Explaining the Voluntary Administration process

Written on the 23rd of August 2010 by Fiona Taylor & Richard Hughes

With the recent increase in insolvencies and some industries faring poorly, it is perhaps timely to explain the Voluntary Administration process.

The voluntary administration process was covered by one of the joint liquidators of the Kleenmaid Group (the largest retail franchise collapse in Australian history) and Partner at Deloitte, Richard Hughes at our Franchise Forum 2009.

He explains:

• The voluntary administration process
  
• Why companies use voluntary administration
  
• The difference between voluntary administration and a receivership
  
• What happens at the start of the voluntary administration process
  
• The aim of the voluntary administration process
  
• The effect on stakeholders during the voluntary administration process
  
• Possible outcomes of voluntary administration
  

 

What is the voluntary administration process?

 

In short, the voluntary administration process allows a company experiencing cash flow or solvency problems breathing space from its creditors to restructure.

It is generally a short period of approximately one month, whereby the directors hand control of the company to an independent administrator.

In that month, the administrator secures and protects the assets and assesses the business to provide a recommendation to creditors on whether they should:

1. Liquidate the company, or
2. Execute a deed of company arrangement (DOCA) – meaning compromise the debts in some way and allow the company to continue in existence, or
3. Return the company to the control of the directors.

Importantly, the final decision on the future of the company rests with the creditors.

 

Why do companies use voluntary administration?

 

Voluntary administration is used regularly by companies in distress, principally because directors are required to take steps to avoid trading whilst insolvent – and trading whilst insolvent can attract severe consequences.

Voluntary administration is specifically used as one of the major defences to insolvent trading in that the director took steps to avoid incurring debt and appointed an administrator.

It is a criminal offence to knowingly incur debts whilst insolvent. The maximum criminal penalty is two years in jail and a $250,000 fine.

In addition, a liquidator can pursue a director for insolvent trading resulting in the amount of the debts incurred after the point of insolvency being paid by the director personally, back to the creditors.
 

What’s the difference between voluntary administration and a receivership?

 

To initiate the voluntary administration process administrators are generally appointed by the directors by a board resolution, to take control of the company and represent all creditors’ interests.

A receivership is where a bank or a secured creditor appoints a receiver to recover assets on its behalf.

The principal duty of a receiver is to the secured creditor and he or she does not represent all creditors (all though there are some important safeguards to protect the other creditors).

Importantly, the voluntary administration process allows for a moratorium period whereby creditors, landlords, stock suppliers, personal guarantee holders and most other stakeholders are statutorily barred from taking action against the company until the voluntary administration is complete.

This can be particularly useful, for example, where a landlord on a retail business attempts to evict the tenant, thus severely devaluing the assets available for creditors.

During voluntary administration, generally, a landlord would need to wait until the conclusion of the voluntary administration period before taking action under a lease. Receiverships have no such moratorium period.

 

What happens when a company starts the voluntary administration process?

 

The administrator takes control of the company and the directors lose their power to contract on behalf of the company. The debts of trading incurred after the appointment of an administrator then become the personal liability of the administrator.

The administrator has a priority for those debts out of the assets of the company, however, administrators are very cautious about trading if it appears that by doing so substantial losses will be incurred, or they will exceed the assets available to them.

The administrator also communicates with all stakeholders at the start of the voluntary administration process, and advises them of the appointment and the steps they should take to make a claim on the assets of the company.

 

What is the aim of the voluntary administration process?

 

Most restructures prior to the enactment of the voluntary administration regime were attempted outside of an insolvency procedure.

As a result, Australia generally had a poor record of restructuring businesses what would otherwise be quite viable businesses as it was always difficult to bind all creditors to the arrangements, and the directors were exposed to insolvent trading.

The voluntary administration process was enacted to allow companies more companies to restructure and survive. It is intended to give the company a short period to restructure without having to deal with the demands of creditors, landlords, suppliers and other claimants.

The aim is to allow companies to restructure and return to health without the need to go through a painful liquidation process.

Any restructure via a DOCA is binding on all creditors, as long as the majority are in favour and hence a small creditor cannot hold the restructure to ransom to advance their interests, as was the case prior to the voluntary administration regime.

 

What is the effect on stakeholders during the voluntary administration process?

 

There’s a number of effects on suppliers, landlords, creditors and other stakeholders.

Generally, all action to recover debt, or possession of assets is frozen, pending the resolution of the administration process

• If you are a creditor your debt is frozen pending payment from assets realised or from any deed that may be proposed
• If you are a landlord you generally cannot take action to evict the administrator of the company during the voluntary administration period, unless that action has already commenced
• If you have supplied stock under a Retention of Title arrangement you cannot seek to repossess those goods (although your claim is taken into account by the administrator)
• Banks cannot exercise any rights under their security after a certain period

 

What are the possible outcomes form the voluntary administration process?

 

The company’s destiny is in the hands of the creditors. The administrator recommends the course, however, the creditors are the body with the ultimate power to vote the resolutions at the meeting.

There are three possible outcomes that the creditors can resolve:

1. The company can be returned to the directors – however, this rarely occurs in practice and generally would only be if for some reason the company was solvent.
2. The second is liquidation. If the company is insolvent and there’s no other option, or if there is a deed, but it does not provide for a superior return than liquidation, companies will often go into liquidation.
3. The third possible outcome is a Deed Of Company Arrangement (DOCA). A DOCA is a compromise of the debts due by the company. It is a very flexible arrangement, and as a result, the possible arrangements put forward are many and varied. For example, the following types have been regularly used in practice:

• Payment of a lump sum to meet all debts due
• Payment of a series of instalments
• Trading and paying either instalments from profits or a lump sum from final sale
• The sale of an asset and payment of proceeds (which may not be known)

DOCA’s have also been used to re-list insolvent companies on the ASX.