- What is voluntary administration?
- What occurs during a voluntary administration?
- Who are the key players in a voluntary administration?
- What is the purpose of voluntary administration?
- How does voluntary administration actually work?
- What does a voluntary administrator do?
- Who appoints a voluntary administrator and when can they do it?
- Who can be a voluntary administrator?
- How do I know if I should go into voluntary administration?
- How do you pick the right voluntary administrator?
- What are the difficulties with voluntary administration/the impact of COVID-19?
- How do I prepare for a voluntary administration?
- When can a creditor replace or remove a voluntary administrator?
- What are the main perceived benefits or motivations for voluntary administration?
- What is a successful voluntary administration?
- What is the typical outcome of a voluntary administration?
- What are the potential negative impacts of a voluntary administration?
- What are the alternatives to a voluntary administration?
- Who should I consult or where can I get more information about voluntary administration?
What is voluntary administration?
Voluntary administration is intended to support businesses that are insolvent to continue operating and, where that is not possible, achieve a greater return for creditors than the immediate winding up of the company through a restructure.
For an assessment of whether voluntary administration is actually likely to be successful see section headed ‘What is a typical outcome for a voluntary administration’.
It is important to understand the distinction between voluntary administration and a range of other legal concepts that it is sometimes confused with:
- Insolvency is a situation where an individual or business cannot pay their debts as they fall due and payable. In making the decision to enter into voluntary administration, directors are guided by their duty to prevent the company trading while insolvent.
- Receivership occurs when a secured creditor (or occasionally, the court) appoints an independent specialist (‘the receiver’) to have control of the company’s assets. The receiver’s task is to sell enough of the company’s secured assets to repay the debt owed. This process does not affect the existence of the company.
- Liquidation means the winding up of a company, including an investigation into the company and the distribution of assets to creditors.
- Bankruptcy is the process where individuals (rather than companies) are declared unable to pay their debts as they fall due and their assets are formally sequestered. In this process, an independent professional is appointed to assess tax liabilities, and, if there are assets remaining, distribute them to creditors.
Voluntary administration, receivership and liquidation are sometimes referred to as different types of ‘external administration’.
What occurs during a voluntary administration?
On appointment, the voluntary administrator gains control of the company, its business affairs and its property. The company’s directors are then required to assist the voluntary administrator in carrying out their job.
The voluntary administrator’s key outputs are a set of recommendations to creditors as to what should be done with the company and its property, as well as accompanying reports.
Summary of voluntary administration
|How is a voluntary administration commenced?||Usually by directors of the insolvent company|
|What criteria needs to be met for a voluntary administrator to be appointed?||The company must be insolvent (or about to become insolvent)|
|What happens when the voluntary administrator is appointed?|
The voluntary administrator assumes control and the powers of directors are suspended. The voluntary administrator then decides whether the business trades day-to-day
How long does a voluntary administration last?
|Usually about 6 weeks in total|
|What is a successful voluntary administration?||Occurs when the creditors vote in favour of a deed of company arrangement (DOCA) proposal and the business of the company survives to complete its obligations under the DOCA|
|What is an unsuccessful voluntary administration?||The directors expect that a DOCA will succeed but it is voted down by creditors and the assets of the company are sold in a fire-sale after liquidation|
Who are the key players in a voluntary administration?
A creditor is someone who is owed money by the company in question. Usually, this is because they have provided goods, services or a loan to the company and are yet to be compensated. Creditors include retail customers owed product, employees owed salary or wages and banks or lending agents owed repayments or interest. There are two types of creditors: secured and unsecured.
- A secured creditor has a ‘security interest’ over some or all of the company’s assets. This ensures their debt is repaid should the company default on the loan. The collateral for a loan may be a mortgage over real property, or a security interest over personal property. Security interests over personal property (excluding land) can be registered on the Personal Property Securities Register (PPSR) to ensure the security interest is enforceable and accorded the highest priority possible
- An unsecured creditor does not have a security interest in the company’s assets. Unsecured creditors include employees, who are of a special class, and are typically paid back before other unsecured creditors.
In the event of insolvency leading to voluntary administration or liquidation, secured creditors are paid back in full before unsecured creditors.
A director is the person or persons who, under the law, have overall responsibility for a company. They may themselves be actively involved in the running of the company, or, they may delegate day-to-day running of the company to others. Typically, directors:
- Act with full discretion ‘as the company’
- Have the authority to approve or reject strategy and financial decisions
- Have control over company assets
- Are reasonably perceived by people both internal and external to the company as a director, and guide the day to day operations of the company.
Directors can be ‘de jure’ (elected knowingly in accordance with the company constitution and relevant legislation) or ‘de facto’ (acting in the capacity of a director without official appointment). De facto directors are also sometimes known as ‘shadow directors’. Both types of director carry a large amount of personal liability.
Directors have a range of duties which, if breached, may result in civil and criminal penalties. Directorial duties that carry penalties, if breached, include:
- Ensuring that the company does not trade while insolvent
- Avoiding conflicts of interest
- Exercising good faith and reporting to liquidators where applicable.
In the event of a voluntary administration, directors will have to relinquish control of the company to the voluntary administrator.
What is the purpose of voluntary administration?
The voluntary administration regime was introduced into the Corporations Law in 1993 to provide an alternative to liquidation and the immediate closure of insolvent businesses. The intention was to protect the going-concern value of insolvent businesses. The law did this by creating a flexible process of implementing a compromise with creditors with minimal Court involvement.
The process of voluntary administration is controlled by an independent insolvency practitioner who is appointed by the directors. If a compromise offered by the directors is not accepted by a vote of the creditors, then the company goes into liquidation nevertheless.
It is fair to say that voluntary administration, as a process, has not achieved its stated purpose. Success rates for voluntary administration are very poor. For more information see the section headed ‘What is the typical outcome of a voluntary administration?’.
How does voluntary administration actually work?
Within five business days of being appointed, the voluntary administrator must call a first meeting of the creditors.
The creditors will determine:
- Whether to replace the voluntary administrator with someone else; or
- Whether a committee of creditors should be appointed to correspond with the voluntary administrator throughout the course of the voluntary administration.
Within 28 to 35 days, the voluntary administrator will need to call a second meeting to determine the company’s future. The voluntary administrator will release a range of information for the meeting and offer an opinion on three options:
- Whether it is in creditors’ interests to execute a DOCA. A DOCA is a binding arrangement between a company and its creditors resolving how the company’s affairs will be dealt with and what proceeds they will see. It binds all unsecured creditors whether they voted for the DOCA or not
- Whether it is in creditors’ interests for the administration to end and give the company back to the directors; and
- Whether it is in creditors’ interests for the company to be wound up through a liquidation.
In response, the creditors must make a decision to do one of the following:
- Execute a DOCA
- End the administration
- Have the company wound-up, or
- Adjourn the meeting for up to 60 days.
What does a voluntary administrator do?
A voluntary administrator(voluntary administrator) essentially discharges the duties of a director in crisis mode. They have all the powers of the directors of a company, including the ability to sell a company’s business, sell assets and dismiss employees.
A voluntary administrator seeks to achieve the best possible outcome for the business and its stakeholders. They will make assessments about the business and its viability which will inform their recommendations. Primarily, voluntary liquidators look for ways to increase profitability and allow businesses to continue to trade. However, they are ultimately answerable to creditors, not directors (or shareholders), despite being required to act impartially.
Voluntary administrators will recommend one of three things: giving control back to directors (ending the administration – rare), commencing a liquidation, or executing a DOCA to satisfy creditor debts. The voluntary administrator must report on the likely effectiveness of all three options.
The voluntary administrator must also report to the Australian Securities & Investments Commission (‘ASIC’) on possible offences committed by people involved in the company.
Once the administration is complete, the administrator must file an end of administration return, which consists of an account of receipts and payments.
Who appoints a voluntary administrator and when can they do it?
The decision to appoint a voluntary administrator is one that can be made by three key players:
Under section 436A of the Corporations Act 2001, a voluntary administrator is validly appointed by directors if the board resolves in writing that, in the opinion of the directors, the company is insolvent or is likely to become insolvent, and that the voluntary administrator should be appointed.
The appointment of a voluntary administrator protects directors from civil penalty provisions relating to insolvent trading under the Corporations Act 2001. Unless the directors have a safe harbour arrangement (e.g., a turnaround plan), the prospective insolvency practitioner will advise the directors they must appoint them because they are in breach of their directors’ duties.
The importance of solvency/insolvency for a business to be able to continue operating, means it is crucial for directors to be aware of the solvency of their company as it trades. That way, they can avoid a claim for insolvent trading under the Corporations Act 2001 (see 588G of that Act).This way, directors will be aware if there comes a time when a voluntary administrator or a liquidator must be appointed.
On the other hand, it is important that a voluntary administrator be appointed only where there is a ‘proper motive’: I.e., where there are valid grounds for appointment. One situation where it is improper for directors to appoint a voluntary administrator, is where directors do not possess good evidence to assert that the company is or is likely to become insolvent.
The Victorian Supreme Court in ASIC v Planet Platinum and anor  VSC 120 considered this issue. The court confirmed there that it is insufficient for there simply to be no evidence presented that the company is solvent (see paragraph 46 of the judgment). In that case, a voluntary administrator was appointed in spite of there being positive evidence of solvency. The Court found that this appointment was invalid.
In addition, in that case, the Court found that the purpose of appointment was improper as the aim of the appointment was to halt the appointment of a provisional liquidator and to proceed with company privatisation. That case also provided a lesson for voluntary administrators as the Court also found that the voluntary administrator failed to take reasonable steps to confirm the validity of his appointment.
In In the matter of Condor Blanco Mines Ltd  NSWSC 1196, the New South Wales Supreme Court pursued this line of reasoning further, holding that voluntary administrators need to be aware of matters that may call into question the appropriateness of their appointment.
A secured creditor
Under section 436C of the Corporations Act 2001, a voluntary administrator may also be appointed by a secured creditor with a security interest in all or substantially all of the company’s property. The security interest must have become and remain enforceable at the time of the appointment.
Usually a secured creditor would appoint a receiver and manager to enforce their security, however in some cases this might not be desired by the secured creditor. For example, the secured creditor may be aware that a voluntary administrator is likely to be appointed anyway and be worried that the fees and expenses of both the receiver and a voluntary administrator would deplete the company’s asset pool to their disadvantage.
A liquidator, or provisional liquidator
It is also possible for the liquidator/provisional liquidator to appoint a voluntary administrator themselves under section 436B of the Corporations Act 2001. As with directors, liquidators or provisional liquidators may only pursue this option if they are of the view that the company is or is likely to become insolvent.
This option may be pursued where the liquidators consider that a DOCA, a potential outcome only achievable by voluntary administration, would provide a better return for creditors that proceeding with a winding up. If a voluntary administrator appointment is made, the winding up will be suspended for the period of the voluntary administration. Note, however, that the liquidator will still need to deal with liquidation (e.g., applying to court to stop winding-up) at completion of a DOCA.
Overall, it is very rare that a liquidator/provisional liquidator would appoint a voluntary administrator. The purpose of voluntary administration is to preserve the goodwill value of a business. If the company were already in liquidation or provisional liquidation it would be likely that the brand, goodwill and trading prospects would already be irreparably damaged.
Who can be a voluntary administrator?
There are strict eligibility requirements for an individual to operate as a voluntary administrator. These include:
- Being a registered liquidator (section 448B of the Corporations Act 2001), and
- Not having certain interests in the company, such as being a director, employee or creditor of a certain size (section 448C of the Corporations Act 2001).
On appointment, the voluntary administrator must make a declaration about indemnities, the existence of relevant relationships and lodge a notice of appointment (sections 449CA and 450A of the Corporations Act 2001).
Crucially, once appointed, neither the directors, the secured creditor nor the liquidator that appointed the voluntary administrator, can revoke that appointment (section 449A of the Corporations Act 2001). The key options for removal or replacement lie with creditors, rather than those who appointed the voluntary administrator. This makes sense – the voluntary administrator does not work for or owe duties to the directors: Their duties are primarily to the creditors.
How do I know if I should go into voluntary administration?
Before appointing a voluntary administrator, it is important for directors to be aware of the shortfalls of voluntary administration and other options that may be available to them. The key advantage of voluntary administration, for directors, is to give them ‘breathing space’ to work on a restructure. During that period there is a moratorium on creditor action against the company meaning:
- The company cannot be wound up
- Securities cannot be enforced (with some exceptions)
- An owner or lessor cannot recover property used by the company (with some exceptions)
- Legal proceedings cannot be commenced against the company (with some exceptions)
- A company director’s guarantee cannot be enforced.
However, the time period available to a voluntary administrator is not very long: there is six weeks to approve the restructure. This can be contrasted, say, with the Chapter 11 process in the United States where a formal restructure has, on average, 180 days to be put together.
Ultimately, the most important consideration for directors in deciding whether or not to appoint a voluntary administrator should be whether that appointment has a decent chance of restructuring the business and shedding suffocating debt. There is ample reason to think that appointing a voluntary administrator does not give directors decent prospects of a business revival (for more information, see the section headed ‘What is the typical outcome of a voluntary administration?’).
The typical outcome of a voluntary administration may be described as a “glorified liquidation”. The voluntary administration process is subject to a vote of creditors at the second meeting of creditors that decides the fate of the company (i.e. liquidation or deed of company arrangement). Most voluntary administrations today result in a liquidation rather than a DOCA.
How do you pick the right voluntary administrator?
Once you have made the decision to appoint a voluntary administrator, who should you choose for the role? We list some of the relevant considerations below.
Consideration 1: Having a commercial mindset
The voluntary administration process runs for a short period, so the insolvency practitioner will need to make quick judgments. The most important judgment will be whether to continue to trade. The voluntary administrator will be very sensitive about the decision to keep trading because if there is a shortfall in receipts/payments, then they will have to pay it from their own pocket (i.e. they have personal liability for trading debts).
If they can’t grasp the essentials of the business that the directors are trying to save, they may exercise their discretion and stop trading. The result of ceasing to trade as a going concern would be catastrophic for the prospects of saving the business.
Consideration 2: Having a hands-on approach
There is no training requirement that insolvency practitioners be skilled at managing people, or understand the dynamics of a business.
Most insolvencies come from three industries:
- Building and construction
- Retail, and
Each of these industries needs management that is direct and forthright. If a manager can’t stand up at a pub and get everyone’s attention, they should probably find another industry. Insolvency practitioners are accountants and they usually have no skills in managing difficult industries.
Be on the lookout for voluntary administrators that are actually hands on and will give managing a turnaround a solid effort. Other insolvency practitioners would prefer to sit in the office and send emails – these practitioners should be avoided for a turnaround scenario.
Consideration 3: Being on financier panels
If there is a secured creditor, they may require that an insolvency practitioner be appointed from their panel of preferred voluntary administrators. There is nothing illegal about this, but if directors don’t take into account the wishes of their financiers, they may find that a receiver and manager will be appointed over the top of their own-chosen voluntary administrator . The result would be that the voluntary administration process is empty because the receiver would take control of the business assets.
Consideration 4: Ethical and hardworking insolvency practitioner
It is hard to emphasise how important it is to only engage hard working and ethical insolvency practitioners. The alternative is to engage “Sir Lunch-a-lot” types that are really only salespeople for their firms.
Who to avoid? The corrupt and incompetent insolvency practitioners
The insolvency industry has a long history of corruption and incompetence. It may seem like a good idea to hire an incompetent liquidator, but you are reliant on a voluntary administrator to persuade creditors that their review process has been thorough and that they should accept a meaningful compromise. If you pick a rotten apple you probably won’t get the best outcome you’re looking for.
Who to avoid? The old-school, do-nothing insolvency practitioners
Insolvency practice, as a profession, attracts the most intransigent characters. The reason is that resistant behaviour is rewarded and there is a lot of “noise” in a voluntary administration that should be ignored by the insolvency practitioner.
The insolvency practitioner of the past would often work on appointments only a couple of days a week and then spend the rest of the week at long lunches and bars around the city. This is the type of insolvency practitioner that should be avoided for a voluntary administration because they won’t be available to attend to the demands of a trading business whilst the voluntary administration is running.
Who to avoid? The ‘too-busy’ insolvency practitioner
The key limitation with a successful professional adviser is that they are limited by the number of hours in a day. This means that directors shouldn’t appoint a suitable insolvency practitioner if that practitioner has too many appointments. For example, an insolvency practitioner would probably be unable to properly service two voluntary administrations that are running concurrently.
Who to avoid? The phoenix operator
The phoenix operator has been fairly successful in Australia in recent years. Phoenix operators have become key referrers to insolvency practitioners. These should be avoided as they apply their knowledge of insolvency law to obfuscating the process to their benefit.
How do you check that you’ve picked the right voluntary administrator?
If you’re satisfied that you have found an experienced, ethical, hardworking and appropriate voluntary administrator, you should also conduct the following tests:
- Ask them to provide references from other directors who engaged them as a voluntary administrator
- Ask them for case studies of companies like yours that they have put through DOCA
- Go through an experienced insolvency lawyer to know that they are genuine [Read our article: Insolvency lawyers, what do they do and how do you pick the right one?].
What are the difficulties with voluntary administration/the impact of COVID-19?
Insolvency is hard to prove and directors have new protection for liability
When directors decide to appoint a voluntary administrator , they are often motivated by one thing: fear. They are concerned about the risk of insolvency, and reach out to their lawyer or accountant for advice, who will usually emphasise that insolvent trading is illegal. If a company director hasn’t been through an insolvency process before, they are staring at a very complicated and risky path.
At the top of the director’s mind will be personal liability under the Corporations Act 2001 for insolvent trading, or tax debts if they misstep. This fear may, in turn, lead to the premature appointment of a voluntary administrator to avoid any possible liability for insolvent trading.
Before rushing into anything, directors need to take into account several new (and relatively new) legal provisions that protect their position during times of business difficulty:
- Relaxed time periods and increased minimums for ‘statutory demands’. The most common way for an un-paid creditor to prove insolvency (and therefore start the winding up of a company), is to issue a statutory demand for payment of debt (‘statutory demand’). If the debtor fails to pay a demanded amount within a certain period of time, they can be deemed insolvent and winding up proceedings can be initiated. The new Coronavirus Economic Response Package Act 2020 increases the amount that must be owed before issuing a statutory demand from $2,000 to $20,000 and extends the period for the debtor to respond from 21 days to six months.
- The COVID-19 Safe Harbour. The Coronavirus Economic Response Package Act also provides a new temporary ‘safe harbour’. Directors will not be personally liable for insolvent trading where they meet the following conditions:
- the debt is incurred in the ordinary course of business;
- the debt is incurred in the six-month period from when the law comes into effect;
- the debt is incurred before the appointment of the voluntary administrator or liquidator;
- Standard Safe Harbour. This safe harbour was introduced in 2017, but not all directors understand its implications well. It provides that the duty of a director not to trade while insolvent does not apply if:
- at a particular time after the director suspects insolvency, the director develops a course of action that is reasonably likely to lead to a better outcome for the company; and
- the company debt is incurred in connection with the course of action.
The net effect of these three provisions is that directors have time to seek advice and properly evaluate their options before appointing a voluntary administrator, or a liquidator. In addition, directors will not be breaching their duty, even if they are insolvent, if they take out debts in the ordinary course of business, or they are developing a ‘course of action’ for responding to their situation.
Voluntary Administrators are not required to be transparent with directors
Before a voluntary administrator is appointed, there is no requirement that anyone (including the prospective voluntary administrator), thoroughly explain the consequences of the procedure or whether an informal alternative should be pursued first. The process of appointment only requires that a meeting of directors pass a resolution, and that an insolvency practitioner provide written consent.
In making the decision to enter into voluntary administration, directors need to understand all the consequences of that decision. However, voluntary administrators are under no obligation to disclose this to directors before they are appointed. For example, a voluntary administrator is under no obligation to disclose that:
- by developing a restructuring plan, directors can take advantage of a safe harbour from the insolvent trading prohibition and continue to trade (even if their company is insolvent)
- the appointment of a voluntary administrator can lead to an incredible loss of confidence in the business as it amounts to a public declaration that the company is unable to pay its debts.
In general, business regulation has moved to increased transparency to consumers and investors, but this has not been applied to directors when it comes to insolvency law. The prospective insolvency practitioner is under no obligation to issue a “prospectus” or capability statement, or even look into the individual circumstances of their appointor.
Insolvency practitioners also lack a range of other obligations which would protect the interests of directors. They do not have a duty to act in the interests of directors and the potential for a conflict of interest is significant: The insolvency industry is still a ‘closed shop’ and there are no effective protections for SME directors from being given misleading or conflicted advice by insolvency practitioners and their armies of referrers.
If misleading conduct by insolvency practitioners or their referrers does lead to an appointment, there is no effective recourse for the director. Furthermore, the regulatory framework for insolvency practitioners incentivises them not to provide pre-insolvency advice – it may prevent them from being appointed as a voluntary administrator (as their new obligation to creditors could result in a conflict or perceived conflict of interest).
By contrast, in a lawyer-supervised informal restructuring process, such as a ‘pre-pack insolvency’, there are strong duties of disclosure, to avoid conflicts and to act in the interests of the director (the client).
Getting finance is almost impossible
A crucial part of recovery for many struggling businesses is getting ‘rescue’ finance to tide them over. This need is particularly acute for SMEs who have restricted financing options in the first place. However, the voluntary administration process does not encourage or enable that financing and, often, acts as a barrier to such financing.
The Corporations Act 2001 does not have a mechanism for financing during the insolvency process. If a company in voluntary administration needs finance to continue to trade, its financier doesn’t get a priority and the voluntary administrator themselves is required to personally guarantee the debt. There is little incentive for a voluntary administrator to make themselves personally liable: They are being paid an hourly rate after all and do not receive a success fee.
In a SME voluntary administration, financing may be limited to “friends, fools and family” of the owners. Directors should be aware that if the company in administration is unable to pay both the voluntary administrator’s fees and trading expenses from its assets, the directors will be asked to contribute further funds or face liquidation.
The Australian process can be contrasted with Chapter 11 of the United States Bankruptcy Code or the Singapore Companies Act which give ‘super-priority’ to rescue and restructuring finance over other creditors. Without sufficient working capital at the bank there is no chance that a voluntary administration will succeed – because in that circumstance the voluntary administrator will simply stop trading.
By utilising an informal restructuring process such as a ‘pre-pack insolvency arrangement’, directors may be able to access financiers that would not find it viable to lend to a company in voluntary administration, or who are otherwise ‘put off’ by the stigma of a formal insolvency process. Either the COVID-19 Safe Harbour or the Standard Safe Harbour might be utilised by directors for this purpose, depending on the circumstances.
Creditors that are ‘out of the money’ can hold the process to ransom
Australia has a ‘creditor-centric insolvency regime’. The creditors (through a vote at the second meeting) make the decision to accept a director’s compromise (the ‘DOCA’), or put the company into liquidation.
The terms of the director’s offer of compromise are put to creditors by the voluntary administrator in a report along with a recommendation. The voluntary administrator will provide creditors with an opinion about whether they should accept or reject the offer.
Whether the voluntary administrator recommends that creditors accept the proposal is a matter for their professional judgment. The vote requires both a majority in number, and a majority in value of the creditors, to support the proposal for it to succeed. If the creditors do not accept the offer of compromise then the company will be placed in liquidation.
This contrasts with the Chapter 11 bankruptcy process in the United States, for example, where the re-organization plan (the DOCA-equivalent) is supervised by the Court. The Court can enforce a ‘cramdown’ – force the plan to go through in spite of the objection of some creditors or class of creditors.
How do I prepare for a voluntary administration?
Once you have worked out that voluntary administration is the right move, what do you need to do? There are five key steps you should take to prepare for a voluntary administration, which we set out below.
Preliminary assessment of the books
Only by doing this can a director know just how much trouble the company is in, and whether an independent ‘solvency review’ is necessary. When doing this analysis, directors should consider:
- The state of bookkeeping. Sometimes directors neglect to keep their books-up-to-date and this, in itself, can be a significant factor leading to insolvency. If your accounting is a little untidy – don’t despair, but now is the time to get on top of it. Track down any missing invoices or receipts and instruct your bookkeeper to reconcile your accounts to date;
- Is your current ratio (current assets/current liabilities) greater than 1? That is, do you have enough cash to cover your most pressing debts? To understand this, you’ll need to have your accounts reconciled and a correctly aged receivable and payable ledger;
- Unpaid creditors. Take particular note of whether you can continue to meet employee entitlements. Note also, whether any statutory demands for payment of debt have been made. Under section 459C (2) of the Corporations Act 2001, a failure to comply can be a shortcut to insolvency (note, however, as set out above, the payment period and minimum amounts have been temporarily relaxed due to COVID-19);
- Tax debts. You need to work out accurately what your tax debts are. Directors should consider negotiating payment terms for any existing debts with the Australian Tax Office (ATO), in order to defer insolvency. Directors need to be particularly careful if issued with a Director Penalty Notice (DPN) from the ATO. The issuing of this notice means that the director becomes personally liable for the tax debt if not paid within 21 days;
- Reviewing title to assets. Which entity in a corporate group owns the core assets of the company? This will determine which assets are at risk in the case of insolvency and possible liquidation. Any restructuring adviser will take a keen interest in which entities in your business hold title to assets because it may be the key to a restructure.
Establish insolvency and get a professional review
You need to work out whether the company is insolvent (or likely to become so). Insolvency matters because if you suspect that your company is or may become insolvent, yet continue to trade and incur debt, you may be breaching your duty to prevent trading whilst insolvent (for more information, see section ‘Who appoints a voluntary administrator and when can they do it’?
Note that there are exceptions to liability under this section in the form of the ‘safe harbour’. In many cases, individual directors won’t be able to tell if the company is solvent or insolvent. For this reason, it is essential that an independent accounting professional is consulted to conduct a solvency review and make a determination.
Work out your strategy
Depending on the outcome of the solvency review, directors need to consider what their strategy is. While voluntary administration is an option in the case of insolvency or likely insolvency, it is not compulsory. And in many cases – it’s a bad idea. You need to look at the state of your business: its relationships, cash flow, customer base, market share and other aspects and determine what option is best for you. Read below for more information on the alternatives to voluntary administration.
Work out your liability
Once it has been decided that voluntary administration is the best option, directors then need to consider their potential liability. If the voluntary administration ends up in liquidation (as is common), there are a range of legal risks for directors. Liquidators may be able to pursue directors for:
- Loan accounts. If directors have drawn down on the company via a ‘loan account’ (i.e. not via a taxed salary), then a liquidator can pursue this against the director;
- Unfair Preference claims. These occur where a creditor has received payment (or another advantageous transaction) for something they are owed, giving them an advantage over other creditors. These can be ‘clawed back’ by a liquidator where they were received by a creditor who knew, or ought to have known, that the company was insolvent;
- Uncommercial transactions. These occur where it may be expected that a reasonable person in the company’s circumstances would not have entered into the transaction, having regard to its benefits/detriments. However, insolvency must be proved at the time of the transaction by the liquidator.
- Unreasonable director related transactions. These occur when a director or close company associate enters into a transaction where a reasonable person in the director/associate’s circumstances would not have entered into the transaction, having regard to its benefits/detriments. Insolvency need not be proved.
- Creditor defeating dispositions (‘illegal phoenix activity’). This occurs when there has been a “disposition of company property for less than its market value (or the best price reasonably obtainable) that has the effect of preventing, hindering or significantly delaying the property becoming available to meet the demands of the company’s creditors in winding-up.” This is a new cause of action and you’ll need professional advice on this because there are no court cases to date that deal with it.
Actually appoint the voluntary administrator
Once an individual director has determined that they wish to appoint a voluntary administrator, they need to:
- Seek agreement of a suitable qualified individual to be appointed
- Convene a meeting of directors to pass a resolution that the company is insolvent, or likely to become so
- As a group, appoint the voluntary administrator.
When can a creditor replace or remove a voluntary administrator?
A voluntary administrator is first appointed by the directors of an insolvent company. Creditors may want to replace this voluntary administrator with another insolvency practitioner. The voluntary administrator may be removed or replaced:
- At the first meeting of the creditors: any creditor who seeks to nominate a replacement voluntary administrator must approach a registered liquidator before the first meeting and get written consent that they are prepared to act. At the first meeting, this individual will need to give the same declarations about any relationships and indemnities given as the original. Creditors then vote at this meeting as to whether they wish to replace the voluntary administrator;
- By resolution under the Insolvency Practice Rules: Sometimes creditors may wish to remove a voluntary administrator after the first meeting of creditors has occurred. In these cases, the creditors may by resolution at a meeting, remove the voluntary administrator and appoint another (See Insolvency Practice Rules (Corporations) 2016, 75-265). Note, how that the voluntary administrator still has the power not to convene a meeting for such a resolution if they consider it to be ‘unreasonable’ (see Insolvency Practice Rules (Corporations) 2016, 75-250);
- By a state Supreme Court or the Federal Court: If other options for removal of a voluntary administrator has failed, there remains the possibility of applying to the Court for a range of orders. These include:
- Such order as the Court thinks necessary to protect the interests of a company’s creditors while the company is under administration. This application may be made by either the creditors or by ASIC (see section 447B of the Corporations Act 2001). This could include the removal and replacement of a voluntary administrator.
- A declaration that the voluntary administrator has been validly appointed. This application may be made by the voluntary administrator themselves, the company or a creditor (section 447C of the Corporations Act 2001).
- General orders that the Court thinks appropriate in relation to voluntary administration. The application may be made by the company, creditors, the voluntary administrator, ASIC or any other interested person (section 447A of the Corporations Act 2001).
It is very rare that creditors will apply to a Court to replace a voluntary administrator because of the legal costs of the application.
Alternatively, creditors could look to work closely with the appointed voluntary administrator by appointing and then joining a committee of inspection. At the first meeting of creditors a committee of inspection may be formed to assist and advise the voluntary administrator, monitor their conduct and to give directions. The voluntary administrator must have regard to but is not always required to comply with these directions.
In cases where the voluntary administrator cannot be replaced, this can be a useful mechanism for creditors to have sway over the voluntary administrator.
What are the main perceived benefits or motivations for voluntary administration?
The most important effect of voluntary administration is the moratorium from the enforcement of creditor claims. This means that a range of actions against the company that would be averse to its continued operation is temporarily frozen in order to give the company ‘breathing space’.
The moratorium means that the company cannot be liquidated and that a range of other legal proceedings against the company and the directors are halted (for more information see section headed ‘How do I know if I should go in to voluntary administration?’
The objective of the regime is to give directors a process to protect the goodwill value in an insolvent business from winding up by creditors.
Other typical objectives behind directors appointing a voluntary administrator include:
- Delay creditors: using the process to delay creditor action
- Litigation tactic: staying winding up applications or other causes of action
- Director’s escape valve: avoiding investigations that may follow a liquidation
- Control of the company: resolution of internal disputes
- Employees: stifle enterprise bargaining
- Future complaints: avoid compensating future claimants
- Relation-back period deferred for unfair preference claims.
What is a successful voluntary administration?
The three elements of a successful voluntary administration process are:
- Goodwill value of business saved: Goodwill is an intangible asset that represents the value of a business over the total value of assets (e.g. plant and equipment). This is the X-factor of business valuation and it is usually related to a ‘multiple of maintainable earnings’. Every business owner, at some time in their career, faces the issue of developing an exit strategy. At the end of the day, if they don’t create goodwill value in a business (that gives them a sale value) they won’t receive any fruits of entrepreneurship.
- Jobs saved: Australia, unlike many other countries, genuinely cares about the protection of workers and their entitlements in the insolvency process. The government foots the bill for a large portion of unpaid entitlements through the Fair Entitlement Guarantee. This means that one of the key elements of insolvency law policy (and a key justification for business restructures) is the protection of jobs.
- Unsecured creditor debt payments: The payment of unsecured creditor claims is a key element of a successful voluntary administration. Over time the returns to unsecured creditors from voluntary administration have deteriorated but a decent return to unsecured creditors would be in the double digits of a percentage. For example, a deed of company arrangement that delivers a dividend to creditors of 20c in the dollar for their debts would be preferable to receiving no return in a liquidation scenario.
An exceptional outcome of a voluntary administration might include:
- Trading on the business through a DOCA and beyond
- Third party contribution to the DOCA fund
- Arrangements with continuing creditors to ensure ongoing support outside the DOCA
- Motivated management and staff (good culture)
- Some return for non-continuing creditors (e.g. 10c in dollar)
What is the typical outcome of a voluntary administration?
The answer is that it is unlikely to be at all successful for directors or their company’s creditors.
The creditors can expect returns from a deed of company arrangement (DOCA) in the order of 5-8c on the dollar. Directors should not expect to trade through the voluntary administration, or for deed of company arrangement periods to result in a company that is free and clear of legacy debt (10% chance or less). In the market, other businesses view voluntary administration as the equal of liquidation and it carries a stigma that results in the ultimate destruction of goodwill value.
The winners are the administrators with the average fees being in the order of $97,000 in small voluntary administration processes.
In its submissions to a parliamentary inquiry the ASIC reported that between 1993 and 1997 of the 5760 companies that entered into voluntary administration, only 10% resumed “normal trading”(Source: Parliamentary Joint Committee on Corporations and Financial Services, Corporate Insolvency Laws: a Stocktake (June 2004)).
As the DOCA is the tailored outcome of the voluntary administration process, it is important to look at how common the DOCA outcome is as a proportion of voluntary administration outcomes. In the years 1992-2001, 25 to 50 percent of voluntary administrations ended with DOCAs. Recent analysis by Jason Harris shows that this proportion has remained relatively stable over the years. For the 2017 year, DOCAs made up 28.5% of all insolvency appointments.
In a 2014 study, Mark Wellard looked at a cross-section of DOCAs in depth to see the quality of the outcomes that they provide for companies and creditors. His study demonstrated that:
- Creditors received, on average, 5-8 cents on the dollar
- 72 per cent of DOCAs were ‘compromises’ which might be thought of as “glorified liquidations”. In the remaining 28 per cent there was some substantial carrying on of the company’s business through the DOCA.
In 2015 the Productivity Commission reinforced this point showing that, again on the basis of ASIC statistics:
- 37 per cent are deregistered within two years of the commencement of a voluntary administration
- 57 percent are deregistered within three years
- 70 per cent are deregistered within four years, and
- 78 per cent are deregistered within five years.
All-things-considered, there is not very strong empirical evidence to suggest that voluntary administration is meeting the goals of the process as set out in the Corporations Act 2001. Only a small proportion of companies are continuing to substantially trade after voluntary administration and the average proceeds available for creditors are meagre. We estimate that less than 1 percent of voluntary administrations are ultimately successful.
While it is possible to argue that many of these businesses would have been wound up anyway, and the distributions to creditors may have been less than from a straightforward liquidation, the continued decline in popularity of voluntary administrations suggests that companies themselves are seeing it as less desirable than other insolvency options.
The voluntary administration process is subject to a vote of creditors at the second meeting of creditors that decides the fate of the company (i.e. liquidation or deed of company arrangement). Most voluntary administrations today result in a liquidation rather than a DOCA.
Further, of the companies that do enter into a DOCA, the majority (49/72*) are non-trading and therefore the company that is subject to the DOCA becomes a shell. The purposes of this DOCA may be to stall litigation, resolve a directorship dispute, obtain breathing space from tax liabilities and/or discharge liability for unfair preference claims or director claw-back actions. One of the main benefits of a DOCA compared to a liquidation is that the directors are protected from claw-back actions because the company does not go into liquidation.
What are the potential negative impacts of a voluntary administration?
As well as having a low success rate, voluntary administration can have some negative consequences for businesses. Voluntary administration could result in:
- Reputational damage. Not only is voluntary administration likely to damage the company’s relationship with suppliers, it can also negatively impact on the relationship with customers. The differences between distinct insolvency appointments like voluntary administration and receivership are sometimes not understood by the broader public. As Jason Harris put it: “the public perception of formal restructuring procedures is one of failure. Voluntary administration is reported in the press as the end of a company, with corporate undertakers sent in to sell the business, often in conjunction with a receivership.”
- A perception of misconduct. In some industries, voluntary administration has become synonymous in people’s minds with misconduct or wrongdoing. For example, the widely publicised Independent Inquiry into Construction Industry Insolvency in NSW in 2012 found that widespread financial mismanagement in the construction industry had led to a multitude of voluntary administrations.
- Inability to hold licences. Another significant potential negative effect is the impact on any licenses held by the company. For example, for energy retailers, special provisions of the National Energy Retail Law kick in upon voluntary administration and in the building industry, depending on the jurisdiction, licences may be cancelled immediately;
- Secured creditors making the decision to appoint a receiver (as is their right).
What are the alternatives to a voluntary administration?
The poor success rate of voluntary administration means that it is worth considering other options before making this decision. Options worth considering include:
- Informal arrangements: See our podcast and interview on the safe harbour from insolvent trading
- Pre-pack insolvency arrangement. This involves coming up with, and executing, a restructuring plan to save the business, through a sale of company assets to a new company for fair market value: Read our whitepaper
- Obtaining further finance (debt or equity). Note that both the standard safe harbour and COVID-19 safe harbour can support access to rescue finance
- Putting the company into liquidation.
Who should I consult or where can I get more information about voluntary administration?
It can be difficult for directors without formal training to determine what the best course of action should be for their business when it is in financial trouble. It is highly recommended that directors seek the help of a professional adviser before committing to any one option. For more information, view our presentation on who to avoid during the downward spiral of company insolvency.