When is the right time to enter voluntary administration?

As more organisations are confronted with the possibility of insolvency, boards may decide to enter into voluntary administration. Henriette Rothschild shares what directors need to know.

This year is not business as usual. Directors are navigating an environment not previously seen in this country and certainly more challenging for most than the global financial crisis. The COVID-19 pandemic has brought many underlying business issues to a head.

Unprecedented revenue declines and upheavals in many industries are prompting directors to consider what the future holds. The extension of government, rental and bank relief packages has provided an opportunity to address cashflows for the immediate term, but this assistance does not mean directors can ignore the need to ensure ongoing viability. As safe harbour extensions come to an end, directors need to have taken appropriate action to ensure their organisation survives.

In times of “business as unusual”, directors may need to access a different toolbox — the one stored at the back of the top shelf, for emergency use only. Tools otherwise avoided will yield results in this environment, and directors will be best positioned to use these with effect if they address the fears and misconceptions associated with them. One of these tools is voluntary administration (VA).

The definition of insolvency — being unable to pay debts when they become payable — is widely understood across Australian board networks. Despite this, few boards have direct experience with tools such as VA — and the subtleties of voluntary administration as a tool to proactively avoid liquidation and instead restructure into a financially and operationally stable position.

The power of VA legislation is that it provides access to mechanisms not available during a consensual restructure. It also allows the restructuring process to be accelerated so a process may be addressed in six weeks instead of taking months or years to work through. This allows a business to hit pause on certain creditors exercising their rights, such as landlords taking possession of leased property. The administrator also assumes liability for debts incurred during the process, which can encourage suppliers to trade with confidence.

Despite the widely reported hardship surrounding COVID-19, ironically the Australian Securities and Investments Commission (ASIC) has reported a 39 per cent reduction in insolvencies between April and May 2020, compared to the equivalent period in 2019. This indicates many organisations would be in severe distress if not for current support such as JobKeeper. A business survey by the Australian Bureau of Statistics, released in late July, reported 10 per cent of firms believed they would shut without current support.

The substantial government support has provided businesses with time. Organisations that continue to trade today will face significant distress once those support measures are withdrawn. These organisations need to act now, before it is too late.

Action can take a number of forms. Many organisations will look to hibernate their operations with a plan to recommence once conditions improve. For some, however, this won’t be enough. Directors must be proactive, engaging with a restructuring expert to understand and consider options, maximising the chances of the organisation — or as much as possible of its operations — continuing to exist.

Reset device

The term voluntary administration strikes fear into the hearts of many Australian directors. Few have ever been involved in a VA, let alone put their organisation into one. The belief that it represents failure at the hands of a board, that it will destroy directors’ reputations and that it will lead to complete loss of control is widespread within the Australian director community.

In the US, the Chapter 11 bankruptcy process is viewed as a legitimate mechanism to reset business models. In the COVID context, retailer Neiman Marcus has recently filed under Chapter 11, signalling the decision as a key part of its turnaround journey. In a statement in May 2020, Nieman Marcus chair and CEO Geoffroy van Raemdonck said that the binding agreement “gives us additional liquidity to operate the business during the pandemic and the financial flexibility to accelerate our transformation. We will emerge a far stronger company”.

Van Raemdonck cited the “inexorable pressures” of the COVID-19 pandemic as a legitimate, external event requiring this course of action. Prudent directors can make the decision now to take decisive action unencumbered by past plans and will, instead, be judged on how they manage this crisis.

In Australia, several organisations, including clients of KordaMentha, have used the VA process to emerge more viable, including retailers Kikki.K, Tigerlily and Harris Scarfe. These boards used the process to slim down store networks, reset their cost base, exit unprofitable contracts and inject new funding into their organisations. Most recently, Virgin Australia entered VA in April. CEO Paul Scurrah said the decision was “about securing the future... and emerging on the other side of the COVID-19 crisis”.

Network 10, emerged from VA in 2017 after being acquired by CBS through VA. Director Debbie Goodin was involved in the process. “Directors need to understand the importance of preparation and timing in using VA strategically,” she says, noting a timely third party review of financials, cash and covenants gave Network 10 options when faced with changed circumstances.

However, realities should be acknowledged. Directors’ powers are suspended during a VA and they need to recognise they may not retain their position afterwards. However, if directors hesitate to put organisations into VA because of such concerns, are they putting the interests of the entity first? This is where adequate planning and early intervention make a difference. Often viewed as a last resort by many directors, the best restructures occur when directors and management help develop a well-considered plan before appointing administrators.

Further to this, administrators are legally required to undertake investigations into the company’s affairs prior to appointment, and if it is determined that the company was insolvent or there was mismanagement, the directors can be investigated and penalised. Given this, directors will not take this process lightly. However, those boards that have adhered to their directors’ duties should have little concern.

Deed of company arrangement

An option for restructuring through a voluntary administration is the use of a deed of company arrangement (DOCA). This is a binding agreement between the company and its creditors, which details how the company’s affairs will be dealt with following an administration. A DOCA must offer creditors a better outcome than liquidation and is binding on all unsecured creditors, even if they vote against the DOCA; and secured creditors, if they vote in favour of it.

There are several benefits of engaging with a VA early and having a well-structured DOCA. These include, but are not limited to:

• Time — VA provides access to tools to resolve issues in a matter of weeks that may otherwise take considerably longer, if achievable at all.
• Flexibility — a DOCA is put up by the interested party and can be innovative and bespoke.
• Protection — the Corporations Act 2001 (Cth) restricts the termination of certain contracts by counterparties, allowing businesses to preserve crucial contractual relationships.
• Contract renegotiation — through the process, businesses can renegotiate or choose not to adopt certain contracts.
• Footprint rationalisation — the ability to avoid certain contracts enables the exit of unprofitable (onerous) leases.
• Debt restructure — allows select past liabilities to be quarantined and dealt with expeditiously via the DOCA.

As directors, we are overseeing organisations in the most extreme and unusual of times. However, prudent boards will consider all transformation tools available. VA is one tool that, in times of distress, may have the necessary edge to ensure the organisation survives and thrives.

Henriette Rothschild GAICD is a partner at KordaMentha and a director of Richmond Football Club and Brown Family Wine Group.