Restructuring & Insolvency

Voluntary Administration – a powerful, flexible tool to save a business

The voluntary administration process is designed to maximise the chances of a company or its business continuing to exist.

Voluntary administration is one of the courses of action available to a company in financial distress. Its objective is to maximise the chances of survival for the company or its business by providing a framework for a commercial proposal to be agreed with the company’s creditors. The regime’s flexibility is enhanced by the fact that, whilst administration[1] is underway, creditors for the most part are not permitted to interfere; a moratorium is in place that prevents most creditors from pursuing actions that could compromise the business’ ability to continue.

The process usually begins with the company’s directors resolving by simple majority that a voluntary administrator should be appointed and nominating a professional insolvency practitioner to act in that role. The insolvency practitioner accepts the role by providing his consent.

When should voluntary administration be used?44
Voluntary administration should be used when the directors are confronted with three types of circumstances. The first situation is where the directors believe the business could be saved or that a restructuring plan offering better outcomes for creditors is possible. Certainty around the plan is not required.

The second situation is where it is not practical to obtain the necessary 3/4s majority resolution by shareholders in order to appoint a liquidator and the directors wish to avoid insolvent trading. Put simply, it is often easier to put a company into voluntary administration than into liquidation.

The final situation is where a winding up action is underway in the courts. If successful a liquidator, likely nominated by the petitioning creditor, will take control of the company. The directors may prefer to place the company in the hands of an administrator of their choosing instead. The laws do not allow directors to appoint a liquidator.

Commencement of voluntary administration
Voluntary administration commences when a voluntary administrator is appointed. This is a very important event because it results in the administrator assuming full control over all of the company’s affairs, assets, finances and trading activities. The director’s powers are suspended, however, their duties continue. They are also required to hand over assets and books and records of the company in their personal possession, and also assist the voluntary administrator.

The voluntary administration process
Regardless of the type of business, an administrator will pursue certain core activities during his appointment. These activities include:

  • taking control of the company’s assets and trading locations;

  • investigating the company’s affairs;

  • reporting to creditors on the course of action that offers the best financial outcome to creditors;

  • call and hold the required creditors meetings; and

  • provide limited assistance to interested parties wishing to formulate a deed of company arrangement proposal (DOCA).

If a sale of the business is contemplated, the administrator will often seek to continue trading after their appointment. The merit and financial risks of doing so will be considered carefully, usually when the voluntary administration begins. Apart from special rules relating to rental and lease arrangements, debts incurred by the company after the appointment usually become personal debts of the administrator if the company is unable to pay them.

Importantly, the administrator acts on behalf of the company and in the interests of the company’s creditors, as a whole. He does not act on behalf of the directors and cannot provide advice to them personally.

The administrator will hold at least two creditors meetings. The first creditors meeting occurs within eight business days after the appointment and it is largely a procedural meeting to confirm the appointment.

It is the second creditors meeting that determines the company’s future. There are three options available to creditors at this meeting:

  1. the company should enter into a deed of company arrangement; or

  2. the company should go into liquidation; or

  3. the administration should end and control of the company be returned to the directors.

In making their decision creditors will consider the voluntary administrator’s report to creditors. This is a significant document in which the administrator reports his findings from his investigation and the terms of any proposed DOCAs. The report will also contain the administrator’s recommendation regarding the company’s future.

The merit of a DOCA proposal is assessed by comparing its expected return to creditors to the likely outcome for creditors in liquidation.

Choosing a DOCA for the company’s future necessarily means it is not going into liquidation. (At least, not at that time. Liquidation can still occur if the DOCA fails.) Actions by a liquidator, including pursuing directors for insolvent trading and recovering voidable transactions, will therefore not occur.

Resolutions tabled at creditors meetings require a majority in both number and value of creditors voting in order to pass.  If there is no result for a resolution (there is a majority in value but not in number or visa versa), then in most cases the administrator can use a casting vote to determine the resolution.

From voluntary administration to deed of company arrangement
A DOCA is a powerful instrument that can address every type of financial issue previously holding the company back. It can even address contingent liabilities. The DOCA phase continues the moratorium that began with the voluntary administration. Creditors remain barred from interfering with the company’s assets and terminating contracts (subject to negotiated terms where required).

A DOCA can be proposed by anyone. The voluntary administrator can provide general guidance with the DOCA’s terms, but they cannot advise on it. For that reason, it is not unusual for the DOCA proposer (called “proponent”) to engage his own advisor and we frequently act in this role.

Your DOCA proposal – a rough draft is okay
A DOCA you are considering does not have to be fully formed by the time of the second creditors meeting. Completing its documentation can wait until after creditor approval. What is important is that your proposal clearly sets out the DOCA’s main terms and method of implementation. The administrator will include this information in her report to creditors prior to the second creditors meeting. As the voluntary administration period passes quickly and unforeseen issues tend to arise, we recommend that work on an intended DOCA proposal begins as soon as possible.

Creditors can propose changes to the DOCA proposal at the second creditors meeting and submit them to a vote. Where creditors vote in favour of such changes, those amendments must be incorporated into the DOCA. However, any such changes may make the DOCA unfeasible, and it may not be able to be executed.

Your DOCA is approved. Now what?
If creditors vote in favor of a DOCA, the proposal is converted to a legal agreement that must be signed within 15 business days after the second creditors meeting. If that does not happen the company is placed automatically into liquidation.

Once the DOCA is signed, the administration comes to an end and the DOCA now governs how the company operates. The administrator usually becomes the deed administrator and is responsible for administering the DOCA’s terms and paying planned distributions to creditors.

Certain rules must be followed in the DOCA agreement. For example, it cannot give a creditor an inferior return compared to what the creditor may receive if the company is immediately liquidated (typically a low threshold given the catastrophic loss usually experienced by creditors in the liquidation of small and medium businesses).

Bringing the DOCA to an end
A DOCA ends when its terms have been carried out and the planned distributions paid. At that time the liabilities that existed on the company’s balance sheet when the voluntary administration began are usually extinguished.

A DOCA can also terminate if key parts of the agreement are not followed. If that happens, the deed administrator must inform creditors of the breach. He may also convene a creditors meeting in order to place the company in liquidation.

 DOCA compared to safe harbour
The two strategies are similar in that they are both tools for designing and implementing a restructure strategy whilst avoiding personal liability for insolvent trading. There are some key differences, however. First, the DOCA can only be executed by a voluntary administrator and is administered by the deed administrator. In safe harbor the directors control the restructuring process. Second, a DOCA is a “public” restructuring tool. Documents with the company’s name must include the words “(subject to deed of company arrangement)” whilst the DOCA is in place. It is also a formal process in that it requires notifying the company’s creditors and key government agencies such as the ATO and ASIC. Also, a search on ASIC’s databases will indicate that the company is subject to external administration. This type of disclosure does not occur with safe harbor.

Your bank and other secured creditors during voluntary administration
Voluntary administration prevents some partly secured creditors from enforcing their security. For example, a wholesale supplier cannot demand the return of unsold goods, and assets subject to finance cannot be recovered by the financier (although their security remains intact and finance payments will likely be payable). This moratorium, however, does not extend to secured creditors with a charge over everything. This is typically the bank and it can appoint a receiver to take control of the company’s assets away from the administrator. The receiver will then most likely sell the assets and distribute the proceeds in accordance with insolvency laws until the secured creditor is fully repaid.

Unsecured creditors during voluntary administration
Unsecured creditors include most trade suppliers, the ATO, employees and related parties that have not taken out security on loans advanced to the company. These creditors are barred from enforcing their claims or applying to wind up the company during the administration period. They also cannot commence proceedings and any actions already underway will be placed on hold until the administration has finished.

Use of assets owned by others
It is likely that the company uses assets belonging to others (eg. landlord) or assets that are subject to security interests granted by the company to others. The company may require the continued use of these assets as part of a restructure proposal. With that thought in mind, voluntary administration prevents these parties from “reaching in” and seeking control of the relevant assets. The laws prevent:

  • the owner of property used by the company from recovering that property;

  • the landlord from taking back possession; and

  • a secured party with physical possession of the asset forming its security from selling the asset.

Furthermore, the administrator can sell assets subject to a security interest or owned by others:

  • with the consent of the secured creditor;

  • with the consent of the court; or

  • in the ordinary course of business.

Not surprisingly, the net sale proceeds from such transactions must be paid first to the holders of the security interests until their debt is repaid.

Voluntary administration and personal guarantees
The moratorium on the company’s creditor claims extends to the personal guarantees in respect of those claims. Personal guarantees granted by the director therefore cannot be pursued during voluntary administration. This creates additional breathing space for the directors whilst they consider their next steps. This protection, however, ends when the administration terminates and it cannot be continued under the terms of a DOCA.

What does it cost?
It is impossible to provide guidance on the cost of a voluntary administration as it depends entirely on the size and complexity of the company’s affairs.  It is important to note though that there is no requirement for directors to pay these costs personally. Professional fees and the administrator’s disbursements are paid first from the company’s assets and then, if previously agreed, from additional amounts that may have been contributed by the directors or a secured creditor.

Ending voluntary administration
A voluntary administration usually terminates when creditors resolve to either liquidate the company or accept a DOCA proposal. A DOCA’s termination depends on the specific terms that were included in the DOCA.

[1] The terms “voluntary administration” and “administration” are used interchangeably, as are “voluntary administrator” and “administrator”.