Insolvency in Business

The next two years will represent one of the most challenging times for Australian businesses.  We need to consider a different approach to dealing with customer insolvency in a way that preserves or grows our own business.

In short, it costs five times more to acquire a new customer than to retain a current customer, so why when a customer gets into financial difficulty, do we move to write them off immediately?

While insolvency might be inevitable for many businesses, the outcome is not, and the collapse of one business often causes the collapse of two or more of its suppliers.

Unfortunately, most insolvency advice is designed for directors on how to use business turnaround services, not for creditors on how to get the best outcome, and if creditors can maximise their own outcomes, then the domino effect of business failure ends.

The problem is that the majority of trade creditors act as passive participants, the voluntary administration process is confusing, and they rely on the Administrators Report, which is historical and only provides a return at a fixed point in time.

So here are the five things we tell creditors, as a business advisor:

1. Take the emotion out of the process, be angry, that is fine, but understand that only 1 in 10 failures are the result of fraud, the other 9 are poor management decisions.  We all make poor management decisions at some point.
2. Work out the cost of the loss, not the profit but the hard costs and labour, and compare it to what you have made in the last 12 months off the same customer – put the loss in context.
3. At the first meeting of creditors, read the attendance register.  The attendance register lists the creditors by amount, and at the meeting talk to as many of them as possible.  Just ten creditors working together can negotiate a better deal or block a bad one.
4. At the first meeting encourage the directors to put forward a deed proposal, you don’t have to accept it, but it sends a message to the Voluntary Administrator and the directors, that you support a restructure if the benefits of it drive your future growth – focus on the opportunity, not the loss.
5. Talk to the directors about on-going supply arrangements, negotiate better rates, and larger order values if the deed proposal is accepted.  Look to the future.

But in order to make an informed decision, creditors need to be able to understand what they are being told, and what they are not being told in the Voluntary Administrator’s Report.

So here is what we say about reading an Administrator’s report:

1. Ignore the recommendation – at least at first and go to the tables in the annexures and look for the table showing the return to creditors.  This table tells you where the realisations will come from and what the total creditor claims are and the expected dividend under company liquidation and the offer. Average returns in liquidations are often less than 10%.
2. Be mindful of dividends driven by litigation – If the liquidation value is largely made up of realisations from litigation, then creditors should beware. The average time to complete litigation once an action is commenced is 18 months – 2 years, and depending on the value the minimum legal costs will be at least 25% of the value of the claims.  At the end of the day, there is no certainty that the claim will be successful.  Litigation claims also need to be funded, and if there are no assets in the company, then this will be either creditors or a litigation funder which will further reduce the recovery, as both will ask and are entitled to claim a higher return or a fee often 40% of the net recovery.
3. Vote against preference recoveries – Look at the value attributed to preference recoveries.  Preference recoveries are monies paid to creditors in the six months prior to the appointment of the Administrator and which may be recovered by a Liquidator.  The basis of preference recoveries is to even the recoveries between creditors, but ultimately pay the Liquidators fees.  Administrator Reports don’t disclose who received the alleged preference, but this may result in the dividend in a liquidation being derived from monies being recovered from creditors.  Creditors who have received preferences should always vote against liquidation.
4. You are always better off with the customer you know – If the Administrator is contemplating selling the business, what does this mean for creditors with respect to on-going supply agreements and future orders.  If the purchaser is to a competitor, then the future value will be limited. In this respect, we think that Administrators should always seek approval or advise creditors of an intended sale before the second meeting.
5. Dividends in liquidation have no future value – The Administrators Report is a point in time return, it does not take into account the benefits to individual creditors or the future value of the on-going business, or the time value of the distribution. 

Creditors should always vote in their interests, but they should see insolvency as a way to understand their customers better, improve their profitability, and grow their sales.

There is no better certainty that a company is solvent than one that has had its debts settled through a deed of company arrangement and a moratorium.

If you’re a creditor of a business that requires voluntary administration services, contact us today for an obligation-free consultation with one of our specialists.

Read next: Olvera’s 5 tips to building business resilience