COVID-19 fallout: Creditor options for recovery

The COVID-19 pandemic has resulted in unprecedented challenges across all sectors of the economy and has left various debtors and creditors alike in unchartered territory. Certain coronavirus debtor relief measures, including measures prescribed under the Coronavirus Economic Response Package Omnibus Act 2020 (Cth), were initially due to expire on 24 September 2020 but have recently been extended until 31 December 2020. Some prominent features of this relief include:

• affording directors limited relief from liability for insolvent trading;
• increasing monetary thresholds for issuing statutory demands which creditors can rely upon in commencing a winding up or bankruptcy proceeding; and
• extending the time for debtors to respond to any statutory demand or bankruptcy notice from 21 days to 6 months.

These measures effectively provide a moratorium on new insolvency proceedings.

In light of the recent extension, and speculation around the government’s intention to further extend the relief measures, creditors should be mindful that there are still many options available to when seeking to secure their position with potentially insolvent debtors.

Here are 5 steps that creditors can take to ensure the security of their position. It is important to note that the sooner a creditor takes action, the more options are available to it, maximising the opportunity for cost efficient outcomes to be achieved for both creditors and debtors.

1.Actively monitor and review the collateral position

Creditors should be diligent in monitoring and reviewing their collateral position. A defect in a security interest may cause it to be ineffective, leaving the creditor unsecured in the eventuality of an enforcement scenario.

Creditors should:

• conduct due diligence to determine the debt and liquidity position of the debtor;
• make sure they have taken all steps necessary to ‘perfect’ any security interests, such as mortgage or PPSR charges. A creditor’s security interest will determine its priority as against competing creditors and there are strict rules for perfection which creditors should observe;
• ensure that the value of any collateral to which its security interest is attached is sufficient to satisfy the outstanding debt; and
• consider the risk of insolvency of the debtor and the possibility that a liquidator may seek to claw-back any payments made to the creditor.

If the debtor has other valuable assets, including shares, real estate, receivables, equipment, other contractual rights and projects which can generate cash flow, the creditor should consider varying their agreements, or requiring the debtor to provide additional security over such assets, to reduce risk.

2. Initiate a debt restructure

Creditors should discuss with their cash strapped borrowers a potential debt restructure as a tool in securing their position. Creditors should consider:

• imposing greater reporting requirements. Increased reporting requirements provide the creditor with greater oversight into the debtor’s financial health, allowing the Creditor greater visibility to foresee potential cashflow issues and other adverse financial events. Creditors may request for monthly reporting requirements to ensure Borrowers provide timely and up to date financial and operational information on a regular basis.
• amending their covenants. Having the right covenants set at proper levels can reduce risk for creditors by providing greater control and oversight over their debtor, and the ability to detect problems earlier. To the extent Creditors are able to receive regular reporting information from the Borrower, they maybe in a position to loosen certain financial covenants to give the Borrower some head room to navigate the challenging business conditions.
• a debt to equity swap. Depending on the debtor company and the sector, creditors may be able to convert their debt into an equity position. Instead of the creditor paying a cash subscription amount for the issue of the shares, the issue price for the shares is satisfied by the repayment of the debt. The closer the debtor is to insolvency when it undertakes the share issue, the greater the discount to the current market share price usually required by creditors. Alongside the issue of shares or equity, however, it is important to consider the need for potential FIRB approval, and in respect of public companies, shareholder approval requirements under the ASX Listing Rules.

3. Sell or assign the debt to a third party

Selling or assigning debt to a third party can be an effective way of reducing risk. This, however, is subject to negotiating the correct pricing of a creditor’s debtor book. In the current environment of uncertainty, it is increasingly difficult to value future receivables. Creditors should also be wary of the risk that may be associated with offloading debt in the current climate, as a potential third-party debt collector may pursue aggressive tactics in debt recovery which may unfairly taint the previous creditor’s reputation.

4. Enforce the security interest

A quick and efficient way to recover a secured debt is to repossess the collateral and sell these for market value, most commonly through an auction process. In the current environment, however, it may prove difficult to value any assets, and therefore achieve market value. Further, it is not possible for non-circulating assets, i.e. land, and once an asset is repossessed, any short-fall on the debt becomes unsecured.

If there is substantial collateral against which the creditor is secured, it may prefer to instead appoint a receiver, subject to the creditors’ agreements with the debtor. Once appointed, a receiver can actively manage the creditor’s collateral and sell the secured assets to pay the debts. It is important to note that funds are paid in order of priority, including other creditors with a higher priority, or employee entitlements, and that the appointment of a receiver does not prevent another insolvency procedure from occurring with the debtor company, for example, liquidation.

In circumstances where the creditor’s security interest attaches to substantially all the debtor’s assets, for example by way of a PPSR charge on all present and after acquired property, the creditor can also choose to appoint an administrator. This may be desirable in circumstances where trading-on the debtor is likely to achieve a greater return than a ‘fire sale’ of its assets.

5. Commence legal proceedings

Creditors still have the option of enforcing their debts through court proceedings. Other than the temporary measures put in place by the Economic Relief Package, there are no other legislative measures in place which may restrict creditors taking legal action.

Commencing proceedings by way of originating process (statement of claim) in either the Local, District or Supreme court, depending on the value of the claim, may be an effective way to enforce a debt. This may be desirable if there is a dispute as to the debt.

It is important to note that creditors should be aware of any defence the debtor may put on in response to any claim which can increase the costs of an action. Further, should the claim be successful, it is important to consider the different rules each State may have in place regarding the enforcement of a claim.

Queries

If you have any questions about this article please get in touch with the author or a member of our Banking & Finance team.

Disclaimer

This information and the contents of this publication, current as at the date of publication, is general in nature to offer assistance to Cornwalls’ clients, prospective clients and stakeholders, and is for reference purposes only. It does not constitute legal or financial advice. If you are concerned about any topic covered, we recommend that you seek your own specific legal and financial advice before taking any action.