What Is Business Restructuring?
Restructuring involves actions taken by a company or group of companies to reconstitute their balance sheet/s, function/s and inter-entity relationships with the object of increasing business efficiency, mitigating commercial risks and if appropriate, compromising unsecured debt. Examples include:
- Raising new investor capital to retire debt and/or increase working capital;
- Reducing debt and future liabilities under a compromise arrangement agreed by creditors;
- Disposal of non-core assets to free up cash;
- Reallocating core assets within group entities to rebalance commercial risks;
- Rearranging relationships between group entities to preserve asset value and mitigate risk in the event of adverse trading conditions;
- Creation of specific purpose entities within a group to spread commercial risks and lessen the impact of adverse events on the group.
In practice, corporate restructuring that involves a proposal to compromise unsecured debt should be undertaken in a formal manner under the supervision and control of an external administrator, through the use of statutory mechanisms such as Small Business Restructuring or a Deed of Company Arrangement. This is important for the reasons discussed below under the heading ‘Informal Restructuring’.
The Corporations Act provides three statutory regimes to facilitate corporate restructuring:
Schemes of arrangement are comparatively expensive, requiring court approval and extensive involvement by lawyers. They are normally only suitable for large restructuring arrangements involving substantial asset values and complex issues. Consequently, they are used infrequently.
As an SME focussed restructuring practice, we specialise in arrangements suited to SME businesses in financial distress, namely:
Single Entity Restructure
If the company is solvent
Restructuring of a solvent entity may be performed without invoking any form of external administration. Directors should not wait until insolvency is imminent before acting. The corporate structure should be reviewed and steps taken to mitigate commercial risks through appropriate restructuring at a time when the business is solvent.
However, it is often the spectre of insolvency that motivates directors to seek advice on restructuring options. Our focus on this page is therefore to outline the issues surrounding an informal restructure of an insolvent entity.
Asset transfers out of an insolvent company - possible, but be wary of traps
We have seen many cases where the directors of a financially distressed entity receive advice from an unqualified, untrustworthy and unregulated advisor, who arranges for assets to be transferred from the old insolvent entity to a new (solvent) entity controlled by the same directors, leaving creditors of the old company unpaid and abandoned. This is known as illegal phoenix activity and can leave the directors and the new entity exposed to substantial claims and penalties for breaches of the Corporations Act or other laws, both civil and potentially criminal.
Small business owners in financial distress are urged to avoid dealing with unregulated pre-insolvency advisors. These operators may sound confident and persuasive, but are often sloppy in their approach, making key errors in the formulation, documentation or execution of a plan. They are only interested in taking your money and have scant regard for the risks and exposures you may be unwittingly led into. Many such advisors have been bankrupt themselves on multiple occasions.
It is possible to legitimately transfer assets from an insolvent entity to a new (solvent) entity controlled by common directors, provided the process is expertly managed to minimise the risk of any breach of the Corporations Act. As experienced, regulated and insured practitioners, IRT Advisory is well placed to advise clients in relation to all such risks if engaged to undertake an informal restructure.
Informal debt compromise - a high bar to jump
Informal restructuring in which creditors are asked to voluntarily compromise their debts is likely to be problematic. A successful informal debt compromise arrangement requires the support of 100% of creditors. This may be possible if the number of creditors is small, but gaining 100% agreement across a larger body of creditors is likely to be difficult, particularly if relationships have soured. There need only be one unhappy creditor dissatisfied with the arrangement who issues proceedings against the debtor company, to render the compromise proposal unworkable.
An informal debt compromise proposal put forward by the company’s directors or advisor is unlikely to undergo the same level of scrutiny as that of an independent insolvency practitioner appointed as external administrator under the Corporations Act. Creditors may lack confidence in the information provided to them, with the offer not perceived as being subject to the same level of rigorous, independent review as a proposal recommended by a statutory appointee who owes fiduciary duties to the general body of creditors.
Importantly, in most cases the Australian Taxation Office will not support an informal scheme involving compromise of principal tax debt. In our experience, most companies in financial difficulty have unpaid tax debt.
For the above reasons, it is unlikely in most cases that an informal debt compromise scheme on a stand-alone basis will represent a workable approach. However, if engaged to act, we will consider whether such an arrangement is possible, as part of our assessment of the options available to you.
Restructure Into Multiple Entities
Restructuring the business conducted by a single entity into multiple, specific purpose entities can make sound commercial sense from a risk mitigation perspective.
As a general proposition, it is preferred that entities exposed to trade, payroll-related and taxation liabilities should not own fixed assets, brands, trademarks or intellectual property. A properly structured group can ensure the value in goodwill is effectively protected, so that should the operating entity encounter adverse trading conditions, the failure of that entity may not be fatal to the group as a whole.
We are well placed to advise our clients in relation to appropriate structures to minimise commercial and insolvency risks.
Risks To Directors Personally
Potential for breach of duty or other offences under the Act
Restructuring plans undertaken informally (outside a statutory mechanism) carry with them the potential for inadvertent breach of duty by the directors of the insolvent company. Invariably, this will occur when unregulated, unqualified and untrustworthy advisors persuade directors to enter into schemes that may have superficial appeal but expose the directors to claims and litigation from a future liquidator.
The more common of such claims include:
- Failure to act in good faith and in the best interests of the insolvent company;
- Use by the director of his/her position or available information to benefit the director while disadvantaging the company;
- Entering into uncommercial transactions designed to benefit related or friendly parties to the detriment of the insolvent company and its creditors; and
- Trading whilst insolvent.
As registered liquidators ourselves, we are well aware of the traps that dishonest, unregulated pre-insolvency advisors can lead their clients into. We bring our extensive knowledge and experience to each engagement to ensure as far as practicable, that the informal restructuring plans we recommend to clients do not result in directors breaching (or committing any further breach of) their duties under the Act.