Client Journey: Talk to High-Price Financiers

In article:

When Australian companies face liquidity problems, talking to financiers is appealing. Rescue financing might provide the necessary funds to stabilize operations. Interestingly, however, rescue financing is not as popular in Australia as it is in some other countries. 

Here we look at rescue financing options for distressed businesses in Australia and consider why this support can be difficult to access. 

Why rescue financing is unusual in Australia

Rescue financing in Australia faces several hurdles that make it less attractive compared to lenders than rescue financing in countries like Singapore or the US. Namely:

• Rescue financing has no automatic super-priority. In the United States and Singapore, rescue financing has ‘super priority’: New financing gets repaid before existing debt in case of insolvency (see section 366 of the US Bankruptcy Code and section 68 of Singapore’s Insolvency, Restructuring and Dissolution Act 2018). This provides a significant incentive for lenders. In Australia, rescue financiers will usually seek to secure their lending with an “All Monies” security or a an AllPAAP (“All present and after-acquired property”) security. However, secured creditors will usually have priority based on date of registration of the security — meaning rescue financiers come in last. 
• Voluntary administrators have personal liability.  In voluntary administration, an independent professional is appointed by Directors to administer a company that is insolvent or likely to become insolvent. Importantly, the administrator is personally liable for debts incurred during the administration period. This means that a voluntary administrator would need to apply to the court and have this liability waived — otherwise they take a massive risk in allowing rescue financing. So, why would they do so?
• High costs and collateral requirements. Rescue financing in Australia tends to be expensive. Lenders often require significant collateral, which might mean business owners have to put up personal assets such as their homes. Further complicating matters here, by the time a company is in financial distress, the director(s) has often already used their home as collateral, or put their home in play as part of a director’s personal guarantee. 

Rescue financing options in Australia

Assuming that a company is able to find a lender, which forms of rescue financing are available in Australia? Some options are. 

• Regular overdrafts and personal bank loans. These unsecured debt options are generally not sufficient for significant liquidity issues. It might be a temporary fix, but not enough to stabilise the business.
• Specialist bridging loans: These loans are typically used in property development scenarios where a quick injection of funds is needed to bridge the gap between the current state and the completion of a project. Bridging loans can be effective but are generally short-term and come with high-interest rates.
• Refinancing or debt consolidation. Through this option, the business takes out a new loan to pay off existing debts  — ideally at a lower interest rate than the sum of existing interest rates on multiple loans.  Of course, it may be difficult to get interest rates lower than existing rates given the deteriorated financial condition of the company. This may mean that the lender is only willing to lend at a higher interest rate, but may be more lenient on the term of the loan. 
• Accounts receivable discounting/factoring. This involves selling receivables (i.e., incoming payments from creditors) at a discount to get immediate cash. The primary advantage of this option is that approval is based on the quality of the receivables rather than the borrower’s financial position. A lender may be willing to take a risk on an unstable company if, for example, the incoming receivables are from trusted Australian brands who would take a big reputational loss in not paying what is due.  
• Supplier financing. Occasionally, suppliers might extend credit to help a business survive. This type of financing is often informal and might come with its own set of terms and conditions. This can be a good informal option where the distressed company has a good relationship with its suppliers. 
• Friends, fools, and family. When formal financing options are exhausted, Directors may need to go cap in hand to their personal networks. While loans from friends and family may be flexible, they carry the risk of damaging personal relationships if the business cannot repay the loan.

Safe harbour financing and court applications

If rescue financing is considered before the appointment of a voluntary administrator it might be pursued under the safe harbour provisions in section 588GA of the Corporations Act 2001(Cth). The safe harbour provisions provide directors with protection from personal liability for insolvent trading if they are developing one or more courses of action that are reasonably likely to lead to a better outcome for the company. Of course, seeking rescue financing may be one such “course of action”. 

Post-appointment, if the debt is to be secured, an application to the court is generally required. The court will need to approve the terms, especially if it involves significant security interests like “All monies” security agreements. 

The Need for Super-Priority Rules in Australia

Arguably, the lack of super-priority rules for rescue financing is a major failing of the Australian insolvency system. While Australia has come some way in creating a debtor-in-possession regime for small businesses through Restructuring under Part 5.3B  of the Corporations Act 2001 (Cth), no special provision for rescue financing was made there. This has been a missed opportunity. 

Talking to financiers 

Formal rescue financing in Australia is expensive and rare. Lack of super-priority and the personal liability of insolvency practitioners in voluntary administration mean that no one has an incentive to make this funding available. This means the best bet for most small companies in Australia is to talk to their existing creditors and try and work out an informal arrangement. Given that very poor returns for creditors in voluntary administration and liquidation in Australia, most creditors would prefer that the business continues as a going concern, if at all possible.