What are the options you have when your Company is in financial distress?

What are the options you have when your Company is in financial distress?

COVID-19 has had a vast impact upon Global economy and our Australian economy at home, with small to medium sized businesses being some of the ones who have been most effected having to be forced to shut for up to three months with very limited income, or without income at all. Whilst the Government has provided various businesses with economic stimulus packages to keep afloat, in many instances it has not been enough.  If your company has been impacted financially due to COVID-19, this article will provide you with information as to some options to consider for your company including the closing, liquidation, or restructuring of your company.

Your company may have various creditors seeking payment from you and you simply no longer have the ability to pay those creditors even in the near future, once the pandemic passes. As such, you may be considering placing the company into liquidation or administration or simply considering to de-register. It is a director’s duty to ensure that, amongst other things, they act in good faith, avoid conflicts of interest, exercise director powers for a proper purpose, and retain discretion and to exercise reasonable care, skill and diligence. Acting in this way includes ensuring the company does not trade whilst insolvent. While the safe harbour provisions under Section 588GA of the Corporations Act 2001 (Cth), provide some protection for directors who incur debt of the company, due to directors taking a course of action that would lead to a better outcome for the company, one of the options foreshadowed below may be viable to you to avoid breaching the directors duties, if the safe harbour protection provisions do not apply to you.  If you are unsure as to whether you have breached your director’s duties or whether the safe harbour provisions apply to you, see our article “Temporary Changes to Safe Habour Provisions” by Kate Witt HERE.

Voluntary Administration

Voluntary administration may be a viable option for your company if there is a prospect to resolve the company’s existing financial distress with a view to continue to trade in the future. The appointment of a voluntary administrator may be affected by either a secured creditor, a liquidator (or provisional liquidator), or most commonly, by a resolution of directors that the company is insolvent, or likely to be insolvent. In these circumstances, the appointment of a voluntary administrator will place the company’s future in the hands of an external professional and qualified person to take carriage of the company’s financial affairs and navigate the period of financial distress.

The main benefits of voluntary administration for the company may be some or all of the following:

  1. Avoiding liquidation and closing the business long term;
  2. Allowing the administrator to assess and put in place a viable plan for the company for the benefit of the company and its creditors, which ultimately relieves the stress of the director having to do this;
  3. Allowing the company to continue to trade and derive an income;
  4. Provide a return to creditors whilst the company continues to trade;
  5. Reduces the possibility of secured creditors enforcing their security against the company while the company is in voluntary administration.
  6. If voluntary administration is approved, there is a possibility that any alleged insolvent trading carried out by the director, may be eliminated;
  7. At the end of the voluntary administration, the creditors can decide as to the future of the company by voting on the following options:
  • Allowing the director to return to take control the company so that the director can continue carrying on the business; or
  • accept a deed of company arrangement which will particularise repayments of debts owed by the company to creditors; or
  • place the company into liquidation.

Upon the appointment of a voluntary administrator, within 8 days the administrator must hold a first meeting of creditors whereby creditors can vote at the meeting to place the administrator and/or create a committee of inspection. The second meeting of creditors is to take place within 25 days of the appointment where the creditors may make a decision as to the future of the company taking into consideration the options referred to in item g. above. Many companies which enter voluntary administration are able to survive and carry on after the period of administration which makes voluntary administration an appealing option for many directors of companies which are suffering from existing financial distress but have an opportunity to continue to trade long term with good assistance and planning.

Director Initiated Liquidation

If voluntary administration is not a viable option for your company as there may not be future prospect for continual trading of the company, appointing a liquidator to your company will mean that you place the company in the hands of a qualified person to take control and attend to the orderly winding up the company in a fair way for the benefit of all creditors to the company. A director-initiated liquidation will generally a require calling a meeting of members (also known as shareholders) to vote on the winding up of the company and the appointment of a liquidator.  Upon the winding up of the company, it is important for the director to understand that upon the winding up, the director no longer has control over the company and that the liquidator has the power to:

  • carry on the business of the company so far as its necessary for the beneficial disposal or winding up of the business;
  • collect, protect, sell / realise assets of the company to pay creditors;
  • investigate and report to creditors as to company’s affairs;
  • make inquiries as to the reasons why the company has failed. This may include making inquiry with the director, or pursuing the director for breach of directors’ duties;
  • distribute any proceeds recoverable in the liquidation.

The liquidator has a number of legal obligations upon being appointed and it is likely the liquidator will require the director’s assistance in being able to fulfil these some of legal obligations. Accordingly, it is important that directors comply with the liquidator’s requests as to the affairs of the company and producing the company’s books and records, otherwise there may be serious penalties, including fines and criminal charges.

Deregistration

An alternative to the above external administration options, if you are in a position where you do not have any creditors, and are simply seeking to close your company you may be considering to voluntarily deregister to your company with Australian Securities Investments Commission (“ASIC”). In order for you to apply to de-register your company with ASIC, the company must meet the following criteria:

  •  all members have agreed to the deregistration;
  • ensure the business is no longer being conducted;
  • have company assets less than $1000;
  • have no pending legal proceedings;
  • declare that there are no creditors to the company (including employees);
  • have no outstanding fees owed by your company to ASIC.

upon confirmation that the company meets the above criteria, you may seek to apply to ASIC for de-registration. ASIC will review the application and process it upon being satisfied that the company fits the above criteria.

The consequences of all types of external administration and/or the deregistration process differ depend upon whether the company is placed into voluntary administration, liquidation or is deregistered, some of which may be consequences imposed upon the directors themselves and can include suspension of directorship, fines or criminal penalty. As such, it is important to obtain independent legal advice and financial advice prior to considering the options foreshadowed above, to ascertain the best option for you, the creditors and the business.

How we can help you

JHK Legal regularly assists various companies in financial distress and with our vast range of expertise having acted for both companies and directors and insolvency practitioners, we can facilitate a legal pathway for you and the future of your company. If you require assistance in relation to determining your company’s future, please reach out to the JHK Legal team.

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Written by Hayley Tibbie, Associate

Another win for Small Businesses: Bendigo Bank’s contract terms are declared “unfair”

The November 2016 amendments to Schedule 2 of the Competition and Consumer Act 2010 (Cth) (“ACL”) to extend the definition of “unfair contract terms” to apply to small businesses has again provided for the necessary protections it had set out to achieve in the recent matter of ASIC v Bendigo and Adelaide Bank Limited [2020] FCA 71.

Previously, we wrote on the applicability of the ACL and small business contracts to leases – which can be found here. As discussed, a small business can rely on this legislation if they have entered into a “small business contract” in circumstances where:

  • At least one party is a business that employs less than 20 people – whether that be you or the other party;
  • Upfront price payable does not exceed $300,000, or does not exceed $1,000,000.00 if the duration is more than 12 months; and
  • The contract is a ‘standard form contract’.

The ACL is specific to ‘standard form contracts’ in the areas such telecommunications, utilities, travel industries or commercial leasing.

More specifically to financial products, the Australian Securities and Investments Commission Act 2001 (Cth) (ASIC Act) applies to the provision of financial services including consumer contracts and contracts for credit facilities. Section 12BG(1) of the ASIC Act, states that that a term of a contract will be deemed as unfair where:

  • it would cause significant imbalance in the parties’ rights and obligations arising under the contract; and
  • it is not reasonably necessary in order to protect the legitimate interests of the party who would be advantages by the term; and
  • it would cause detriment (whether financial or otherwise) to a party if it were to be applied or relied upon.

Of note, from October 2021, the unfair contract terms regime under the ASIC Act will also apply to insurance contracts under the Insurance Contracts Act 1984 (Cth).

ASIC v Bendigo and Adelaide Bank Limited [2020] FCA 71

In ASIC v Bendigo and Adelaide Bank Limited [2020] FCA 71, ASIC brought proceedings citing concerns that Bendigo and Adelaide Bank Limited (Bendigo Bank) held as many as 15,529 non-compliant loans with values of under $1 million dollars which included bank guarantees, overdrafts and general commercial loans.  While Bendigo Bank acknowledged that the terms were unfair and that Bendigo Bank had not relied any of the relevant terms in a manner that was unfair or caused any borrowers to suffer loss or damage, ASIC chose to pursue for declaratory relief.

ASIC summarised their concerns for small businesses in a statement on 29 May 2020 – “Small businesses, like consumers, are often offered contracts for financial products and services on a ‘take it or leave it’ basis, commonly entering into contracts where they have limited or no opportunity to negotiate the terms. These are known as ‘standard form’ contracts. Small businesses commonly enter into these ‘standard form’ contracts for financial products and services, including business loans, credit cards, and overdraft arrangements.”

Justice Gleeson held, amongst orders to replace provisions contained within the contacts, that Bendigo Bank provide an undertaking to the Court that they would not use or rely upon the provisions.

There were four contentious types of clauses that were considered by the Federal Court:

Indemnity Clauses

Clauses of this nature is where one party (the Borrower) provides an obligation to another party (the Lender) to compensate for any liability, loss or costs arising out of the contact.

The Court considered in this matter the relevant clauses were unfair:

  • as they could cause detriment to the Borrower if applied or relied on by the Lender;
  • as it created a significant imbalance of parties’ rights and obligations in circumstances where:
    • there were no corresponding rights of indemnity provided to the borrower; and
    • the Borrower had no control over the costs that could be incurred and the Lender could control some (if not all) of the circumstances where costs may be incurred;
  • there was limited to no transparency within the terms – ie “legal expenses on a full indemnity basis” and contained numerous cross-references to other terms; and
  • as there was nothing else in the contract to mitigate the unfairness.

Event of Default clauses

This type of clause set out events or circumstances that would constitute a default by one party (the Borrower) and the acts which the other party (the Lender) can take as a result of the default.

In this matter, the Court considered the event of default clauses to be unfair as the clauses created a significant imbalance of parties’ rights and obligations where:

  • the consequences were disproportionately severe to the default;
  • they did not provide the borrower with an opportunity to remedy any default (where a default can be remedied);
  • the event of default does not create any detrimental credit risk to the lender;
  • there was nothing else in the contract to mitigate the unfairness; and
  • the clauses could cause detriment to the Borrower if applied or relied on by the Lender.

Unilateral variation or termination clauses

Where by one party (the Lender), without the other party’s (the Borrower’s) consent can vary the terms of the contract or terminate without notice.

These clauses were considered unfair as they created a significant imbalance of parties’ rights and obligations in circumstances where:

  • insufficient notice period would be granted to the borrower where the lender seeks to reduce the amount of funds available to them under the facility;
  • the clauses allowed the Lender to vary the terms without consent and no corresponding rights were afforded to the Borrower;
  • the lender was able to terminate the contract if the Borrower did not accept new varied terms, or the Lender would need to pay fees if elected to terminate;
  • there was nothing else in the contract to mitigate the unfairness; and
  • the clause could cause detriment to the Borrower if applied or relied on by the Lender.

Conclusive evidence clauses 

In these clauses one party (the Lender) has the ability to provide a document (usually in the form of a certificate) to the other party (the Borrower) which states the amount outstanding under the contract and that no further evidence is required to substantiate same. It places the evidential burden of disputing the debt on the Borrower.

It was decided these clauses created a significant imbalance of parties’ rights and obligations in circumstances where:

  • the evidential burden is placed on the borrower to provide the primary evidence and, when disputed, there needs to be evidence of a manifest error;
  • the clause could cause detriment if the certificate issued was incorrect and there was no way for the Borrower to disprove it;
  • there were no corresponding rights afforded to the Borrower; and
  • there were additional duties imposed on the lender.

JHK Legal regularly act for both lenders and small businesses in providing advice on unfair contact terms contained in standard form loan agreements. This determination in particular, provides a timely reminder to lenders providing financial accommodation to small businesses to review their contracts in light of the Court’s findings and the possible financial sanctions that could be imposed by ASIC in the event their terms are read to be unfair. Similarly, if you are a small business who have entered into, or looking to obtain finance, please reach out to the JHK Legal team to obtain advice on your rights, interests and obligations and the enforceability of the loans by the lender.

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Written by Isabella Matassoni, Associate