Saving Stakeholders & Saving Businesses
Editor’s Note & Disclaimer: This fact sheet is inextricably linked to an understanding of the Corporations Act. Where necessary, reference has been made to the Act to enable readers to understand what the implications are in regard to issues of responsibility and potential liability. This is particularly relevant for those who are classified as directors under the Act. As with all issues involving liability, the events resulting in liability need to be proved and there needs to be a commercial benefit to the parties involved in pursuing legally a matter of liability. For a proper understanding of your financial position and its impact upon you and your company, we strongly suggest you seek independent advice. What is set out below is a general understanding of the issues relating to insolvency and they cannot be specific to your circumstances.
WHAT IS BUSINESS FAILURE?
Most businesses do not fail’ in the literal meaning of the word and even less fail because of a solvency issue. Many businesses which do not survive as a trading entity may just be under performers who have been sold or taken over by another stronger, more powerful competitor or industry player. In many other cases, the owners want to move on and do something different in their lives and so they sell their business to the highest bidder.
However, those businesses that do fail from insolvency’ inevitably fail due to a lack of available cash when they have to pay suppliers. These payments can be for operating expenses such as stock purchases or overheads or it can be payments owing to the ATO for unpaid taxes. Or, they can involve the refinancing of existing financial obligations which need to be renewed.
when cash is tight planning is critical
In terms of the business, the most critical issue to address with businesses suffering from a lack of available cash is planning. Plans can include a way out’ plan or a back up to where we were’ plan or a minimise the damage’ plan. But there must be a plan.
For directors, the reason to plan is even more critical. (What applies to directors also applies to holding companies). Under the Act, directors are expected to know exactly where the company is today’ in terms of its financial position. They also have a fiduciary responsibility in regard to stakeholders such as creditors, who do not have the same intimate knowledge of the financial affairs of the company. It is also important to note that ignorance for whatever reason is no defense for a director.
However, the law takes a director’s responsibilities even further and holds the director personally liable for certain debts incurred by a company. If a director should suspect’ that a company is insolvent, they are expected to take action to prevent the incurrence of any debt(s), which could result in the company becoming insolvent. “Insolvent” is defined in the Act as “a person who is not solvent” and “solvent” is defined as: “if and only if a person is able to pay all the person’s debts, as and when they become due and payable.”).
The alternative to taking appropriate action as deemed by the Act is to wear the risk of personal liability for any loss or damage suffered by the person owed the debt.
The purpose of developing a plan is to prevent directors from potentially worsening their personal financial position as well as saving the business and stakeholders – or at least doing as little damage to the business and stakeholders as possible at the time a decision is made to do something about the company’s financial affairs.
A plan is particularly important where the directors need to be protected – either protected from claims of trading whilst insolvent under the Act or protected from personal liability arising from the Australian Taxation Office issuing Director Penalty Notices to the directors for unpaid PAYG taxes (issued under Section 222 of the Income Tax Assessment Act).
In spite of the lack of a plan, many businesses sail close to the wind but manage to scrape through and survive due to supportive market conditions or a series of fortuitous events.
SHORT TERM SOLUTIONS FOR INSOLVENCY
Crisis points in a business’s viability can sometimes be overcome by achieving an informal repayment plan, negotiating new trading terms or changing suppliers or financiers.
By obtaining agreement from a supplier that the date on which a debt becomes “payable” is extended may allow the company and its directors to form a view that the company is now “solvent”.
Often a new supplier stakeholder replacing an existing one may be prepared to get involved because they do not have the bad history’ of broken promises and under-achievement associated with the past. Or, these new stakeholders, particularly in the area of finance and lending, may have what is euphemistically called a greater appetite for risk’. This is another way of saying that they are prepared to price in the higher risk from dealing with the company by charging more rather than refusing to deal with the company because of this higher risk.
Such lenders do not always anticipate a long term and sustainable relationship and their cost of funds would often be prohibitive for a business to sustain for any length of time. However, they can provide an important short term circuit breaker for a business that needs to get back on track via a business turnaround and needs short term financial support to do so.
In knowing when to approach such stakeholders and how, it is important that the business is properly prepared for the turnaround needed to move forward. Continuing to carry baggage from the past and not fully addressing the issues for the turnaround (often equating to a scenario of denial), means the stop-gap solution of a new stakeholder becomes just another step on the road to decline and eventually failure.
turnarounds require INDEPENDENT THOUGHT AND ADVICE
t is in times like this that a business owner or manager needs advisors who can speak from experience, who know what needs to be done and who know that a sense of urgency is needed to ensure a successful turnaround plan is put in place.
When a turnaround is a possible scenario, our experience suggests that the implementation of a viable plan can achieve a fantastic financial result for the key stakeholders in a business – the owners, the directors, the guarantors, the managers and the employees as well as the suppliers, customers and financiers.
When staring at potential downturns in performance, which could affect the solvency of the business, it is often a good idea for the Directors and the Chief Executive Officer (CEO) to get an objective second’ opinion on the current position and the risks the business might need to address to ensure it avoids failure. This is when a business owner should be turning to their accountant, financial advisor or insolvency specialist for expert advice on the critical solvency issues.
When things are not going 100% as planned, this advisor can often be a good sounding board for the Directors and CEO (and also the Chief Financial Officer; CFO) to clarify the critical areas which need to be addressed and the timing in which they need to be addressed.
THE unanticipated IMPACTs OF INSOLVENCY
When business failure is inevitable, it has more than just an adverse financial impact on the lives of those involved although this is of course a very real and painful consequence of business failure.
Some of the other less obvious but just as real consequences of business failure include the personal and emotional trauma caused by a loss of income and a loss of livelihood and the uncertainty of not knowing what is likely to happen next.
All of these issues can cause extreme emotional anxiety for those involved (and their partners and families) thus decision making under these circumstances is often impaired. The people most at risk, both financially and emotionally, are the directors and owners and their families as well as the employees and their families.
To ease the emotional burden, your advisors should have have a strong sense of empathy for the direct and indirect stakeholders impacted by business failure.
It therefore greatly assists to have someone on your side who not only understands the business and technical insolvency issues but who can also understand the importance of assisting you deal with some of these less tangible and personal issues.
CHOOSING THE RIGHT type of INSOLVENCY APPOINTMENT FOR YOUR RESTRUCTURING NEEDS
When considering some form of formal insolvency appointment, there are many issues to consider. For details on the various appointment types, visit the Australian Insolvency Practitioners Association of Australia website: click here.
An experienced insolvency practitioner will guide you through these various alternatives and structure a solution which best suits your needs. It is always important to remember the outcome you are seeking to achieve: to convert an insolvent situation into a solvent one so all parties can move forward and not have to continue dealing with an insolvent predicament.