What are the benefits of the Small Business Restructuring Process compared to Voluntary Administration?

Corporate insolvency in Australia underwent a seismic shift in 2021 with the introduction of the Small Business Restructuring Process under Part 5.3B of the Corporations Act 2001 (Cth). This process is referred to under the Act, and generally known simply as ‘Restructuring’. This new process aimed to provide a more cost-effective and simplified debt restructuring pathway for insolvent small businesses, compared to the existing Voluntary Administration (VA) regime under Part 5.3A.

Here we ask: What benefits does Restructuring hold over VA? At the same time, which features or limitations of Restructuring mean that VA may be more appropriate?

Restructuring Benefit 1: Directors Maintain Control

One potential advantage of Restructuring over VA is that only the directors can choose to initiate the process. This stands in contrast to VA, where secured creditors can also instigate proceedings.

Further, Restructuring is the first ‘debtor-in-possession’ restructuring process in Australia. It means that during the process the directors maintain control of the business and they are expected to run it day-to-day (s453K). This means that theRestructuring Practitioner (RP)they appoint is a monitor of the process rather than actually running the business. The limits of the powers of directors are that the directors can’t enter into transaction out of the ordinary course of the company’s business without the approval of the Restructuring Practitioner (section 453L).

By contrast, under VA, the Voluntary Administrator assumes full control of the company and is permitted to continue to trade in the name of the company (s437). The directors lose their powers and are prevented from dealing with the company’s assets and affairs without the Voluntary Administrator’s consent. This loss of control can be disconcerting for many directors, making the appointment of a Restructuring Practitioner a more appealing option.

Restructuring is an acknowledgment of commercial reality, that even during a VA process the directors will need to continue to contribute to day-to-day management and offer support to the voluntary administrator.

On the other hand, it is worth pointing out that continued director control is not always a good thing. It presents the risk that whichever issues cause the financial difficulties in the first place will continue. By contrast, appointing a Voluntary Administrator reduces the risk that incompetent or ineffective directors will continue to hurt the company. This is especially true where the there are multiple directors —competent directors can be hampered in turning around the business if the problematic directors still retain control.

Benefit 2: Lower costs

Financial considerations play a significant role in insolvency proceedings. For example, one of the main criticisms about the Chapter 11 process in the United States is its high costs. Restructuring offers two advantages, first, the costs of the restructuring are fixed and therefore, unlike VA, cannot be revised upwards and second, the latest ASIC research shows that costs of Restructuring are much lower than VA.

Restructuring offers fixed costs as opposed to time billing under VA, making it a more reliable option. In VA, costs are typically calculated on a time cost basis, and they are usually higher due to Voluntary Administrators assuming control of the company and therefore doing more professional hours of work. Restructuring, however, operates on a fixed fee agreed upon prior to the appointment of the RP by the directors. The initial cost estimate given to directors in a VA process is usually revised upwards.

The ASIC report 756 found that the median total cost of Restructuring Practitioners (including completing the restructuring process) was $22,055. Whereas research undertaken by Mark Wellard in 2014 found that typical costs for Voluntary Administrators (including restructuring through a deed of company arrangement) were in the order of $60,000.

In defence of VA costs, it is worth pointing out:

• The low returns of VA mean that the Voluntary Administrator is more commonly ‘Out of the money’, than a Restructuring Practitioner (though no statistics are available on this point). 
• VAs are generally used for much larger and complex businesses, increasing the costs for the Voluntary Administrator.
• Voluntary Administrators and Deed Administrators have a more complex creditor negotiation process (since a Deed of Company Arrangement requires agreement by the majority of creditors in number and value).
• VAs can trade as the business, substantially increasing the costs of operating. 

Benefit 3: Streamlined process

Restructuring provides a streamlined process with minimal reporting to creditors. This gives the directors of an insolvent company a significant advantage because the creditors will be given basic information rather than an inquisitorial report. This will be likely to take the heat out of the process because they won’t be accused of potential insolvent trading and otherwise put through a grilling.

The Restructuring Practitioner investigates and verifies the company’s business, property, affairs, and financial circumstances. However, unlike VA, there’s no requirement to report these findings through a detailed report to creditors. Rather than providing a recommendation to creditors, unlike VA, the Restructuring Practioner is only required to make a formal declaration as to whether the company will likely be able to discharge obligations under the proposed plan. The role of the Restructuring Practitioner is to provide assurances to creditors regarding the process and if they are not comfortable or find anything improper they are expected to terminate the Restructuring.

Under Restructuring, creditors’ meetings are not required and creditors vote by submitting a written statement indicating whether the Restructuring Plan should be accepted. This contrasts with the VA process, which mandates at least two meetings, adding to the time and complexity of the process. This may take the steam out of the insolvency process because creditor meetings often break down into argument and accusation

Benefit 4: Simpler Restructuring Plans

Restructuring allows for simpler turnaround arrangements, limiting them to cash-only offers to creditors. It also prohibits directors from discriminating between creditors and it precludes the directors themselves from voting or receiving monies from the Restructuring Plan. These restrictions provide a straightforward and easy-to-understand mechanism for both creditors and the company. The creditors know that the company is insolvent and therefore they will not receive their full debt claims so they can decide whether to accept the compromise put by directors by way of cash payments

On the other hand, a VA process can become very complex because it involved a proposal put by directors that has few limits. Directors can often control the voting process through related party votes, they can discriminate between creditors and they can propose opaque arrangements that are impossible for creditors to discern. The reality is that the voluntary administrator has a relatively short period of time to get a grip on the company’s affairs and so their investigations may not have depth.

Benefit 5: ATO Support For Process 

Additionally, the Australian Taxation Office (ATO) has shown support for plans that provide better outcomes for creditors than a liquidation scenario. This backing from a significant creditor in most small business insolvencies is another key advantage of the SBRP. The ATO may also support VAs but the anecdotal evidence is that the ATO likes to support genuine businesses through a quick SBRP at much higher rate than VA. The ATO is developing its own policies about which SBRPs it chooses to support but the overall direction it has is to support real businesses that have a track record of tax compliance and up-to-date entitlement records and payments.

Benefit 6: No Automatic Liquidation if process doesn’t succeed

In a Restructuring, if creditors vote against the Restructuring Plan, they do not necessarily get to vote for a liquidation. In VA creditors decide the outcome for the company, including resolving to liquidate it if they vote against a restructuring through a deed of company arrangement. In Restructuring, if the simple majority in favour of a Restructuring Plan (by dollar value) isn’t achieved, the restructuring process ends, and all creditor claims once again become due. There is no automatic roll-over into liquidation, although shareholders can resolve to wind up the company if they wish.

On the other hand, in some cases this feature of VA could streamline the entire insolvency arrangement: Where liquidation is inevitable the process can commence immediately rather than initiating a separate step.

Benefit 7: Better success rates

The restructuring process has shown promising signs of success since its inception, with a high proportion of businesses using the procedure successfully. This track record evidences the effectiveness of restructuring and its higher success rate is a key benefit over VA.

Overall, the contribution of VA to wholly successful restructures may only be 1% of insolvent companies in Australia. This ‘back of the envelope’ calculation from statistics is as follows:

1. 13% of insolvent companies appoint Voluntary Administration over liquidation (pre-COVID ASIC statistics);
2. 29% of Voluntary Administrations entered into a deed of company arrangement as opposed to going into liquidation (Mark Wellard research paper)
3. The author’s estimate of the percentage of successful deeds of company arrangement is 25% of all Deed of Company Arrangements entered into;
4. The multiplier effect is 0.13*0.29*0.25= 0.01

Despite the low number of appointments over its first 18 months of operation (2021-mid 2022), the proportion of Restructuring Plans approved by creditors is remarkably high at 87% (source: ASIC research report 756). This high approval rate indicates that Restructuring has been effective in helping small businesses restructure their debts and reach agreements with their creditors.

Final Thoughts

Restructuring and Voluntary Administration both have their place within the Australian insolvency framework. Restructuring is usually the best option for small businesses (and is not available for larger businesses). It’s simplified structure usually makes it a cost-effective and fast tool for attempting to turnaround a struggling business. On the other hand, Voluntary Administration can still be a viable alternative for larger businesses who would otherwise go straight into liquidation.