Many businesses have been significantly impacted by the Covid-19 pandemic. This may have resulted in them accruing unmanageable debts, such as tax debts, deferred finance or lease payments and debts to trade creditors. A lot of these businesses will return to profitability. However, it will not be possible for them to make sufficient future profits to pay off the unpaid debts they have incurred. The options for businesses impacted by Covid-19 include voluntary administration or a legal phoenix arrangement.
Example of Businesses Impacted by Covid-19
An example of the financial position of a business which has been impacted by Covid-19 is:
The owners of this business may think it can trade profitably in the future. However, they don’t know what future profits will be and whether or not they will be sufficient to:
- Pay a reasonable amount to the business owners via a salary or other distributions; and
- Pay down the businesses’ accrued debts over a reasonable period of time.
Covid-19 – Legal Phoenix Transactions
A phoenix transaction involves the sale of assets from an insolvent company to a related entity. The new entity is then able to continue trading without the burden of historical debt. The old company will then ultimately be placed in liquidation.
A sale of a business or assets done properly will not result in a director breaching his or her duties. Nor will it give rise to claims by a future Liquidator. Even the ASIC recognises this and their publication regarding phoenix activity includes advice that:
Where a director has responsibly managed a company and it subsequently fails, they can operate the same business using another company without engaging in illegal phoenix activity.
There are various matters which must be considered to ensure a business sale is properly transacted, however, some key issues are:
- Stakeholders need to consider what part(s) of the old business the new company is acquiring. As not all parts of the old business may be profitable.
- The sale of assets must be transacted for fair value, which will require the assets and any goodwill being valued.
- Certain debts assumed by the new entity may be able to be credited against the sale price. This may include employee entitlements and secured finance obligations.
- The entity selling the business must use the sale proceeds received appropriately.
- If the insolvent company is placed in liquidation consideration needs to be given as to whether there will there be any residual liabilities for the company’s directors such as claims for personal guarantees or claims by the ATO pursuant to director penalty provisions.
Using the above example, the company’s assets including any goodwill could be valued by independent parties and a new entity set up which would then purchase the assets for proper value. Where assets are financed, the purchase price for them can include the new entity taking over any finance agreements or obtaining refinance.
Company directors considering a sale of a business to a related entity, should obtain professional advice regarding how the transaction can be entered into legally, as if a business sale to a related entity is not done properly a director could be breaching their duties and the transaction could result in claims being pursued in the future by a Liquidator of the failed company.
Covid-19 – Voluntary Administration
To overcome the financial effects of Covid-19, voluntary administration can be an effective solution.
A company can appoint a voluntary administrator with a view to a proposal to creditors for a Deed of Company Arrangement (‘DOCA’) being put forward to settle debts and return control of the company to the directors.
In some circumstances a voluntary administration can be an effective way of a company dealing with financial problems. This can result in the company being able to continue trading profitably in the future. However, there are a number of possible problems and risks associated with the appointment of an administrator to a company which need to be considered including:
- There can be significant costs associated with the appointment which can impact on the company’s ability to continue to trade and limit the funds available to put forward a proposal for a DOCA.
- In a lot of cases, the funds required for a voluntary administration and DOCA, will be significantly greater than the amount required to transact a business sale via a legal phoenix transaction.
- A company’s existing clients and suppliers will be notified, or become aware of, the appointment of an administrator. This may affect existing relationships.
- Even if the voluntary administration and DOCA process is successful, the company’s directors can still be left with personal debts. These debts can include claims under personal guarantees or pursuant to director penalty provisions.
It is therefore important to obtain proper advice prior to proceeding with the appointment of a voluntary administrator. This includes advice regarding the estimated costs and future risks involved with that type of appointment.
How We Can Help
Pearce & Heers is here to help with advice, assistance and solutions to help you overcome the financial effects of Covid-19. This includes advising and assisting with legal phoenix transactions or the voluntary administration of a company. So, please get in contact with us today for a free, no obligation initial consultation.