In the current environment, as the impact of covid lingers, we are finding that many sophisticated creditors do not really want to force a company into liquidation through formal recovery action. They would much prefer the shareholders put the company into liquidation voluntarily. This way, the creditor’s name does not appear in Court listings and they can avoid any negative publicity associated with recovering their debt. In this month’s case study, we look at the case of Michael and ask the question, “how voluntary is a Creditors’ Voluntary Liquidation?”
Michael operated a bakery business for many years. He later expanded to operate a small café at a large retail centre. While the bakery business was profitable in the past, Michael had little experience operating a café and had trouble controlling its expenses. Soon, the bakery business was effectively subsidising the café, profits suffered and cashflow became critically tight.
Then Covid hit….. social distancing. Lockdowns. The café business was severely affected. The bakery, that also supplied local retailers, was likewise impacted. At first, Michael battled on. He negotiated some rent relief with his two landlords. He took advantage of all of the Government assistance programs that he could. He even took out a SME Recovery Loan. Even after all of this, Michael started falling behind with creditors including the Australian Taxation Office (ATO).
What happened next?
Good news! Covid restrictions were eased and life started going back to something close to normal. The café and bakery businesses started to improve. Life going back to normal, though, was not all good news. Government relief programs came to an end. The landlords for the café and bakery started calling about resuming full rent payments and catching up the arrears accrued from rent relief. Creditors started expecting that their accounts would be brought up to date.
Like many business owners suffering cashflow issues, Michael had avoided talking to the ATO. He made all his lodgements when they were due, but he did not respond to their letters following up payment when they finally recommenced recovery action. When they started ringing, he dodged their calls. Now, like a lot of us, the ATO does not like being ignored. They decided they needed a way to get Michael’s attention.
The ATO have some powerful tools at their disposal to get this attention. They could have sent a Garnishee Notice to Michael’s bank. This would have required the bank to remit credit funds held in Michael’s business accounts directly to the ATO up to a certain amount. One type of Garnishee Notice is actioned by the bank on the day it is received, then fails to have any further affect. However, another type of notice can apply for a period of time and requires the bank to send every credit to the bank account to the ATO instead. This can have a devastating effect on a business, leaving it with no cash to meet critical expenses. In this case though, this is not what the ATO did.
Instead of a Garnishee Notice the ATO sent Michael a Director’s Penalty Notice (DPN). Directors can be held personally liable for unpaid GST, PAYGW and superannuation under a DPN. As Michael had reported all of the obligations within the prescribed timeframes he had a chance to remit his penalty. His options were to pay the amount owed, which he could not do, enter into a payment plan, which he could not afford, or have the company put into liquidation or voluntary administration within 21 days of the date of the notice. If Michael did not take one of these actions within the 21 days his penalty would “lockdown” and he would be personally liable for the amount of the notice, in this case $176,000.
Michael discussed the DPN with his accountant and formed the view that there was no way he could manage the penalty if it become a lockdown. His accountant arranged a meeting with de Jonge Read to talk through all the options available.
After listening to Michael’s goals, and considering both his personal and business circumstances, we recommended that he exit the business in a controlled and organised manner. Given the DPN had already been issued, the clock was ticking, and it was critical to Michael that he remit his penalty under the DPN.
Michael wished to retain the company’s motor vehicle and some other minor assets, including a laptop and some furniture for his home office. Independent valuations were arranged, and these assets were sold to Michael for a fair market price. Sales proceeds were banked into the company’s account. Michael provided notice to his landlord and other service providers that he would be exiting the agreements. A liquidator was then appointed to the company and took control of the bank account.
So, Michael did a Creditor’s Voluntary Liquidation. None of his creditors had to take legal action against him, and their names will never appear in Court listings as having been involved at all. Still, once he received a DPN, in view of his circumstances, what choice did Michael have? In a lot of cases, a Creditor’s Voluntary Liquidation is more of a necessity rather than purely voluntary. In the period from July 2020 to March 2021 the ATO only initiated 3 company wind-ups Australia-wide. However, as we saw with Michael, this may not tell the whole story.
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.
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