How to Avoid Common Pitfalls in Voluntary Administration
Most Australian companies that enter voluntary administration are deregistered within three years of the commencement of the administration. An understanding of the legal framework and common problems can help you avoid this and maximise the prospects of returning to success.
Understanding the legal framework
It is vital to be fully aware of the legal requirements associated with voluntary administration and the strict timetable that you must adhere to during the process.
Once the decision to enter administration has been made, the next step is to appoint an external administrator who will take total control of the company and its assets during the process. Once voluntary administration is entered, trading ceases and all claims by creditors, landlords or other stakeholders are put under a stay until the company’s future is decided.
The administrator’s role, as sanctioned under the Corporations Act 2001, is to review the viability of the company and the prospects of future success. These findings are presented and accompanied by options which are to be voted on by creditors. Crucially, although every effort should be made to find a way to return to trading, an external administrator’s primary responsibility is to a company’s creditors, not its directors or their employees. Once this process is underway there is a clear framework to follow:
The administrator must contact creditors no later than the next business day after they are appointed to schedule the first meeting of two meetings. The first meeting must occur within eight days of the voluntary administration beginning and creditors must be given five days notice
At the first meeting, creditors can vote on whether to retain the current external administrator or not. Creditors and directors will also be updated regularly throughout the process about fees incurred and options being explored by the administrator.
Directors give up control of the company during the review stage but they are still required to fully cooperate with the administrator by making financial records available and providing other essential information. There are legal ramifications for directors if they fail to carry out their duties and responsibilities.
The second meeting must be between 25 and 30 days into the process, also with five days notice. At this point, creditors must vote on the options presented by the administrator.
The external administrator can recommend one of three options based on their analysis of the company:
- The company is deemed viable and returned to the directors’ control
- A Deed of Company Arrangement (DOCA) is designed, stating the company’s intentions going forward (this must be signed by all relevant parties within a further 15 business days
- The company is wound up and put into liquidation(this begins immediately)
The changing landscape of business requires legislation to be adaptive. Significant insolvency reforms came into effect on January 1, 2021 with the introduction of simplified liquidation and small business restructuring. Designed for businesses with less than $1 million in liabilities, they aim to reduce the costs associated with insolvency. Furthermore, small business restructuring allows directors to remain in control of their company while working alongside a restructuring practitioner. Read out small business restructuring FAQs for more details.
How to make a voluntary administration successful
It’s possible that a creditor may be arguing for liquidation in order to recoup their investment and distance themselves from the failed venture. Meanwhile, company directors may want to restructure and continue trading. This means that whether a voluntary administration process has been a success or not is partially subjective. That said, if the option of voluntary administration is being considered it is highly likely that, unless the company’s fortunes change significantly, all stakeholders have already realised some losses on their investment. Therefore, one of the main success criteria for any administrative action that everyone can agree on should be to minimise these losses.
Beyond the legal requirements laid out in the Corporations Act, there are several considerations that can make all the difference in whether you achieve your goals from the administrative process or not.
When it comes to the timing of voluntary administration, the key is to take action before it’s too late. As outline in the Productivity Commission notes, earlier entry into a formal restructuring process like administration increases the chances of an effective restructure as it’s more likely you still have the assets, time, and scope for success.
Since the administrator could recommend return to directors’ control, DOCA, or liquidation, starting the process of administration before it’s too late will give a business the best chance of survival. This is because the external administrator must have reasonable grounds to believe that the company is capable of being a viable business not to recommend liquidation. The further a company falls into insolvency and the longer the directors leave it without exploring insolvency processes, the more likely that there will be an absence of key elements including there will assets, time, or other resources for the administrator to utilise.
Directors are legally obligated to prevent insolvent trading. Trading insolvent can result in criminal charges and significant civil penalties. As a result, it is in the best interests of any company director to act quickly if administration is the right step forward. By consulting with insolvency experts such as Australian Debt Solvers in a timely manner, you can get accurate advice on whether voluntary administration is appropriate.
Keep costs down
The Productivity Council’s study also revealed that insolvency costs are around 8% of business value in Australia. This is comparable with costs in the United States but high relative to New Zealand and the United Kingdom. If your business is suffering from cash-flow problems you will want to keep this figure to a minimum to avoid further exacerbating the issue.
Although voluntary administration is designed to assist cash-strapped business back into the black, the costs associated with it can quickly mount. The cost of hiring an external administrator, although unavoidable, is not insignificant and other auditing costs will come with it. In this regard, another success criteria would be to keep the timeframe of the administration process to a minimum, which should be around 30 days.
Despite most of the process being held to a legal timetable, there are some areas where creditors can extend the process. Examples of this include voting to select a new external administrator or using all 15 days allowed to sign the DOCA. Keeping the amount spent analysing the company's options to a minimum makes available to largest sum possible to repay creditors in the case of liquidation. Similarly, the additional funds can be used to invest in new growth opportunities if trading resumes.
Commit to your chosen course of action
This point relates to the first two but it is important enough to warrant its own explanation. Once the external administrator has made their assessment and the company’s creditors have agreed on a suggested course of action, that plan should be implemented immediately.
According to the commission’s report, the median time spent in winding up a company is around 500 days, which is comparable with or slightly above overseas processes.
A substantial part of the delay and cost in insolvency is due to the processes involved in creditors approving and challenging the insolvency practitioner’s fee, which comes out of what sum, if any, can be recovered from the liquidated business.
Read the fine print
Finally, there is good news for directors hoping that entering administration will just be a temporary blip on their company’s long history. A newly implemented reform on ipso facto clauses in a commercial contracts could offer fresh hope for business leaders looking to return to trading after voluntary administration. The amendment, which came into force on 1 July 2018, states that a contract can no longer be terminated solely due to one party entering voluntary administration.
This reform aims to tackle the catch 22 of the previously common scenario where a company would enter administration in order to restructure its finances only for its trading contracts to be terminated, thereby rendering its situation unviable. The stay on contract terminations will remain in force for the duration of the administrative period.
By leveraging this new opportunity to retain value in the business, companies entering voluntary administration today will have a greater chance of successfully re-entering the market and turning to profit.
Take the first step
Australian Debt Solvers specialises in voluntary administration to help save your business. Acting quickly may be the determining factor between a successful restructure or being forced into liquidation. For expert advice and a free consultation, Contact Us today.
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