Gareth Hoole: VA and earlier distress calls

COMMENT

The long-awaited Insolvency Law Reform Bill has finally emerged and addresses the equally long-awaited and much-debated topic of voluntary administration (VA).

It is a fact of commerce that some businesses will fail, even in times of economic strength and buoyancy. It is not disputed that in some such cases, where the state of the company has deteriorated beyond repair, the only logical outcome is liquidation.

However, as a liquidator, I will never find it easy to tell the staff of failed businesses that they no longer have jobs, no matter how often that unpleasant task is carried out.

All too often, one has to wonder whether the company and the jobs of its employees could have been saved through earlier intervention.

Voluntary administration provides for the appointment of an administrator who takes charge of the company and prepares a rehabilitation plan which is then presented to the creditors for their approval.

If that approval is granted, the administrator sets about implementing the plan, hopefully with an outcome which sees payment to the creditors and an ongoing venture, albeit possibly in a different form.

However, if a VA regime is to work effectively in New Zealand there is a need for a significant change in attitudes on the part of company directors, creditors and financiers.

A VA regime is more debtor-driven than the present alternatives of liquidation or receivership and this may encourage directors of troubled companies to acknowledge their distress in a more timely manner. They must recognise that the VA regime provides a viable mechanism whereby their company may be rehabilitated if they do not wait until it is too late before appointing an administrator, thereby resulting in more corporate rescues than we now see.

The key is early recognition by the board of the symptoms of distress and being prepared to put the company into the hands of an administrator before the point of no return is reached. Too many directors of ailing businesses fail to recognise the warning signs and acknowledge the need for specialist assistance.

Detractors of a VA regime have argued that the provisions of Part XIV of the Companies Act 1993 relating to compromises with creditors are strong enough to not warrant a new regime. Respectfully, it is submitted that those provisions seldom result in workable compromises which lead to the rehabilitation of a distressed business.

The main advantage of the proposed VA regime over the existing Part XIV provisions is that a moratorium period of at least 21 days is contemplated.

This means that the administrator will have a period of that length to properly investigate the affairs of the company in administration and to formulate a viable proposal for its rehabilitation.

The difficulty experienced by insolvency practitioners in relation to creditor compromises is that while the proposal is being formatted and prepared for presentation to the creditors, there is nothing to stop a creditor from taking precipitous action against the company. That action can result in the entire compromise being derailed.

From personal experience, it takes just a single creditor to do so.

Often, the action is based on anger and frustration and a desire to seek retribution through a liquidator.

Admittedly a liquidator has wide powers of investigation which may result in an action being brought against management of the debtor company for reckless trading. However, the statistics show that liquidations seldom result in significant distributions to unsecured creditors and actions to hold directors liable for losses personally are the exception rather than the rule.

Where there is any prospect of a better economic return to the creditors through a compromise or VA than through a liquidation, creditor pragmatism should prevail. Statistics from across the Tasman indicate, generally, a better result from a creditor perspective in administrations than is usually achieved by liquidations.

For a VA regime to work, creditors will need to be prepared to allow administrators to work through a rehabilitation plan and accept that a dividend on the dollar and an ongoing business is preferable to vindication and a moral victory but a poor financial outcome.

Other stakeholders in distressed companies who will need to consider different views are financiers.

In the US, where Chapter 11, their equivalent of a VA regime, has been in place for many years, a great deal of its success is attributable to innovative and flexible financing options. While it may seem to be a tough call for a banker or financier who is exposed to a distressed company, continued financial support provided to the company's administrator could make the difference between success and failure.

Traditional banking practices may need to be reviewed, with a move towards North American and European trends of debtor-in-possession funding or asset-based lending.

Naturally, financiers will need to preserve their own positions but for a VA regime to succeed there is likely to be a need for innovative financing options to be made available to administrators to ensure ongoing survival of the company, at least in the short term.

On the whole, therefore, a VA regime as proposed by the draft bill will be a welcome innovation, providing a more robust means of giving distressed companies an opportunity to rehabilitate. But it will require a change in some deep-seated attitudes and approaches by those affected in insolvency scenarios.

If even a few jobs are saved every year by a VA regime, it will have served a very useful purpose.

* Gareth Hoole is a director in the Corporate Recovery Services Unit of Staples Rodway, Auckland. The views expressed are his own and not necessarily those of Staples Rodway.