Covid 19 – How do I save my business? Holding DOCAs, Safe Harbours and more….
What do you do when your customers start disappearing, business survival is uncertain and you fear that insolvency is near.
Here is a very quick overview of the main legal options available as at 24 March 2020.
The Federal Government is moving quickly. There has been only a short time between an announcement of insolvency law changes and then the passing of the amending legislation. Further, the Treasurer is being given powers to do quick Corporations Act amendments.
To offer some temporary insolvency relief, Treasury has announced various financial payments, plus the following temporary insolvency law changes have been made law:
- Statutory demands can only be for $20,000 and over;
- Their compliance period is now 6 months (previously 21 days);
- Bankruptcy has similar dollar and period extensions;
- Directors are relieved of a duty to prevent insolvent trading for debts incurred in the ordinary course of business;
- Egregious cases of dishonesty and fraud will still be criminal acts.
PM Morrison made a statement on the weekend that residential and commercial landlords will not be able to remove defaulting tenants. No formal announcement about that proposed moratorium has been made however. Without such a measure, this may present challenges for Administrators under voluntary administration restructuring.
The Federal “stimulus package” also includes relief for small business that includes tax refunds and grants that vary from $10,000 to $100,000 through to 30 June 2020 and the same relief for the period July 2020 to December 2020. These and other available arrangements are being reviewed and upgraded regularly.
Banks have announced a 6 month small business payment holiday, but interest will accrue. This is a cash flow deferral measure.
Safe harbour restructurings offer a statutory defence to insolvent trading claims for “trade-on” debts if the restructuring follows strict rules, but the restructuring fails. They require an ongoing substantial compliance with employee and tax payment obligations. An expert insolvency practitioner will be needed to assist the company to develop its restructuring plan, to monitor its finances and to advise.
This form of restructuring is one tool which can be used to deal with the commercial effects of the virus, although given the cost to implement, versus the government’s and bank’s measures stated above, we doubt whether this will be too popular.
Voluntary administration (VA) is a further restructuring option.
Different to safe harbour restructuring, this process lets creditors vote and decide on the merits of a deal offered under a deed of company arrangement (DOCA) with independent guidance and vetting from the administrator. The creditors’ decision can be subject to a right of appeal to a court on certain grounds.
Whilst it can be costly to implement a voluntary administration for a small company due to the fees involved, it does provides for flexible restructuring and potentially greater certainty. The longer an SME waits to take this path however, the greater the prospect that it or its directors will lack the assets or cash needed to fund the process. This will become a greater issue if asset values plummet as a result of the corona virus effect.
DOCA’s have been approved in many different forms. Some typical DOCAs are:
- A lump sum is paid to creditors and the company ceases trading and is deregistered;
- A lump sum is paid to creditors and the company is handed back to directors to trade on;
- A lump sum is paid to creditors and the shares are transferred to a buyer to allow a trade on; and,
- A creditor moratorium is approved to allow a trade-on, monitoring occurs by the Deed Administrator with some interim payments to creditors and a final lump sum at the end.
Key impediments to DOCA have been the limit to which banks and landlords can be bound to the restructure if they choose not to be.
During the VA period, banks have a period during which they can enforce their securities. They could enforce at the end of the administration as well. Personal guarantees of directors can also be enforced after the administration ends. The banks’ current leniency may make sensible DOCAs and stays on the enforcement of personal guarantee easier to sell to them.
The administrator becomes personally liable for rent if they trade on the company in rented premises. Unless this personal liability is temporarily removed by the government many administrators will give up the company’s leased premises. Landlords may be more willing to be bound to DOCAs which given them a lesser rent payment for a short period in the current environment.
A 2018 High Court 3-2 majority decision in a case called “Mighty River”, approved of the use of a moratorium on old debts as part of a possible restructure under a Deed of Company Arrangement, with no set payments promised to creditors.
These types of DOCAs have been called “Holding DOCA’s”. The Mighty River case gives guidance on what a Holding DOCA would need to contain to be valid if it is challenged in a court. Some key requirements are:
- The moratorium on claims of creditors from the time the VA can be appointed is for a set term;
- The assets available pre-DOCA should be stated, even if no payment is offered to creditors;
- The DOCA administrator must have power to monitor the company’s trading, to check its ongoing solvency, to investigate its affairs and to report to creditors and call an early meeting if required; and,
- There needs to be a valid basis for the administrator being able to conclude that the moratorium, with whatever steps are to occur during it, is likely to lead to a better outcome for creditors than a winding up.
Once the moratorium ends, the DOCA proposer also needs to be ready to put a fresh proposal which is acceptable to creditors at a creditors meeting, or face a probable liquidation.
Liquidation is a quick but drastic option and sometimes the only suitable option, but:
- It is a black mark against your name;
- It is probably destructive to the business, although you might try to buy the assets off the liquidator and start again;
- Key suppliers may be chased by the liquidator for possible preferences – hampering any fresh start;
- It will lead to an adverse report to ASIC, if you have committed any offences;
- Any loans made to you by the company will get called in; and,
- Personal guarantees or mortgages may be called in by creditors, but perhaps not banks at this point in time.
‘Phoenixing’ has been used by some badly advised SME’s, often at an exorbitant cost, as a means of directors trying to avoid the effects of a business failure. Thankfully this method has been targeted by the February 2020 illegal phoenixing legislation. ASIC also now has wide, but controversial “judicial” powers in this area.
The announced government measures and bank initiatives should also discourage the use of this flawed restructuring method.
Some business may be able to achieve an informal negotiated restructuring outside of the safe harbour provisions, via a combination of the financial aid linked to the Federal economic stimulus package, bank loan moratoriums and the insolvent trading freeze. It could include the prospect of fresh equity injections, tax payment plans, employee stand downs, negotiated lease variations and supplier term variations or discounted payments.
This combination of informal arrangements is likely to become far more prevalent than in the past. Good documentation of any such arrangements will be essential.
We are available to assist during this very unusual and difficult period.
The author, James Hamilton is member of the Australian Restructuring Insolvency and Turnaround Association (ARITA) and an experienced insolvency lawyer. He has represented companies and individuals, advised boards and regularly advises the insolvency profession on compliance and technical issues.
Be aware, that in this rapidly changing environment the positions of the government and the banks may change at short notice.
This paper is a summary providing general information and is not specific legal advice.
For more details, please contact:
James Hamilton, Solicitor
(02) 9318 6423
© Surry Partners Lawyers 2020