In this month’s case study we look at our client, Darren, the director of a scaffolding company. The business had accrued a significant ATO debt, and Darren was concerned that following the end of Government Covid-19 relief measures he would face recovery action from the ATO. His accountant knew there had been some changes in insolvency laws, but was not sure whether this would play out in his situation, so she referred Darren to de Jonge Read. Following the end of the Government’s Covid relief packages the time to respond to Creditor’s Statutory Demands has reduced from 6 months back down to the original 21 days. During Covid the ATO’s debt book grew from $46bn to $53bn. There is now a lot of speculation that the ATO will recommence its normal debt collection activities. This makes getting timely advice critical! Background Darren had run his scaffolding business for many years but had suffered a serious downturn. With reduced income during Covid he had done his best to pay his trade creditors, but his ATO debts escalated. Now, with relief measures ending, he is facing a real problem. At the time he met with de Jonge Read the company’s position looked like this:
Plant and Equipment (resale value) - $25,000
Motor Vehicles - $50,000
Stock - $10,000
Total - $85,000
Trade Creditors - $25,000
Bank Overdraft - $30,000
Motor Vehicle Finance - $55,000
ATO - $200,000
Total - $310,000
Importantly, the bank had registered a security interest over the company in relation to the overdraft. Some creditors also had such charges over stock supplied.
The changes in legislation Darren’s accountant had heard of was the Corporations Amendment (Corporate Insolvency Reforms) Act 2020, that came into effect on 1 January 2021. Under this new legislation Darren could have tried to negotiate a debt restructure with his creditors, or put the company into liquidation using the simplified process. A debt restructure involves making an offer to unsecured creditors in full and final satisfaction of their debts, with payment to be made over a maximum term of three years. Was this the best option though?
When we met with Darren he advised he wanted to keep trading the business, but didn’t think he could ever get on top of the ATO debt. He also said that he had limited resources available. Understanding what the client wants and their unique circumstances is critical in developing our recommendations.
After a careful consideration of all the options Darren had available, we recommended a business restructure rather than a debt restructure. Key considerations were:
• The security position of the bank;
• The composition of company creditors; and
• Resources available to the company
Based on Darren’s advices, a debt restructure was not considered the best option. He would have been unable to make a reasonable offer and effect payment within the required timeframe. Further, there was a high degree of uncertainty as to whether any offer would have been accepted.
Some people refer to a business restructure as a phoenix. This is correct. They also think it is illegal, and this is incorrect. A business restructure undertaken as a commercial necessity is entirely legal and this has been acknowledged in legislation. To ensure the business restructure was legal we assisted Darren to:
• Obtain valuations of goodwill and all physical assets.
• Ensure a commercial price was paid by a new trading entity.
• Correctly address the position of secured creditors.
• Distribute the funds available according to security and priority positions.
In Darren’s case the goodwill and assets of the business, excluding vehicles, was independently valued at $50,000. With some help from a family member, Darren was able to make payment to the company’s bank account. These funds were loans to the new trading entity, and the family member registered a security interest just like a bank would, becoming the secured creditor of the new company. Funds were then distributed as follows:
Payment to secured trade creditors for stock sales - $10,000
Clearance of the secured overdraft facility - $30,000
All staff were re-employed by the new trading entity, which assumed liability for all outstanding employee entitlements. By doing a business restructure all staff retained employment and the business was able to continue trading in the name of a new company.
The next step was to liaise with the motor vehicle financiers. In this case, they agreed to assign the finance agreements to the new trading entity on the basis that all payments would be maintained. This was entirely appropriate as there was no equity in the motor vehicles.
This left the company with $10,000 in its bank account. Darren then appointed a liquidator to the old company, who took their fee from the company bank account. The liquidation will be done using the simplified model introduced by the new legislation. This will involve less reporting by the liquidator, less investigations and no creditor meetings. The idea of this model is to make it quicker, simpler and easier to complete a liquidation with the goal of improving the return to remaining creditors.
Darren was able to bring finality to all claims against the company and deal with the insurmountable debt it faced. The new company was able to trade without the burden of these debts. The key is understanding all options that are available. In this case, while one of the options under the new legislation was not viable, the other was a perfect fit for Darren’s unique circumstances.
Should you have clients or associates that you know are struggling with financial issues or need assistance in reviewing their business affairs in preparation for what’s around the corner, our team of Strategists would be pleased to discuss options that are available on how to best design and implement insolvency strategies.