Restructuring your business 101 – Part Two

This article will detail some options and issues you may need to address for:

• A simple structure where you have a company and it is experiencing financial difficulty; and
• A structured group where the trading company is experiencing financial difficulty.

Please Note: This article relates to the last days of a trading entity which is a private company. Other methods can be adopted for other types of entities (e.g. trusts, partnerships, public companies and individuals).

Ways to Finalise a Company:

A company which is having trouble or is no longer required can be finalised in several ways, depending on the circumstances. Refer to Appendix A – Mechanisms of Closure. Which method you adopt depends on the circumstances and parties in play.

Single Entity Structure:

A sole company structure may have experienced an unfortunate event that has resulted in financial hardship. For example, your major client representing 40% of income has gone into liquidation and owes you $1 million. Because of this adverse event you now have:

• major creditors outstanding that you cannot service (ATO, suppliers, landlord, lenders, etc…);
• too many employees compared to the reduced work levels; and
• premises, stock and equipment that are more than you need or can afford.

You know if you could eliminate some of the above burdens, you could start again. However, you may need or prefer to retain some of the remaining contracts, client lists, business name, some of the stock, plant and equipment and staff. Whilst a Deed of Company Arrangement (DOCA) may be an answer, you would need the majority of the creditors to vote in favour of a DOCA and you may not be sure if that will happen.

Alternatives for the trading company may be:

• To sell the business to a new company you have incorporated for market value, and detail what assets, IP, contracts and staff are to be transferred to the new entity.

Under this arrangement you would offer the employees that you want to take over employment with the new entity, and adjustments to the purchase price would be made to facilitate any employee entitlements accrued under the old entity and transferred to the new entity.

The employees who do not take up the offer to come over, on terms no less than their current terms of employment, will need to be paid their employee entitlements by the old company, however they would not be entitled to redundancy payments.

Employees you did not want to come over would continue to be employed by the old entity and if that business ceased to trade then redundancies would be payable to such employees by the old company (subject to the small business redundancy exception).

You may make the business sale subject to the buyer/new entity securing a lease and finance on terms acceptable to the buyer.

The sale of a business may have tax, GST and stamp duty consequences and you should seek advice around such costs. However, if the sale of business is as a “going concern” then it may be GST exempt.

Normally, the old entity has a major lender which has security over the business. You cannot sell assets free from such security, so you will need to discuss with the lender to consent to the sale and provide releases over such assets being sold. It is quite common for the outgoing secured party to do so and fund the new entity acquiring the business.

• Leave behind the debts, liabilities, employees and assets you do not require and buy the assets you need to start again at market value. As this will not be the sale of a going concern there will be GST payable but stamp duty may not be applicable – advice should be obtained. If any of the employees do start working for the new entity you need to be mindful of the Fair Work Act (“FWA”) continuity of employment provisions which will deem certain employee entitlements on the new entity from the old entity – again, advice should be obtained in relation to this issue.

Once the settlement has occurred you may take steps to wind-up the old company. Upon the company going into liquidation, the employees in the old entity will be entitled to claim via the Fair Entitlements Guarantee (FEG):

• Up to 13 weeks unpaid wages;
• Unpaid annual leave and long service leave;
• Payment in lieu of notice—up to five weeks; and
• Redundancy pay—up to four weeks per full year of service.

Unpaid Superannuation Guarantee Contributions cannot be claimed via FEG but the outstanding superannuation is required to be paid before payments to ordinary unsecured creditors of the old entity in liquidation. This means it ranks equally with employees’ entitlements for wages and super contributions as long as there are assets available for distribution to priority creditors.

Beware of the Illegal Phoenix:

A big issue is if you transfer assets of the old entity to the new entity for less than market value. If you do so then this may be considered illegal phoenix activity and this can involve breaches of director’s duties, fraudulent concealment or removal of assets and fraud by company officers under the Act. Penalties include large fines and up to 5 years imprisonment for company directors and secretaries.

The law holds each of the people involved in the activity, from the pre-insolvency adviser, valuer, accountant, lawyer, liquidator and dummy directors, equally responsible. They may be subjected to the same penalties if it is proved they aided, abetted, counselled or procured a director to engage in illegal phoenix activity. It is important to get proper advice and never, ever be tempted or believe an adviser that says you can take the assets for free and leave the liabilities behind.

It is strongly advisable to obtain an independent valuation from a reputable valuer regarding any assets or business being transferred.

Does physical cash have to be presented at settlement? Not always.

A simplified example:

• You are acquiring a business for market value of $500,000;

• The business is subject to security in favour of NAB for $450,000 and they need to be paid out in full at settlement to provide the release of the business being sold;
• The purchase price is to be adjusted by $50,000 relating to the accrued employee entitlements of the seller which are being assumed by the buyer; and

• The incoming financier for the buyer is NAB and they are providing $450,000 towards settlement.

In this circumstance, the settlement monies required would be $500,000 less $50,000 = $450,000. This money could be paid by NAB to NAB at settlement or via NAB doing a book entry.

Common Asset/Group Structure:

The above is an example of the collapse of a single entity structure. The process is considerably cleaner, more flexible and with greater control where a group asset structure has been adopted like the following:

1. Holding Company that will own shares in its subsidiaries (e.g. Trading Company and Asset Companies).
2. Trading Company that will trade.
3. Labour Company that will employ the staff and contract to provide to the Trading Company.
4. Asset Entities (where applicable):
   1. P&E Company that will acquire plant and equipment and hire out the P&E to the Trading Company.
   2. Land Company that will acquire land or lease land from third parties and then hire/on-hire to the Trading Company.
   3. IP Company that will own the intellectual property of the group (including business names, patents, designs and trademarks) and then licence it to the Trading Company.

If the trading entity experiences financial difficulty then the following could occur:

• The Holding Company can call in its secured debt/loan, crystalise any circulating assets and appoint a receiver over the assets and the trading company to take control of the assets, contracts and the books and accounts. It could then sell the assets and take over existing contracts via its receiver who would then complete such contracts and recover the proceeds from same to offset its secured debt balance and then distribute to the other secured creditors. Or it could sell the contracts at market value and the proceeds would be applied towards the amounts owed to the secured creditors (including itself) and if there is surplus then the liquidator would control and distribute such surplus.
• Any Asset Companies licensing/hiring out premises, IP and plant & equipment to the Trading Entity will terminate the hire and licence agreements if it has failed to pay the rental or licence fees and take back the hired assets, cancel the licence to use the business name/IP and retake control of the premises. If the hire/licence agreements have charging clauses in them and registered on the PPS register then they too could call in their secured debt, crystalise any circulating assets and possibly appoint a receiver. It would rank behind the Holding Company but before the liquidator.
• Any Labour Hire Company could cancel its supply of labour under a labour hire agreement with the trading entity and if such agreement had a charging clause therein and registered on the PPS register then it too could call in its secured debt, crystalise any circulating assets and possibly appoint a receiver. It would rank behind the Holding Company but before the liquidator.
• The Holding Company, Asset Companies and Labour Hire Company could enter into new loan, hire, licence and service arrangements with the new trading entity.
• If, regardless of the above, the old Trading Entity does have assets left that are needed by the new trading entity and not secured, then the Group entities could buy such assets or the business from the old Trading Entity for market value – similar to that detailed in the Single Entity Structure example above. However, the market value of a business that has no labour, plant and equipment, business name and premises available to it will be substantially less than the Single Entity example above.

Key Suppliers

Sometimes a trading entity may have burnt bridges with a key supplier to the point that such supplier will not supply to any new trading company or any entity associated with the old trading company unless the debts of the old trading company are paid out in full. A potential problem for a supplier is that any payment they receive regarding the old trading company that is greater than what other unsecured creditors would have received may be considered a preferential payment. A way to reduce the risk of such payment being clawed back, resulting in an unhappy supplier who refuses to supply to the new entity is instead of paying out their old debt, the Holding Company may consider buying the supplier’s debt and having the supplier’s rights to the debt assigned to the Holding Company. This is then not a preferential payment. Ideally the Holding Company would find an alternative supplier or do a deal to reduce the amount payable to the Supplier to buy the debt.

Conclusion

As you can see, there are numerous options to consider and implement. The more you put things in place from the beginning, the more options you have to mitigate adverse events.

You must never do things with the intent to defeat creditors, you must always transfer assets for market value and you must always comply with the Act. That does not mean you, a receiver, administrator or the liquidator have to do more than they are obligated to do.

The key is to get proper advice throughout all phases of a business and remember there are numerous ways to turnaround a business in distress and/or preserve the things that matter.

Queries

If you have any questions about what you should do next or to begin a review of your contract terms, please get in touch with an author or any member of our Corporate 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.

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APPENDIX A – Mechanisms of Closure

Deregistration

You can voluntarily deregister a company provided all of shareholders agree to the deregistration; the company is no longer carrying on business; its assets are worth less than $1,000; there are no outstanding liabilities; it is not a party to legal proceedings; and all fees and penalties under the Corporations Act 2001 (Cth) (“Act”) have been satisfied. This is clearly not suitable for a company that is under threat from its creditors but is suitable for trading entities that no longer trade and have squared away their assets and liabilities.

Members’ Voluntary Winding Up

A means to wind-up a solvent company. The directors resolve to call a meeting of the shareholders to wind up the company. The directors must complete and file with ASIC a declaration of solvency which provides that the company is solvent and can pay all its debts within 12 months. The company is then wound-up upon resolution of the shareholders. A liquidator is appointed and takes charge of the assets with the intent to liquidate the assets and discharge the liabilities to such an extent that the liquidator can then apply to have the company deregistered.

Liquidation

A company can be placed into liquidation via a couple of means. The most common are:

• By the Court, usually upon application made by a creditor of the company after a statutory demand has been served and not satisfied within 21 days and a wind-up application has been filed and determined. The applicant/creditor will nominate a liquidator to be appointed and such liquidator will need to consent to such appointment.
• Creditors’ Voluntary Liquidation (“CVL”) is where the directors resolve the company is insolvent and that it should be placed into liquidation. A shareholders’ meeting or circular resolution is held and passed that the company is insolvent and should be placed into liquidation. The shareholders appoint a liquidator who will then take control of the company’s assets and liabilities.

A CVL cannot be used when winding-up proceedings have been filed in Court or an administrator has been appointed.

This is why you commonly see companies enter into a CVL within 21 days of receiving a statutory demand from a creditor. If that 21 days expires, the creditor can file for winding-up, and the creditor then dictates who the liquidator could be. Such liquidator may be maligned/motivated in favour of the creditor and impose more than what is legally required, which could result in legal but unnecessary pressure, stress, delay, proceedings, claims and costs being incurred on the company and its directors, and less than commercial determinations regarding the sale of company assets to related or third parties.

A liquidator appointed by the Court or via a CVL must discharge its duties in accordance with the Act. Either type of liquidator must investigate voidable transaction and possible insolvent trading claims against directors.

Liquidators can be removed in certain circumstances and disciplined by ASIC if they are acting improperly.

However, if your company is insolvent and creditors are marching towards a hostile liquidation then a CVL may be preferred. This is to try and take some control of the wind-up process, or at the very least appoint a liquidator that will be reasonable and open to dialogue with you and your related entities, and the commercial distribution of the assets of the company in liquidation. We cannot stress enough that such CVL liquidators must still comply with the Act and not facilitate illegal phoenix activity.

Receivership

A secured party has a charge over the trading entity and enforces its security by appointing a:

• receiver over the assets of the trading entity and sell such assets (maybe to a related party of third party for market value); or
• receiver and manager to take control and run the business of the trading entity and sell its assets.

The secured party could be a third party (e.g. NAB) or the holding entity of your group structure that is owed monies by the trading entity which has given security to the holding entity.

A receiver takes precedent over a liquidator regarding the control of the company and its assets. The receiver has obligations to keep the liquidator informed and provide copies of certain books and records but, in essence, the receiver is the party in charge and greatly impacts what other parties can see and do, including an administrator or liquidator. There are exceptions to such control or priority over the assets, such as a secured party/receiver will be entitled to first priority over secured non-circulating assets but a liquidator can have first priority over certain circulating assets to meet certain statutory creditor claims (largely unpaid employee entitlements).

Administration: there are multiple forms of administrations but a common one is where the directors of the company resolve that the company is, or is about to be, insolvent. An administrator is then appointed and holds creditors’ meetings to determine if the company is to be handed back to the directors, placed into liquidation or enter into a Deed of Company Arrangement (“DOCA”) with the creditors of the trading entity. DOCAs are usually an agreement detailing a game-plan to continue to operate the company with the intent to yield a better result for the creditors and/or enable the company to ultimately become solvent and be released from the administration. Creditors under DOCAs are commonly requested to take considerably less than what they claim (e.g. 20 cents in the dollar) and usually approve a DOCA if it is likely to yield a result better than liquidation. In essence, it’s an agreement to facilitate a better commercial outcome for all concerned.

Unlike a liquidator, the administrator has no power to commence recovery proceedings against a director for insolvent trading or recovery proceedings relating to voidable transactions. Nonetheless the Administrator is still obligated to investigate such claims and make recommendations in its report to creditors. Such recommendations may result in the administrator and/or the creditors rejecting the proposed DOCA and resolving to place the company into liquidation.

Safe-Harbour and Turnaround Management

A company that is not doing well may have a plan to work through its impending insolvency.

For example, a company may have a large contract that has been delayed and will not return monies until it is completed in 6 months’ time but in the interim, it may run out of funds to meet 100% of its debts going forward.

When a company is insolvent, any debts incurred by the company will then make the directors of the company personally liable for insolvent trading (subject to various defences, etc…). Because of this personal liability, many directors would be advised to place the company into liquidation. However, doing so may result in a worse outcome for the employees, customers and creditors of the company, compared to letting the directors run the company and work towards completion of the contract that would result in everyone getting paid in full.

A DOCA could be used but the appointment of an Administrator could be an unnecessary cost and reputational damage that may put at risk completion of the contract.

The government recognised this and passed legislation to facilitate “Safe Harbour” options to enable a director to continue to run a company and incur debts whilst the company is insolvent provided the outcome was better than what the company would realise if it went into liquidation.

However, directors wanting to afford themselves this quasi-defence to insolvent trading must meet certain requirements and devise, implement, monitor and adapt a plan with advice from an appropriately qualified entity (e.g. insolvency practitioner, turnaround specialist, lawyer and/or accountant) that is “reasonably likely to lead to a better outcome”.

Furthermore, debts incurred during the safe harbour must be incurred in accord with the safe harbour plan, the company must continue to pay all employee entitlements (including Super) and comply with all tax reporting obligations. If any of these items are not satisfied, then the director is forgoing the safe harbour protection.