Coronavirus Alert: Avoiding and managing insolvencies

In our experience, clients who recognise early signs of financial trouble are most likely to avoid insolvency.

This can be achieved with our assistance through restructuring and turnaround solutions including forbearance arrangements with creditors, such as the Banks, like waiving interest payments or delay or suspension in payments. You might also qualify for new government assistance programs.

Insolvency

At a high-level, insolvency is when a person or a company can no longer pay its debts when they
fall due.

Insolvent Trading

If you are a director of a company, it is most important you understand insolvent trading and its implications so you do not end up losing your personal assets.

Section 588G of the Corporations Act creates a duty to avoid insolvent trading – you must ensure the company does not trade or incur further debts of any kind once the company reaches the point of insolvency or incur a debt that would lead the company into insolvency.

A company director that fails to prevent the company from trading while insolvent may become personally liable for debts incurred when there were reasonable grounds for suspecting the company was insolvent or would become insolvent. Liquidators and ASIC are usually very critical of directors they suspect traded while insolvent and penalties can be severe.

One of the measures announced by the Federal Government to enable businesses to trade through the impact of COVID-19 is a six month exemption from personal liability for trading while insolvent. This temporary relief applies to debts incurred in the ordinary course of the company’s business and the debts will remain payable by the company.

Directors must still act in the best interests of the company and any engagement in fraud or dishonesty by directors during this period could result in criminal penalties.

Further information about the government’s measures are available here.

Recognising when to get help

Are you unable to:

1. Pay your bills?
2. Keep your wages and superannuation payments up to date?
3. Make payments due to the ATO up to date?
4. Obtain access to affordable short-term finance?

If you answered “yes” to any of these questions, we recommend you talk to us about navigating your way through the coming months to understand what insolvency might mean for you and your options.

Consequences of Insolvency

Individuals

Bankruptcy applies to individuals and occurs when you are declared to be unable to pay your debts under the Bankruptcy Act 1966. The standard period for bankruptcy is 3 years, but you can be discharged early in some circumstances. Once bankrupt, and then after you are discharged, you do not have to pay most of the debts you owe but it can affect your future ability to borrow money. There are other significant implications of bankruptcy which should all be seriously considered and understood, including your ability to travel overseas, to work in certain trades or professions and the impact on your credit report. An alternative to bankruptcy is entering into a debt agreement or ‘personal insolvency agreement’ that can also discharge you from most debts without going bankrupt.

Companies

Voluntary Administration is used to quickly resolve a company’s future by appointing a qualified independent person to take control of a company to determine if it can be saved. In some circumstances, a company can be saved by a ‘trade-on’, a sale of business by the administrator or by restructuring using a ‘DOCA’ (deed of company arrangement). If the company can’t be saved, the administrator will prioritise increasing the return to creditors. An administrator can be appointed by the directors, a liquidator, creditors of the company or the Court. During the administration, landlords can be prevented from re-taking possession of business premises, and creditors can be prevented from enforcing personal guarantees given by directors.

Liquidation occurs when a qualified independent person takes control of an insolvent company to wind up its affairs in an orderly and fair way for the benefit of creditors. Shareholders, creditors or the Court can place a company into liquidation after which unsecured creditors cannot pursue or continue legal action against the company without Court approval.

Receivership is the appointment of a qualified and independent person by a secured creditor or, in certain circumstances, the court, to control some or all of the company’s assets. A company in receivership can also be in provisional liquidation, liquidation, voluntary administration or subject to a ‘DOCA’.

Restructuring is an option to prepare a company for an economic downturn. It enables directors and executives to downsize and simplify a business to meet changing demand and market conditions. To do this, a director might be entitled to take advantage of statutory ‘stand down’ provisions (to put employees on leave without pay), or plan for termination or redundancy payouts.

Companies that pre-empt changes and restructure early are often those that survive market downturns and we are already seeing airlines, hotels and other businesses in the tourism and hospitality industries restructure and adapt to changes in economic conditions. Restructuring can take many forms and may also be a way to handle disruption to supply chains.

Scheme of Arrangement is a formal debt restructuring mechanism that varies the debt terms between a company and its creditors. This is more often useful for a company with a relatively small number of creditors.

Safe Harbour Provisions are designed to protect directors from insolvent trading by enabling a company to continue trading where the company would likely be viable if it were able to restructure or trade out of financial difficulties.

To qualify for protection, the director must show a number of things, including that the company is up to date with its ATO lodgements and payments to employees, that the director has one or more clear plans for the company’s future and that the director took expert advice about Safe Harbour as soon as he or she suspected the company was or may be insolvent. This is a technical area which requires the director to meet a number of thresholds. The current conditions could see a number of companies rely on the Safe Harbour Provisions if there is a belief that the global pandemic can be managed or a vaccination is a realistic outcome.

To download this article in Chinese, click here.