Advising directors of companies in financial distress

Tom Read, Legal Writer - Practical Guidance, LexisNexis Australia

With a flood of company insolvencies expected in 2021, lawyers will increasingly be asked to provide advice to directors of companies facing difficult decisions about the future of their businesses. We provide a checklist to assist with advising directors of companies in financial distress.

Why do company directors need to act urgently?

The temporary insolvency protections relating to insolvent trading liability and statutory demands, which apply to all companies, are due to end on 31 December 2020. For further details about insolvent trading, see What is insolvent trading?

Since the temporary insolvency protections commenced in late March 2020, significantly fewer companies have been going into administration and liquidation, suggesting that directors of many companies have deferred decisions about their insolvent businesses because of those protections and Government support.

Lawyers need to be alert to the risk of clients getting into deeper trouble. Now is not the time for directors to sit and wait. Failure to proactively tackle financial distress may result in increasing unsustainable company debt, risk of personal liability for directors and result in some restructuring options becoming more difficult to achieve.

What should directors of companies in financial distress be doing?

While each company’s circumstances will be unique, directors of companies in financial distress should, at a minimum, consider the following actions.

Directors’ actions

  • Ensure they are receiving timely and accurate financial information showing trading performance, financial position and forecasts of cash flow and trading.
  • Assess the financial position, trading performance and forecasts. As appropriate, seek advice from a fully briefed and appropriately qualified insolvency professional. This is particularly important if seeking to rely on the safe harbour provisions to gain protection from insolvent trading liability. See Using the safe harbour provisions to avoid insolvent trading.
  • Select advisers wisely, avoiding pre-insolvency advisers who may suggest engaging in illegal phoenix activity.
  • Prepare a plan as soon as possible to address the financial position of the company.  Directors should consider each of the main options outlined below. The plan should be regularly monitored and updated.
  • Hold regular board meetings and keep detailed minutes of matters concerning solvency, eg plans, meetings with insolvency practitioners and lawyers. Directors unable to attend meetings should keep themselves informed
  • Comply with the usual statutory and common law duties as directors, which include the duty to consider creditors when the company is insolvent or near insolvent.
  • Communicate with lenders and key creditors. Their support may be critical if the company is looking to undertake a consensual restructure, a debt restructure under the new debt restructuring process scheduled to commence from 1 January 2021 (if eligible*) or a restructure under deed of company arrangement.
  • Ensure employee entitlements are paid. Be aware:
    • that for eligible companies* wishing to undertake a debt restructuring under the new the debt restructuring process, regulations may require that employee entitlements that are due and payable be paid before the company may propose a plan to its creditors; and
    • that a specified level of compliance regarding payment of employee entitlements is a condition for the safe harbour protection from insolvent trading liability.
  • Review the company’s tax position and reporting obligations. Be aware:
    • that for eligible companies* wishing to undertake a debt restructuring under the new the debt restructuring process scheduled to commence on 1 January 2021, regulations may require that the company’s tax lodgements are up to date before the company may propose a plan to its creditors;
    • that a specified level of compliance with certain taxation laws is a condition for safe harbour protection from insolvent trading liability (noting that insolvent trading provisions resume operation on 1 January 2021); and
    • of potential personal liability of directors for PAYG, superannuation guarantee charges and GST under ATO director penalty notices.
  • Take appropriate steps to prevent any misconduct by officers or employees of the company that could adversely affect the company's ability to pay all its debts.
  • Don’t invest further personal funds in the company or give personal assets as security if the business cannot be salvaged.
  • Don’t transfer assets for less than market value.
  • Directors should not make preferential payments to themselves.
  • Check what personal guarantees directors may have given eg to lenders or suppliers.

What are the options for a financially distressed company?

Briefly, the main options for a company in financial distress are:

  • consensual restructuring outside of the formal insolvency processes, involving direct negotiation with individual creditors (if there is a risk of insolvent trading, this should be undertaken under the safe harbour provisions);
  • voluntary administration;
  • creditors’ voluntary liquidation, which will incorporate a simplified process for eligible companies* under reforms intended to commence on 1 January 2021; and
  • a new debt restructuring process for eligible companies* from 1 January 2021 as part of the reforms. (Note that eligible companies* waiting to access the new debt restructuring process will be provided with a form of temporary relief from director insolvent trading liability and in relation to statutory demands).

For further details about options, see Companies in financial distress – guidance and options for directors.

* The eligibility criteria will be set out in regulations, which have not been released at the time of writing. Initial indications are that companies with liabilities of less than $1 million will be eligible.

Contact your Relationship Manager for more in depth information on our Practical Guidance Insolvency module. Alternatively email or call us on 1800 772 772

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