
What does trading while insolvent look like?
Insolvency is predominantly interpreted based on a cashflow test to determine if the available assets of a company can meet its debts as and when they become due and payable.
Determining whether a company is trading whilst insolvent is not always straightforward. It is on a case-by-case basis and determined on the unique facts of the company’s situation.
It is important to establish that temporary liquidity issues are not necessarily equivalent to being insolvent. Temporary liquidity issues can be described as having assets that would otherwise be available for payment of debt, temporarily and unexpectedly tied up that cannot be used for debt repayment in the short term.
Key questions to determine if a company is trading whilst insolvent can include:
- Does the company have overdue trade creditors?
- Does the company have overdue tax liabilities?
- Are the company’s tax lodgements up to date?
- Are the company’s books and records up to date?
- Are there any recovery actions being initiated by creditors?
- Is the company continuing to make losses with a decline in revenue?
- Is the company unable to raise finance to meet cashflow demands?
- Is the company able to unable to obtain and keep up with payment arrangements?
Answering yes to a number of these questions could mean the company is trading while insolvent. Regardless, it does indicate the need for immediate review.
How Voluntary Administration differs from Safe Harbour?
The Safe Harbour regime was introduced in 2017 with the aim of providing insolvent trading relief to directors to encourage them to remain in control of the company (rather than appoint an external administrator). Safe Harbour operates as a behind the scenes restructuring process whilst Voluntary Administration is a formally open and public process. Safe Harbour requires statutory criteria to be met to allow a qualified advisor to assist in a restructuring plan that would likely lead to a better outcome than a Voluntary Administration or Liquidation whilst carving out any potential insolvent trading claims. You can read more on Safe Harbour in our article here.
Every company is unique and will require specialised advice. If your company is showing the signs of financial distress and / or you’re looking to explore options for restructuring, contact your local William Buck Restructuring and Insolvency advisor.