Voluntary liquidation versus voluntary administration
Typically, once a company becomes insolvent, directors have two choices: initiate a voluntary administration or (with the agreement of the shareholders) initiate a creditors voluntary liquidation (CVL). A CVL is the procedure for insolvent companies to initiate their own liquidation rather than wait for creditors to apply for a court to make an order. Here we look at the pros and cons of each option for struggling businesses.
- Pros of voluntary administration (VA) compared to creditors' voluntary liquidation (CVL)
- Prospect to recover the business as a trading entity
- Sometimes voluntary administration means a higher return for creditors.
- Directors can initiate voluntary administration.
- Voluntary administration can provide breathing space for directors.
- Voluntary administration allows for the continued trading of the business for a time and non-enforcement of ipso facto clauses.
- Non-enforcement of director personal guarantees during voluntary administration
- Pros of creditors' voluntary liquidation (CVL) compared to voluntary administration (VA)
- A more streamlined process
- CVLs are generally much less expensive than a VA
- More likely to be funds available for investigations/ recovery from the director
- Prepacks are cheaper through a CVL.
- Lack of creditor meetings can streamline the process
- Creditors voluntary liquidation vs voluntary administration: What’s your best bet?
Pros of voluntary administration (VA) compared to creditors’ voluntary liquidation (CVL)
Prospect to recover the business as a trading entity
The primary goal of voluntary administration, according to section 435A of the Corporations Act 2001 (Cth), is to allow the business to restructure its debt and live on as a trading entity. By contrast, the primary goal of CVL is to get the best outcome for creditors, according to the priority rules set out in the Corporations Act 2001 (Cth). A CVL will involve the termination of trading of the business.
It is worth noting that it is possible to use a CVL as part of a restructuring process through a ‘pre-packaged insolvency arrangement’ (also known as a ‘pre pack’). In pre packs, the directors can use the ‘safe harbour’ from insolvent trading in the Corporations Act 2001 (Cth) to arrange a sale of assets from the original company to a new company they also control. Any such arrangement gets final sign-off by a voluntary administrator or voluntary liquidator. Or at least the voluntary administrator or voluntary liquidator, whilst not approving of a pre pack for policy reasons, may acknowledge that it is not illegal and take no action to reverse it.
Sometimes voluntary administration means a higher return for creditors.
If there was no prospect of a better return in voluntary administration, then the rational choice for creditors would always be to go straight to CVL. But why would the returns be better? In short, the possibility of the business being ‘turned around’ means that directors may have an incentive to contribute their own funds into the pool for distribution, or to arrange financing in order to do so.
Directors can initiate voluntary administration.
A voluntary administration can be initiated by directors resolving that the company is insolvent or likely to become so, and appointing a voluntary administrator. There is no requirement for creditors or members (i.e. shareholders) to be involved at the initiation stage. Of course, in some small businesses the directors will be the sole shareholders in the company, so the distinction becomes academic. But in many cases they are not. This may be pertinent in the event of a breakdown in relations between shareholders about how to respond to company insolvency.
By contrast, the shareholders need to initiate a CVL. Where there is a dispute between owners this could be a barrier to starting a voluntary liquidation.
Voluntary administration can provide breathing space for directors.
Voluntary administrators do not have the power to take recovery actions against directors, such as claims for uncommercial transactions or unreasonable director-related dispositions. These powers are reserved for the insolvent liquidation process (i.e. a CVL). This means that a voluntary administration provides a temporary reprieve for worried directors to work out what steps to take if the liquidator does eventually make a claim against them.
Voluntary administration allows for the continued trading of the business for a time and non-enforcement of ipso facto clauses.
During the voluntary administration, the business can continue to trade with the voluntary administrator in control. This may be particularly useful where works-in-progress can be completed during that time and add to the assets of the company. There is also a moratorium on enforcing ipso facto clauses during a voluntary administration. These are clauses which allow contracts to be terminated on the occurrence of an insolvency event. This further supports the continued trading of the firm, and may be particularly useful in construction where the performance of one contract often relies on the performance of other contracts.
Non-enforcement of director personal guarantees during voluntary administration
Commonly, directors personally guarantee the debts of a company and are liable to pay those debts when the company is wound up. However, these cannot be enforced during a voluntary administration. As with the lack of recovery actions noted above, this gives directors extra ‘breathing space’ while they get their affairs in order.
Pros of creditors’ voluntary liquidation (CVL) compared to voluntary administration (VA)
A more streamlined process
CVLs are generally less complicated, procedurally, than voluntary administration. There are fewer creditor meetings and they can generally be skipped altogether.
CVLs are generally much less expensive than a VA
In a CVL, the liquidator has a discrete task; to investigate the affairs of the company and to realise and distribute assets. By contrast, voluntary administrators also take control of the company from directors and need to operate the business itself. This can add significantly to the cost of the administration. And then there is also the extensive compliance requirements relating to creditor involvement in the voluntary administration (e.g. reports and meetings), which are generally more extensive than what occurs in a CVL.
More likely to be funds available for investigations/ recovery from the director
While voluntary administrators also have a remit to investigate liquidator conduct, they don’t have the same incentive to do so. As mentioned above, only in a liquidation can amounts be recovered from directors through uncommercial transaction actions. In light of this, it is more likely that creditors will fund investigations in a CVL. There is more time in a CVL, for example, to investigate fraud than in a voluntary administration procedure.
Prepacks are cheaper through a CVL.
As mentioned, a pre-pack requires sign off (or tacit acceptance) by either a liquidator or a voluntary administrator. Generally speaking, it is cheaper to do it via a CVL as the upfront costs of appointing the liquidator are lower.
Lack of creditor meetings can streamline the process
The creditors’ meetings in a voluntary administration are an opportunity for disgruntled creditors to ‘throw a cat among the pigeons’ and delay/ extend the process. CVLs can be less volatile due to the reduced requirements for creditor involvement.
Creditors voluntary liquidation vs voluntary administration: What’s your best bet?
While there are pros and cons to both respective types of external administration, generally speaking, voluntary administration is preferable where the business proposition is viable and there is a possibility of the business being turned around (even then, if the debt is small enough, it is worth considering small business restructuring instead).
Where the business is no longer viable, it is generally preferable to save money and move the process quickly by going straight into liquidation via a CVL.
A pre-pack can be undertaken through both procedures but it is more likely to be undertaken through a voluntary liquidation because it is cheaper to do so.