As economic activity ramps up following COVID-19, directors of many organisations are facing brutal business realities. After the bushfire disasters and the lockdown, many are in significant distress and the outlook for cashflow is grim. Following on from long days and workarounds, a period of constrained demand, knock-on effects to suppliers and customers, and changed consumer priorities now present daily challenges with depleted cash reserves and constrained access to capital.
For some, it may well be too much. Companies into which owners have poured their energy, aspirations and capital will not go the distance. Others will require feats of tactical agility, lateral thinking and extensive workouts with financiers, suppliers and business partners — and huge efforts by family.
McGrathNicol partner Matthew Caddy says the immediate surge in businesses seeking assistance in the initial weeks after social distancing began has steadied as businesses have absorbed the measures that have been put in place by financiers and the government.
“As business activity returns, I anticipate an increasing number will seek assistance to restructure and reset their cost base for what is likely to be a period of medium-term reduced demand,” he says. Those unable to adapt could face insurmountable liquidity constraints.”
Phil Ruthven AM FAICD, chair of the Ruthven Institute, says that of the more than 2.4 million businesses in Australia, on average we lose one in eight each year — one per cent to bankruptcy or insolvency. Given the impact of the pandemic, he says, it is likely that more will close than will be created in 2020–21.
Sal Algeri, national restructuring leader for Deloitte, thinks the mantra should be, “speed over elegance”. “Fast tactical moves will improve your chances of staying around,” he says. “These include stopping spending and projects, raising capital and obtaining lines of credit.”
Michael Lalji, insolvency practice leader for Shine Lawyers says directors need to choose the right advice for their circumstances and consider all options. “Generally speaking, the worst outcomes have arisen when directors put their heads in the sand and try to trade out of a problem,” he says.
Hard facts and cash
Lachlan Edwards, co-founder of advisory Faraday Associates and a director of the Turnaround Management Association, says the very first step in surviving COVID-19 is to have a hard think about the problems the business faces. “For many companies, this will be around liquidity — how you ensure access to enough cash and minimise cash outflow to get through to that indeterminate date when your business can start again,” says Edwards.
He notes rigour and discipline around cashflow management should be a priority, advising companies to maintain rolling 13-week and 12-month cashflow forecasts. “A full quarter should give a good snapshot of the business. Also, look at what claims on cash might arise in the near-term.”
Examining scenarios is also vital, says Edwards. “In restructurings, it’s often the ‘unknown unknowns’ — to use a phrase quoted by former US Defense Secretary Donald Rumsfeld — that get you, so you want to determine as many ‘known knowns’ and ‘known unknowns’ as you can.”
He also advises directors to avoid being distracted by things irrelevant to survival. “Keep a constant eye on the cash and have a treasury team that’s on top of the cashflow,” he says. “Have a good company secretary. Get good legal and financial advice. Minute your meetings and decisions made. If you don’t do these things, you’ll be in trouble.”
“Directors should carefully consider the risks of allowing a company to continue trading insolvent under the safe harbour provisions.” Michael Lalji, Shine Lawyers
Keep close to your financiers
Marcus Ayres, the managing director of Duff & Phelps’ global restructuring advisory, believes when having discussions with your financiers, it is important to provide a properly thought out business plan, otherwise it will be difficult for the banker to consider the proposal and to make a credit assessment.
“While debt is cheap, it must be paid back,” says Ayres. “There has been significant overleveraging in the market over the past decade, which is unsustainable. If you’re looking to take on more debt to keep the business alive, it’s important to ensure it’s not done at the long-term expense of saddling the business with unsustainable debt.”
Caddy adds, “If you raise capital or get lender support, ensure you have covered the worst-case scenario as best as possible to provide yourself with as long a runway as possible. If you can, get more capital than you think you need. Injections are likely to be available to good businesses with good strategies on one occasion, but it will probably be a lot harder to access capital a second time — and particularly a third or fourth time.”
Restructuring or administration?
Directors considering options have a range of advice to choose from.
Edwards says many good companies have been caught out by the disruptions of COVID-19, but that does not mean administration is inevitable. Directors of distressed companies should not see administration as their only option. Better outcomes can often be achieved through negotiation with creditors, avoiding incurring the costs of an insolvency process.
“[Restructuring experts] are used to negotiating with people to get an outcome that is more win-win [compared with] insolvency professionals who live within the protections of the courts,” says Edwards.
Ayres says that it is crucial for companies in distress to address their solvency issues early so they can respond effectively. “Insolvency is the least desirable outcome for everyone involved, but with early engagement often come alternatives other than insolvency,” says Ayres.
However, if an insolvency appointment is the only option, then it shouldn’t be seen as a dead end.
“Australian voluntary administration laws are world-class and developed as a way for SMEs to access a regime to restructure in a cost-effective and time-efficient manner,” says Ayres.
“Using voluntary administration can be an effective way to ensure a business survives and moves on quickly, rather than languishing under too much debt.”
Lalji adds that directors are given temporary safe harbour from liability for insolvent trading provisions for six months provided the debt was incurred “in the ordinary course of business”.
“But directors should carefully consider the risks of allowing a company to continue trading insolvent under the safe harbour provisions and whether they expect a return to solvency within the six-month period,” he says.
“If not, they risk liability for insolvent trading if debts are incurred after the six-month safe harbour period. To avoid directors abusing the temporary safe harbour, the onus will be on the director to demonstrate a debt was incurred in the ordinary course of business.”
Lalji also cautions that directors may still be exposed to other claims outside the insolvent trading regime. These might include, for example, claims for breach of duty, uncommercial transactions, unreasonable director-related transactions and unfair preferences.
For more information on insolvency, check out our webinar Insolvency Preparedness - The shifting eye of the storm for members here.
Stages to watch
The road to insolvency can be broken down into three stages, writes Garth O’Connor-Price, principal of restructuring and insolvency at William Buck.
A company is insolvent when it cannot pay its debts when they fall due. An assessment of insolvency will consider more than the liquid assets available to discharge debts and look beyond the balance sheet at the ability to generate future cash, realise or borrow against fixed assets, or obtain funding from shareholders. A failing company can fall into one of three categories:
- Illiquid or likely to become so Liquidity issues left unaddressed can turn into solvency issues. It is important directors who identify liquidity issues created by an underperforming business or other crisis take proactive steps by looking at turnaround (debtor-led) or workout (undertaken in conjunction with financiers) initiatives. Turnaround initiatives could include changes to management, divestment of business segments, cost reduction or refinancing. It is important to ensure financiers and/or shareholders support these plans and have confidence in management to execute any turnaround plan. If it is suspected at any stage during the turnaround that the company may become insolvent, a turnaround may be run under the protection of safe harbour to protect directors from personal liability for debts incurred during the time the company was insolvent, in the event the turnaround plan isn’t successful.
- Likely to become insolvent in the future If a company is looking likely to become insolvent and an informal turnaround or restructuring has failed or not commenced, an option is to appoint a voluntary administrator. This creates a moratorium against creditors enforcing their claims against the company and allows time for an independent assessment to determine whether a restructure of the company’s balance sheet is possible via a deed of company arrangement (DOCA). Creditors have the final say on any DOCA proposal, which could include a binding compromise of all claims or a conversion of claims into equity.
- Insolvent If it is blatantly clear a company has become insolvent (signs are creditor enforcement action, non-payment of statutory debts or endemic working capital deficiencies) and all recovery options have been exhausted, the most viable option is to appoint a liquidator to wind up its affairs by securing and realising its assets, investigating its pre-appointment conduct and dealing with creditor claims.