Restructuring a viable but insolvent company will usually involve formulating a proposal to creditors, either informally or via a formal insolvency process.
Informal Proposals
Informal proposals to creditors are more likely to be successful when:
- creditors with small amounts due are paid in full. This enables the directors to focus on negotiations with major creditors;
- the directors are upfront with major creditors as to the cause of the financial difficulty which the company is facing and what they have done to address it;
- a consistent approach is applied to all creditors with which the company is negotiating; and
- realistic repayment arrangements are entered into thereby minimising the risk of defaults at a later stage.
Sometimes directors involve an insolvency practitioner to assist them in negotiating with creditors. This is often appropriate when creditors are being asked to write off a portion of their debt as the insolvency practitioner will be able to tell creditors their thoughts on the likely return if the company were to be placed into liquidation.
Whilst much of the above would appear to be obvious, we have in the past been appointed as Liquidator of companies that had committed significant funds as a result of negotiations with major creditors, leaving the company without sufficient monies to address the claims of smaller creditors.
Formal Proposals
Proposals to creditors in formal insolvency processes (Voluntary Administration or Small Business Restructuring) usually involve establishing a pool of funds to be distributed to creditors on a pro-rata basis.
The importance of acting early is to maximise the options for proposals that directors have to choose from.
Proposals can take on many different forms and are only limited by the unique circumstances of each business. As such, the terms of each proposal will be different. Some examples that we have seen in the past involve one or more of the following terms:
- Lump sum contribution from the directors’ personal funds or funds sourced from family or third parties.
- Funds from a new investor with or without an associated change in shareholdings.
- Payment of instalments from future trading profits.
- Restricting the ability of related parties to claim from the proposal.
- Sale of the entire business, a certain business division or particular assets.
- Recovery of certain assets (e.g. debtors).
- Pursuit of legal claims.
- Separation of creditors into specific classes (requires sound commercial reasons for this to be done).
Successful Proposals
We are often asked what creditors will likely accept. There are many factors that creditors take into account when considering their options. These include:
- Whether the proposed return is better than the estimated return from the liquidation of the company;
- How quickly they will receive their dividend;
- The security of the funds that form part of the pool for distribution – ie. whether the funds are coming from the sale of surplus assets, third party contributions or future profits;
- Whether related parties are claiming from the pool of funds;
- Whether the directors or officers are suspected of committing any offences;
- Whether the company has a history of non-compliance with any repayment arrangements.
Ultimately, each creditor will make their own assessment of the options available and cast their vote accordingly. We have seen creditors accept proposals that return less than a cent in the dollar on claims and creditors reject proposals that return significantly more than the liquidation of the company. Each case is unique as are the factors which each creditor will take into consideration.
Case Studies
The best way to demonstrate the flexibility of proposals to creditors is by way of a few case studies. Some recent examples include:
- A company in the civil construction industry which at its peak had employed 90 staff, however had been reduced to approximately 15 staff at the time of our appointment. The company had expanded its operations quite rapidly into a related industry without the necessary internal controls, resulting in significant losses. By the time we were appointed:
- the director had already injected approximately $900,000 of his owns funds in an attempt to ensure that the company continued to trade;
- the company had returned to operating solely in the civil construction industry.
- A company in the civil construction industry which at its peak had employed 90 staff, however had been reduced to approximately 15 staff at the time of our appointment. The company had expanded its operations quite rapidly into a related industry without the necessary internal controls, resulting in significant losses. By the time we were appointed:
The director formulated a proposal to creditors which involved fixed contributions to a pool of funds from future profits over 2 years. Creditors accepted the proposal and the company managed to achieve the required contributions.
- A trucking company employing some 47 staff and over 100 trucks and trailers appointed us as Administrators. The cause of the appointment was due to the Australian Taxation Office commenced issuing garnishee notices to each of the company’s major debtors. A proposal was put forward by the director which included a significant lump sum contribution and the recovery of the company’s pre-appointment debtors, which was ultimately accepted by creditors.
- A building company, which the director alleged failed due to inappropriate actions of a former employee. Prior to our appointment, the director had been investigating the conduct of the former employee along with negotiating with creditors in order to prevent the company from being wound up.
A creditor subsequently commenced winding up proceedings against the company which caused the company to appoint us as Administrators. The director’s proposal involved the following aspects:
- Control would be returned to the director to continue investigating the potential legal claims;
- An up-front contribution of $100,000 along with a repayment arrangement totaling a further $100,000 would be paid into the pool of funds;
- A contribution of 80% of the net recoveries from the legal claims would be paid into the pool of funds and secured by a personal contribution by the director of $180,000 if within 2 years less than that amount had been recovered from the legal actions; and
Related party creditors, including the director would not claim from the pool of funds.
Summary
When seeking to address financial difficulties, directors of companies have more chance of being successful if they act early and are upfront with creditors as to the reasons for those difficulties.
We offer free, confidential, no obligation advice regarding the insolvency options available to your clients, including the various types of proposals that could be available. Given the unique nature of each company’s financial situation and the complexities of the legislation, please contact us to discuss these options.
Article written by Travis Olsen (Associate Director ) and Stuart Otway (Director) – Adelaide