In our roles as accountants specialising in insolvency work, we are often approached by directors of companies in a state of financial distress that means a formal administration is unavoidable.
From time to time, companies will encounter financial difficulties – that is one of the risks of running a business. Identifying that the company is experiencing those difficulties promptly gives directors of such companies more options to fix the cause of the problems.
Informal options exist that can be utilised to address problems causing financial distress encountered by otherwise viable businesses such as Safe Harbour and Turnaround Consulting. These options can be used to assist directors in rectifying issues in the business without the need for a formal appointment.
The benefits of such engagements are:
- Unlike a formal insolvency administration, there is no public record of such assignments, thus avoiding any reputational damage to the business and its directors; and
- Engaging an accountant specialising in these types of assignments may reinforce the message being provided by directors to affected stakeholders (such as banks, major suppliers etc).
Section 588G of the Corporations Act 2001 (Act) provides that directors of a company have a duty to prevent a company incurring debts whilst insolvent. If a company is placed into liquidation, the directors can be held personally liable for those debts incurred whilst the company was insolvent which remain unpaid at the date of the liquidation.
This obligation on directors usually meant that a formal insolvency process was required to save the company.
In 2017, section 588GA of the Act was introduced to encourage directors of companies that were insolvent or likely to become insolvent, to implement a plan to restructure the company informally (i.e. without a Small Business Restructure or Voluntary Administration).
The formulation and implementation of such a plan must be “reasonably likely to lead to a better outcome for the company”. The elements of any plan should be compared to the likely result if the company were to be placed into a formal restructuring process.
Section 588G(2) provides:
For the purposes of (but without limiting) subsection (1), in working out whether a course of action is reasonably likely to lead to a better outcome for the company, regard may be had to whether the person:
(a) is properly informing himself or herself of the company’s financial position; or
(e) is developing or implementing a plan for restructuring the company to improve its financial position.
If the directors implement an informal restructuring plan which later fails, they will be protected from personal liability for debts incurred whilst the company was insolvent if they can demonstrate the above matters.
In addition, to be able to commence and then implement such a plan, the company must:
- Ensure that all employee entitlements are up to date at the commencement of the process and remain up to date during the restructuring process (this mainly refers to superannuation contributions of employees); and
- Ensure that all tax reporting obligations are met.
Role of the Expert
The role of an expert in a safe harbour engagement is to:
- Assess the viability of the company and whether the company is eligible for a safe harbour restructuring plan;
- Assist the directors of a company to formulate and implement a restructuring plan;
- Assist the directors in ensuring that the company’s obligations with respect to payment of employee entitlements and taxation reporting are met;
- Manage communications with stakeholders (eg. key suppliers / financiers / ATO);
- Ensuring that sufficient documentation is maintained to support the decisions made by the directors; and
- Support the directors throughout the process.
An expert is a key element of a successful restructuring plan. An expert usually has a background in working with distressed companies and can often bring new ideas when formulating a restructuring plan.
Early engagement with an appropriately qualified expert is likely to lead to better outcomes and relieve stress being experienced by directors by providing clarity as to the options available.
Some of the signs that a business is performing below its optimum include:
- Having to frequently negotiate payment plans with suppliers / ATO;
- Having to loan personal funds to the business on a frequent basis to pay wages;
- Having to borrow funds from family/friends to pay suppliers;
- Receiving demands or being placed on stop supply; and
- Receiving a garnishee notice or director penalty notice from the ATO.
Sometimes these difficulties are brought about by circumstances beyond the control of the business (eg. COVID, bad debts etc), whilst some could have been avoided (eg. adapting to changes in technology). In both scenarios, quick action by business owners and their advisors can put the business back on track.
In some cases, engaging specialist turnaround management services can assist the owners and advisors.
Turnaround Consultants are specialist crisis managers who often look at the business in a different and objective way to the owners and existing advisors.
The role of a Turnaround Consultant usually involves:
- Negotiating with creditors to provide sufficient time for the business to get back on its feet. This usually relieves stress and costs associated with recovery action commenced by creditors;
- Analysing the cause of the difficulty and finding solutions to prevent the problem happening again. This could include organising short term finance, a complete refinance and/or cutting unnecessary costs. The actual solution will depend on the unique circumstances of each business;
- Providing the owners with independent, unbiased views in order to implement a plan for long-term profitability and growth.
Steps in a Turnaround
Step 1: Assess solvency and viability
The first step in a Turnaround is for the consultant to assess the solvency and viability of the business. This would normally involve the preparation of a three-way forecast (cash flow, profitability and balance sheet).
An insolvent but viable business can be turned around. A business with many creditors will be difficult to turnaround on an informal basis. In these cases, a formal recovery process (eg. Small Business Restructure or Voluntary Administration) may be the correct solution for the business. There is little point in trying to turnaround a business that is not viable.
Step 2: Relieve pressure
The consultant would usually negotiate with creditors/lenders to advise of their appointment by the business and seek their cooperation in withholding recovery action until the business had developed a turnaround plan.
Step 3: Analyse the business and formulate options
With the assistance of the owners and advisors who are familiar with the business, the consultant analyses the business to understand the actual causes of the difficulties. Understanding the problem(s) will enable the proper formulation of a plan to turnaround the business.
Step 4: Finalise and implement Turnaround Plan
Based on their understanding of the business operations, the consultant develops a plan for consideration by the owners which is then implemented by the owners and advisors. The consultant can be involved in the implementation if necessary.
Step 5: Monitor implementation and adapt as necessary
One of the key elements to a successful turnaround is monitoring. Close monitoring of the business whilst the turnaround plan is implemented will allow the plan to be altered/improved if necessary.
Both options discussed above are designed to save otherwise viable businesses.
The key differences between the two options are:
- Turnaround can be commenced when business is solvent – Safe Harbour only comes into play when company is insolvent;
- Safe Harbour is more structured as it is governed by statute and adds a degree of independence with checks and balances from independent experts, whilst Turnaround Consulting is more flexible;
- A turnaround consultant provides leadership to directors whilst a safe harbour consultant provides the necessary support to directors who already know what to do.
The key in all situations is for directors to identify that there is a problem in the business and act early by speaking to their accountant or solicitor.