The Complete Guide to working out whether your troubled business should go into Voluntary Administration, Small Business Restructuring or just be liquidated? 

The insolvent liquidation of the business is the last resort. Not only does it mean the end of the business, but in almost all cases, the directors will not see a cent. But in some cases, it will be the only available option — delaying an inevitable liquidation may drain firm asset values, infuriate creditors and put the directors at risk of a future claim for allowing the firm to trade whilst insolvent (still illegal in Australia). 

In many cases, the directors of the business will have little choice in what happens. For example, a creditor can apply to a court to appoint a liquidator in some cases, or a secured creditor could appoint a receiver and manager or a voluntary administrator when it has an      All PAAP security interest (all present and after acquired property – no exceptions). 

Where directors do have a choice, there are a range of options available for directors to attempt to ‘turnaround’ the business. One useful legal option for smaller businesses (those wth debts up to $1 million) is small business restructuring under the Corporations Act 2001 (Cth). Another legal option is to use the      safe harbour from insolvent trading protections to develop a restructuring plan. In this guide, we look at 19 key questions that need to be asked about a struggling business before determining which turnaround option might be optimal. The focus of this paper is to help directors of small-to-medium sized enterprises evaluate what is being proposed to them by their lawyers and accountants.

What are the key options?

Here are the main turnaround options that might be considered by the directors of an insolvent business. These options are pertinent when there is no hope of a turnaround via reducing costs or achieving other operational improvements. 

• Rescue finance. A third party could agree to fund the company so that it is able to pay its debts as they become due and payable, meaning that the company thereby becomes solvent. During the period of negotiation of such finance, the debtor company could be protected by a statutory ‘safe harbour’ which protects the directors of the company from liability for permitting insolvent trading, where they are developing a course of action ‘reasonably likely to lead to a better outcome for the company’ (see section 588GA of the Corporations Act 2001 (Cth)). Unless the directors are prepared to put up collateral, this money isn’t going to be lent by banks in Australia. Unless the directors draw down on their personal resources to fund working capital they often find it difficult to obtain finance.
• Informal ‘workouts’ or ‘private treaties’. In principle, a distressed company could enter into an agreement with all creditors to alter the terms of payment, so that the company can recover and quickly return to, or maintain, solvency. As long as the statutory conditions are otherwise met, the safe harbour could also apply during the development of such a workout/ treaty. This is called an ‘indulgence’ by the Courts and is difficult in practice unless there are very few creditors and these creditors remain on very good terms with the debtor company. A difficult option unless there is very small number of creditors due to hold-outs. 
• Pre-pack insolvency arrangements (‘pre-packs’). In a pre-pack, the directors of the company form an agreement to sell the assets of the old company (‘oldco’) to a new company (‘newco’) (of which they may also be the directors), for fair market value. This transaction could be finalised before or after a formal appointment of a liquidator. The old company is then liquidated, meaning that the debts are not transferred through to the new business. As with the prior two options, if the conditions set out in section 588GA of the Corporations Act 2001 (Cth) apply, the ‘safe harbour’ can apply to the time spent preparing a pre-pack. Note, where a pre-pack goes through prior to a liquidation or voluntary administration, the insolvency practitioner will review and question the pre-pack. Good professional advice should be sought to ensure that any pre-pack doesn’t breach the Corporations Act claw-back provisions. This isn’t a popular option in Australia because of scrutiny applied to the transaction by liquidators and creditors. 
• Voluntary administration. In a voluntary administration, an independent professional, the voluntary administrator (or ‘VA’), is appointed to take control of the company. While in control of the company there is a moratorium on creditor claims and the VA can continue to trade if they wish. The VA aims to reach a binding agreement with creditors, a ‘Deed of Company Arrangement’ (or ‘DOCA’) to settle existing debts. Once the DOCA is complete the business will either continue trading or be liquidated. 
• Small Business Restructuring Practitioner (‘SBRP’) process. This new mechanism, referred to simply as ‘restructuring’ in the Corporations Act 2001 (Cth), applies only to businesses with total debts of less than $1 million. A small business restructuring practitioner is appointed to develop a restructuring plan, which when agreed to by a majority of creditors by value, permits the company to restructure and continue trading. Crucially, the directors remain in control of the debtor company throughout. Read about this process in detail at A Complete Guide to the Small Business Restructuring Process. This process, in its short history, has had a much higher success rate than voluntary administration. 
• Liquidation. An insolvency professional, a registered liquidator, is appointed to realise the assets of the company and oversee its final winding up. This is usually an option of last resort, though delaying it can ‘prolong the pain’ and make eventual pay-outs lower than they would otherwise be. The focus of the company director should be understanding when to liquidate because their business is unsustainable. 

Is the company actually insolvent?

Not all businesses that face creditor action, or have run out of cash, will actually be insolvent. In some cases, they may be a ‘zombie company’, a company that is able to pay its running costs as they fall due, but consistently fails to turn an economic profit. Most small businesses only get enough return to give their owners a wage rather than a return that properly compensates them for the risk they take and the sweat capital they contribute. The opportunity cost of a zombie company is very high for its owners.

In other cases, the company may be suffering from a temporary cash shortage and this does not count as insolvent under the definition in the Corporations Act 2001 (Cth). The definition of insolvency given in section 95A of that Act provides that a company is insolvent if it is unable to pay all of its debts as they fall due and payable. 

Case law has clarified that it is not enough for a business merely to experience a ‘temporary lack of liquidity’, there must be an ‘endemic shortage of working capital’. In the case of The Bell Group Limited (In Liquidation) v Westpac Banking Corporation [No.9] (2008) WASC 239 the terminology ‘insurmountable endemic illiquidity’ was used. 

If a business is not terminally insolvent and it has a cashflow crisis that will be corrected, it would be unwise to look at formal insolvency options. For example, voluntary administration has a chilling effect on businesses that should not be underestimated. The better approach would be to ensure that real time financial information is analysed weekly and that realistic targets are set for the business. Many businesses have faced zombification in the past and their problem is more strategic than legal. Incremental improvement and sensible management could be enough to change the course of the business before it descends into actual insolvency. 

How does a company work out whether it is insolvent?

In Australia, courts have usually focused on cashflow (‘the cashflow test’) to determine whether a business has sufficient cash coming in such that it does not count as insolvent. The first step to working out whether a company is insolvent on this basis is to conduct a thorough bookkeeping write-up to ensure that up-to-date accounting information is available for analysis. It is then a holistic judgement about whether the company has the cash on hand, or can quickly acquire it by realizing assets, to pay debts as they fall due. The most important financial ratio to look at is the ‘current ratio’. This ratio compares the company’s short-term (current) assets with its short-term (current) liabilities.  

It is also important to look at the ‘Accounts Receivable Aging Schedule’ for the business. A slowdown in collecting on accounts suggests that cashflow problems are ahead. 

It should be noted that, irrespective of whether a company assesses or believes itself to be insolvent, under the law it can be presumed to be insolvent under certain circumstances, most commonly when a company has failed to respond to a statutory demand for payment of debt within 21 days. A failure to pay a statutory demand debt could give rise to deemed insolvency at law.

If, on the company’s own assessment, it is not yet insolvent, more creative turnaround options may be available: 

• Rescue finance may be more feasible, with less crippling interest rates than what would be applied to an insolvent company.
• It may be possible to organise a workout/ private treaty with creditors to relax payment terms, as they can be advised that the company can continue to pay its debts in the short-term, but needs flexibility in the longer term.
• It may be possible for a solvent restructure or re-organisation of the business so that it can become profitable in due course. Note that, in this case, general directors’ duties still apply to any restructure. For example, directors must still act in good faith and in the best interests of company and must not improperly profit at the expense of the company (i.e. proper purpose).

If insolvent, voluntary administration, the SBRP process and pre-packs may be available. Note,      voluntary administration is usually a better turnaround option for larger enterprises, rather than smaller businesses who will be eligible for SBRP.           

We discuss the turnaround options for insolvent companies in detail in the questions that follow. 

Is a private treaty viable (or is it the impossible dream)?

In almost all cases, an insolvent liquidation is pushed by creditors. Many directors of insolvent companies would otherwise procrastinate unless supply creditors and the ATO were taking legal action. Therefore, the first question might be, why can’t the directors simply come to a private arrangement with creditors to avoid liquidation? This is otherwise known as a ‘private treaty’.

This is not usually viable, due to ‘holdout’ creditors and the varying negotiating positions of all those involved. Coming to a private treaty where there is a diverse group of creditors is impossible. In most cases, there will be aggressive creditors, or those that refuse to compromise. Where there are very few creditors it may be a viable option to negotiate with those creditors one-by-one.

In attempting to arrive at a private treaty, it is worth considering the variety of competing interests that the directors would need to deal with:

• The Australian Tax Office (ATO). This is usually the largest unsecured creditor for any business in Australia. Concerned about the precedent that it would set, there is virtually zero chance of a debt compromise with the ATO — they would prefer to use formal procedures to resolve the issue. For example, they may issue Director Penalty Notices (DPNs) against directors (more on this below).
• State revenue authorities. Businesses with employees must pay payroll taxes to state revenue departments (such as NSW Revenue). If these authorities are unpaid, they will become an unsecured creditor of the distressed business. They are unlikely to take any legal action before the ATO. They may issue a statutory demand at some point in time, but they have no right to ‘pierce the corporate veil’ and pursue directors personally, as the ATO does. They are therefore mainly a passive creditor but given the employee dimension of payroll tax they are very unlikely to accept a private treaty proposal.
• Financiers. Most SMEs in Australia can’t get bank finance other than credit cards, debt factoring or an overdraft. Any more significant debts usually require directors to personally guarantee those debts and offer collateral. Where the debt is for a large amount, that personal guarantee is likely to be accompanied by a registered security interest, meaning banks would be secure regardless of the outcome of an insolvency scenario.
• Last resort lenders: These lenders, including ‘caveat lenders’ or ‘receivables financiers’, offer financing to businesses in difficulty. They tend to have high interest rates and require personal guarantees backed up by collateral. In many cases, they may also require the registration of cross-collateralisation – where there is an All PAAP over the debtor company, personal guarantees by the directors and mortgages over real property held by the directors. It is worth noting that even where the turnaround works, the burden of this debt may sink the directors personally. Expect these creditors to be aggressive.
• Landlords. These will often be a big creditor, such as in a retail business. They usually have the right to terminate the tenancy for non-payment of rent, and may use bank guarantees. These creditors are some of the least likely to forgive debt – in many cases they would prefer to evict and start again with a new tenant. 
• Suppliers. Historically, suppliers have often gone unsecured. But years of goods suppliers getting burned mean they now usually seek personal guarantees of directors and      Purchase Money Security Interests (PMSIs) over goods supplied. We discuss these kinds of creditors in greater detail below.  
• Trade unions and employees. Usually aggressive in protecting employee entitlements which have priority against general unsecured creditors in the case of winding up. Some unions have a history of militancy. 
• Equipment financiers. Where they have a personal property security registered against equipment, they will exercise this through re-possession. 

What do you do if you need to get all of the above creditors to agree to a private treaty if you want to save your business? Look at a formal insolvency appointment because it is rare that directors can negotiate a private treaty for forgiveness of debt with enough of these competing creditors to avoid an insolvent administration. 

What is the root cause of insolvency? 

The most appropriate turnaround options depend (at least partially) on what caused the insolvency. In its annual statistics, the Australian Securities & Investments Commission (ASIC) keeps track of the most common indicators of insolvency. It consistently notes that poor strategic management, poor controls, failure to keep records and inadequate cashflow are the top causes of insolvency in Australia. 

But, truth be told, these are not the ‘causes’ of insolvency. These are downstream symptoms of a more fundamental illness within the business. To know the cause of insolvency we need to know why the business is failing to keep records, or why it has inadequate cashflow. 

Answering these questions means looking more deeply into the profile of insolvent businesses and their owners/ directors. 

First, look at the owner/ director’s lifestyle. While there are no publicly released statistics on the matter, we have observed time and again that directors of insolvent small to medium-sized enterprises (SMEs) in Australia tend to fit the following profile: 

• Males between 45 and 55 years old, who have been in their industry for 20 years plus.
• Over-worked and rarely take vacations.
• Most commonly operate in the construction and transport industries. These are industries where subcontracting companies often carry the risk of big corporates who hold the principal contract. Large investments in plant and low profit margins are also typical of these industries. 

Why does the profile of directors and their industry matter? It matters because some insolvency causes are potentially more easily ‘solvable’ than others. For example, the tech-phobes may not be aware just how easy it is to run all their incoming and outgoing payments through Xero, QuickBooks or FreshBooks, and thereby have up-to-date and accurate financial records. 

Where the root causes can be identified and fixed, there is strong potential to turnaround the business. 

On the other hand, where there are structural problems leading to insolvency, some companies may be destined to collapse irrespective of their best attempts to turn things around. For example, in the construction industry in Australia, the standard model of chains of contractors means sub-contracting companies bear an unduly heavy degree of risk as a result of their position at the ‘end of the chain’. 

Despite some variations by industry, there are also some general strategies that are useful for responding to the causes of insolvency, across the board. We recommend:

• Downsizing and radical expense reduction.
• Ending projects that have low chances of success.
• Terminating staff that aren’t productive and taking a long hard look at management quality.
• Keeping focused on managing remaining staff by specific objectives and reviewing KPIs regularly.
• Focusing on profitable service and product lines and cutting the rest (respecting the 80/20 rule that 20% of customers deliver 80% of profits).
• Forget about prestige and vanity marketing activities. Stick to marketing campaigns that deliver income.

What type of business is it? 

Your prospects of surviving an insolvency situation are significantly affected by the industry that you are in. For example, are you in a sunset industry? In that case, a restructure can only ever stave off the inevitable. Twenty years ago, this was video stores. In ten years (or earlier) it will be petrol stations. It may not be worth investing sweat capital in a business that has no substantial chance of longevity. 

Some other features of the business to consider: 

• Whether the business has secured creditors: If it has a secured creditor with an All PAAP, a receiver/ receiver and manager could be appointed to take control of the business, under the terms of a General Security Agreement. Where there is a secured creditor who has security over all or substantially all of the assets, they can also initiate a voluntary administration themselves. One advantage of this option (as opposed to receivership) is that the appointed VA can replace directors and run the business during a moratorium period. 
• Whether the asset base is large. The larger the business, all being equal, the more likely that a voluntary administration will result in a successful DOCA and the continued trading of the business (see, for example, the successful voluntary administration of Virgin Australia). This reflects the fact that larger businesses are often more attractive for potential buy-outs, as well as the ability to more readily absorb the substantial costs of voluntary administration. The smaller the asset base of the company the less viable a voluntary administration process will be.
• The ease of running the business. In voluntary administration, the administrator takes over from directors and can continue trading in place of the directors. If the business in question is an agriculture business, and the administrator in question has zero experience in agriculture, this will reduce the desirability of voluntary administration.      Conversely, if the business is specialised, an SBRP process or pre-pack (prepared under the terms of the ‘safe harbour’) may be more desirable, as these processes let the directors stay in control of the company throughout. Though note the monetary restrictions on SBRP – to companies with less than $1m in total debt owing. 
• The simplicity of the business’ products or services. A pure service-based business with no significant plant and equipment or secured creditors should be the easiest to restructure overall through SBRP or pre-pack. 

What kind of reputational risks can the business withstand? 

Insolvent restructuring is not for the faint of heart. There is a fair chance it will fail and sweat capital will be lost. The reality is that often formal insolvency appointments occur when a business is past the point of turnaround. So it’s not surprising that formal insolvency processes have a mixed reception with the general public.           

As it is still a new process,      it is an open question how SBRP comes to be seen by the business community. But as it is a ‘debtor in possession’ regime, with directors remaining in control of the business operations, it could come to have a better reputation in Australia than other insolvency options     , as the famous ‘Chapter 11’ restructuring process has a positive reputation in the United States. 

Pre-packs are sometimes      seen as dodgy in the business community because creditors suspect      illegal phoenix activity. As with phoenixing, in a pre-pack a transfer of assets to a new company occurs behind closed doors, and without the consent or awareness of unsecured creditors. The difference is that the assets are properly valued, are sold at current market value and the liquidator or voluntary administrator has the power to subsequently investigate what occurred. Pre-packs are more accepted in the United Kingdom but less so in Australia.      

However, this element of secrecy/ privacy of pre-packs, which lend them a somewhat dodgy appearance, are also what protect the reputation and goodwill of the business itself. As there is no requirement to inform anyone that a pre-pack process under the safe harbour is being undertaken, the business may continue to trade. The unsecured creditors will need to pursue their complaints through the liquidation process of the Oldco. 

What is the size of the debt? 

To appoint a small business restructuring practitioner, the debt must not be more than AU $1 million. There are no size restrictions on other restructuring options, and generally speaking, the smaller the debt, the more likely any turnaround will be successful (it is more likely that creditors will agree to a compromise). 

Having said that, there is an old saying, often attributed to prominent economist John Maynard Keynes, ‘You owe your banks $10,000 they own you, you owe your banks $10 million and you own them’. I.e. where the amount owed is large enough, a creditor may have a vested interest in your business surviving and recovering and being able to pay back that debt. In other words, debt isn’t just a number it is a relationship.

No matter what the size of the debt, in our experience treating creditors with respect goes a long way. Keep them informed of any hiccups in debt repayment, offer them a reasonable repayment plan and they will be more likely to agree to that restructure.  

Does a secured creditor have an All PAAP?

An ‘All PAAP’ stands for ‘all present and after-acquired property’. It is a type of security interest that secures a debt over all personal property, rather than any particular piece of property. It does not secure an interest in land. This security interest used to be known as a ‘fixed and floating charge’.

A general security agreement with an All PAAP means a secured party has a veto right to any balance sheet restructure. The debtor company cannot transfer assets – like plant and equipment, without the consent of the secured party. 

This means a pre-pack is usually dead in the water: No secured creditor will agree to those assets being transferred to a new company. If there is an All PAAP the secured creditor would probably prefer a voluntary administration      – there is the promise of reduction in unsecured debt, while their position as secured creditor is preserved.

How angry are the creditors?

The attitude of creditors can be a huge factor in working out which turnaround option might be best for the business. Consider: 

• Voting differences in formal restructuring options. The form of creditor agreement in a voluntary administration, the Deed of Company Arrangement (DOCA), requires that the majority of creditors, by number and value, agree to the DOCA. By contrast, a SBRP process only requires that the majority, by value, agree to the restructuring plan in order for it to be binding. This means that it may be easier to ‘force through’ a restructure in a SBRP process, even though several (even the majority) of individual creditors are unhappy. 
• Angry creditors can replace voluntary administrators     . While      voluntary administrators are usually appointed by directors, they can be replaced by the creditors. This is not possible in an SBRP process, which is designed to be as quick and painless as possible. 
• Pre-packs do not require a vote. Creditors do not necessarily get a say in a pre-pack arrangement. However, liquidators (or voluntary administrators     , as the case may be) will scrutinise any transaction and may reject a pre-pack (before it is finalised), or seek to recover assets from a pre-pack as a voidable transaction (after it has been finalised). 
• Landlords can be ornery. If you’ve upset your landlords – don’t expect a debt haircut. Many would simply prefer to evict, with the end result that the business has no premises.
• Equipment financiers can pull the rug out from an attempted restructure. They tend to prefer to realise assets and enforce personal guarantees rather than participate in a restructure. This means, an angry equipment financier can leave the business with no equipment. 
• Trade unions. In some industries in Australia, such as building and construction and transport, they can be quite militant. If employees aren’t covered for entitlements, they may blackball a restructure. It’s worth noting that it is a requirement before even entering the SBRP process that the business has paid employee entitlements up-to-date. 

How big is the tax debt? 

Arguably the Australian Tax Office (ATO) is the most ‘neutral’ creditor – at least compared to militant trade unions, commercially-hardline landlords and trigger-happy equipment financiers. It seeks to recover as much as it can on behalf of the public purse, without being influenced by private gains or emotions. Does neutrality mean that the ATO is benign? Not exactly. Of all creditors, the ATO is most likely to finance and support liquidator legal action. Why is this? 

• The ATO does not appear to be particularly fond of voluntary administrations but it is more supportive of SBRP. The ATO more often votes in favour of SBRP restructuring plans and is positive towards the process (compared to voluntary administration).           
• The ATO is not fond of pre-packs (whether finalised through a liquidation or a voluntary administration). In most cases, pre-packs leave a tax debt with the old company that is wound up, so the ATO gets nothing. The ATO is the most militant creditor in acting against phoenix activity. 

Are the employee entitlements paid up to date? 

Regulators in Australia are particularly concerned about protecting the interests of employees in an insolvency. When a business has run out of cash it will often find itself unable to pay out all of the staff’s accrued entitlements. 

Sometimes, businesses have intentionally used an insolvent liquidation as a way of depriving employees of their wages. Wage theft (as it is called) through insolvency is illegal (see 596AB Corporations Act 2001 (Cth), as well as various pieces of state legislation).

Because of their vulnerability, employees are the most protected of unsecured creditors in the Australian insolvency system. Consider: 

• If employees/ entitlements are unpaid, businesses cannot initiate the SBRP process.
• In the Corporations Act 2001 (Cth), after the liquidator is paid, employees are next in the order of priority for returns.
• There is a statutory scheme (the Fair Entitlements Guarantee or ‘FEG’ Scheme) in Australia which may step in for a liquidated company and pay out employees, unless there is a successor company. 

It is worth noting that the payments to director employees, could in some cases be a voidable transaction (an ‘     unreasonable director-related transaction’), which the liquidator/ voluntary administrator may seek to recover back from a director. 

Is action being pushed by suppliers? 

In most cases, B2B suppliers provide goods on credit. This makes them particularly vulnerable in the case of debtor insolvency. But it also has a disproportionately large impact on the debtor company. In most cases an unbroken supply chain is crucial to their continual operation and trading in a turnaround scenario. It is therefore crucial that B2B suppliers are kept on side as much as possible in a turnaround scenario. Where suppliers are pushing action: 

• An SBRP is likely to be the most seamless process. For a small business, this process is quick, and directors remain in control of day-to-day trading. A compromise may be able to be quickly worked out without a major break in trading. 
• Personal guarantees may come into play. Suppliers have been burnt one too many times and regularly obtain these from the directors of debtor companies. As generally unsecured creditors in any liquidation, their return is likely to be small, so they may be better off focusing on enforcing directors’ personal guarantees than waiting for a dividend from a company liquidation to appear. 
• Suppliers of goods may have PMSIs. Sometimes suppliers will be secured creditors and will register and perfect a particular type of security, a PMSI, through the Personal Property Securities register. This gives them a security interest over collateral that potentially extends to receivables and cash at bank linked to that collateral. In practice, they often miss out because their interest can be difficult to trace.

How hard is it to finalise a compromise with creditors?

Different restructuring options have different mechanisms for getting creditor agreement, some making an agreement more difficult than others: 

• SBRP processes is based upon a straightforward vote. No instrument is required for registering creditor agreement, and vote is by majority by value only. It is not possible for minority creditors (by value) to hold-out against the majority (by debt). 
• Deed of Company Arrangements (DOCAs) are harder to get approval for a compromise (than an SBRP). The DOCA — the ideal outcome of the voluntary administration — is a more formal process. It requires agreement from creditors by majority in value AND number, and requires an instrument to be implemented and overseen by a deed administrator.
• Liquidation is no compromise, with creditors receiving whatever small amount they are entitled to pari passu. 
• Pre-packs do not require consent or compromise from anyone. A pre-pack can be implemented without a single creditor agreeing. Though, as noted before, any pre-pack will be queried by a voluntary administrator or liquidator with any uncommercial transactions being voidable. This is the higher risk approach to corporate restructuring.

How much does each turnaround option cost? 

Obviously, the cost of any turnaround option will impact on the potential returns for creditors and the ongoing viability of the business itself. The business owner will need to budget for this.

• Voluntary administration is relatively costly.      Recent doctoral research from Professor Jason Harris suggests a voluntary       administration generally costs between      $30-50     k for a small business appointment. 
• SBRP is cheaper than voluntary administration. It is expected that the overall cost of the SBRP process will be $10-20k. This reflects the short time-frames, the streamlined process and the fact that the directors still retain responsibility for controlling and operating the business. 
• Pre-packs are difficult to price. Pre-packs are difficult to price because they don’t just involve drafting an asset sale agreement. The better approach is to consider the whole business and assess the future risks of legal action by liquidators. Funds should also be allocated to pay liquidator professional costs. 

What kind of expertise is needed? 

Different turnaround and restructuring options may be implemented by different kinds of advisors. 

• VAs, liquidators and Small Business Restructuring Practitioners are always professional accountants. This means their focus and expertise is on the financials. They may not take on turnaround work because that would preclude them from formal appointments for the same company. 
• Pre-packs are developed by insolvency lawyers and insolvency practitioners. The risks of getting into legal trouble would be high if legal and accounting advice wasn’t sought before undertaking a pre-pack. 
• Lawyers have a role. No matter which process is chosen, insolvency lawyers have a role to play.      Lawyers     always have fiduciary duties to their director clients and this is very important for directors who need an advocate. On the other hand, Lawyers may not be able to help with operational or financial issues that are faced. 

One of the tragedies about this area is that we see the small firm accountant playing a critical role and not referring the client to industry experts fast enough. Private practice accountants have a lot of clients and not a lot of time to dedicate to their insolvent clients. 

Which process is the quickest? 

The end goal of any turnaround process should be to have the business up-and-running profitably as quickly as possible. Or, failing that, liquidated as quickly as possible to maximise returns for creditors. Note that: 

• Pre-packs can be very quick. There is no need for creditor agreement slowing down the process. Note, however, that the subsequent liquidation of the original company could go on for a couple of years.
• The SBRP process is quick. It is to be completed within about 6 weeks and if there is a successful restructure there could be a long payment plan in place.
• Voluntary administration can be quick. It can be done within 8 weeks, but if there is a successful restructure through a DOCA this could go on for some time. 

Which turnaround process gives the best return to creditors? 

Honestly speaking, no turnaround options give the unsecured creditors a big return. A successful restructure of an insolvent company will be likely to include a haircut for creditors claims. 

• Voluntary administration is usually the best for larger businesses’ creditors. High hourly VA fees chew up the asset pool for smaller businesses who would be better suited to SBRP.     
• Liquidation is often better for businesses that are severely insolvent and unsustainable. Liquidation stops the ‘bleed’ and distributes proceeds before they can get eaten up in formal insolvency process.                       
• The SBRP process has good outcomes for creditors. There is empirical research that shows that creditor are receiving decent returns from the SBRP. If a creditor receives 20c in the dollar (on average) this will be above what other restructuring options give to creditors (on average).
• Pre-pack is the worst for creditors. A pre-pack is designed to empower the directors of the debtor company and enable them to continue the business without prior debt hanging over them. Generally, unsecured creditors are left without any return because the liquidated company is deprived of assets by an asset transfer. 
• Informal workouts/ private treaties rarely occur. It is extremely difficult to get agreement to a private treaty from creditors. Directors also need to keep in mind that, if they do reach an agreement with a subset of creditors but subsequently go into liquidation, liquidators could attempt to claw back those amounts as an ‘undue preference’ to the creditor. On the other hand, if there is a small number of creditors a private treaty could provide a return better than a formal appointment process. 

Which process poses the biggest risk to directors of insolvent companies?

It is the directors, not creditors, who actually initiate a turnaround process, so what do they need to keep in mind when choosing the appropriate option? 

• Insolvent trading litigation is rare. It is rare that liquidators            or ASIC pursue directors for permitting insolvent trading to occur. The more significant risk for many directors will be the calling in of personal guarantees and liquidators pursuing voidable transactions (such as unreasonable director-related transactions or creditor-defeating dispositions) against them.  
• The biggest factor for director liability is the size of the asset pool or presence of litigation funders. Most of the time, liquidators do not have the incentive to dig deep into director actions to determine whether misconduct has occurred. On the other hand, the value of potential claims can be very high and someone (such as a litigation funder) may pay lend money towards professional costs.       
• Pre-packs may mean more scrutiny of director action. In a pre-pack, neither creditors, nor voluntary administrators, nor liquidators, are usually present during their preparation. It may seem like a good idea to cloak the transaction but creditors will more upset and a later liquidator’s report could accuse directors of illegal phoenix activity. Due to a recent amendment to the Corporations Act 2001 (Cth) it is illegal for a director to knowingly facilitate ‘     creditor-defeating dispositions’.  This makes it easier for liquidators to reverse pre-pack transactions. The tragedy may be that the director phoenixes an unsustainable business and then loses money on both a second business failure and dealing with claims related to the first business failure. 
• Presence of ATO debt? Directors should be aware of the possibility of a Director Penalty Notice. This allows the ATO to pursue the director personally for PAYG, Superannuation Guarantees and GST debts, and if necessary, garnish their personal income. 
• The SBRP process may be the best hope. As the SBRP process allows for the ongoing trading of the business under existing directors, it naturally reduces the degree of scrutiny compared to other turnaround options. Further, if an SBRP fails the company does not automatically go into liquidation. 

Conclusion

There is no option in Australia that guarantees high      returns to creditors or enables directors to easily turnaround an insolvent company. The insolvency process is designed to scrutinize insolvent companies. The SBRP process could be useful for a restructure, but will only be available for small businesses. Ultimately, directors should work through the key questions (such as the ones listed in this Guide) to work out which turnaround option has the best prospect of success in their situation.