The Case for Voluntary Administration
Why taking early action is the better option when insolvency becomes a very real possibility.
Voluntary Administration was adopted into New Zealand law in 2006. However, the number of voluntary administrations that occur in this country represent only a fraction of the insolvencies. When faced with a situation that threatens the very existence of their company, directors are often overwhelmed and confounded by the options at hand. It is only when all parties have a clear understanding of the far-reaching effects of liquidation that we may start to see the preference for Voluntary Administration increase. We take a look at the benefits of Voluntary Administration and why you would choose it over liquidation.
Businesses are expecting to see difficult times ahead – the pandemic aftermath, supply line constraints, embattlement in Europe, climatic change consequences, interest rate increases and rising prices. All are on the horizon. Any one of these has the potential to be an existence-threatening event for a company. Although such unfavourable circumstances are not usual, adversity of some kind is typical. The reality is that unpredictability is a feature of business.
A company director’s role: Seeing into the future and expecting the unexpected
Directors are required to seriously consider what tomorrow might bring. If corporate failure should occur, directors will be judged by how well they undertook the task of anticipating the future. In a liquidation, the directors’ decisions will be held up against a notional standard of what another person would have done – with the same facts and at the same time. This test establishes something of a benchmark for the director to measure up against, but in my view, it falls a long way short of reality. All the subtleties and nuances that existed at the time, will not feature in the judging analysis.
Surprises around the corner and the expectation that directors should know and plan for all possibilities adds complexity and risk to a company director’s role. As complexity goes up, friction costs increase. These, in turn, load a cost burden on the profit-generating resources. This initially strains liquidity but then cycles back to cause more friction. This vicious cycle is benign in its early stages but if left, the effects accelerate and become more dominant. Eventually organisation-wide congestion results and the only solution is intervention and recalibration.
A business will inevitably confront a difficult patch during its life. The critical question is what should be done in that situation. In New Zealand, the formal insolvency processes that can be called upon are found in Parts 14 and 15 of the Companies Act. They are;
- Part 14 Scheme of Arrangement
- Voluntary Administration, and
There are informal processes also, for example, ad hoc workouts with selected creditors, but they typically only play around the edges of the symptoms and do not address the underlying issues.
Insolvency options in New Zealand
The Voluntary Administration regime builds upon the more flexible Part 14 Scheme of Arrangement by overlaying a model law that frames the same level of flexibility with enforceable elements that are powerful in a restructuring process. Although a Part 14 Scheme of Arrangement has the greatest degree of freedom it must be sanctioned by the High Court. VA on the other hand has comparable flexibility but does not require court approval. The legislation presumes that the affected creditors can resolve in a manner that is in their best interests without the necessity for Court involvement. Ultimately, the facts of the commercial situation will help to decide the best choice of law.
Restructuring models have not featured strongly in the New Zealand landscape. Voluntary Administration was adopted into law in 2006 but its use represents only a small fraction of the insolvencies initiated in New Zealand. The most likely explanation is the low understanding of the tools available to reconstruct the business affairs of the company. There is clear evidence of an international trend to implement recovery strategies to save the business rather than ignore the signals and hope that survival can continue to exist on the back of grit and determination.
Voluntary Administration: An alternative to liquidation
Voluntary Administration should be thought of as an alternative to liquidation – something done to save the business. It doesn’t seem that such a way of thinking would be controversial when a company is confronting an existence-threatening circumstance. What gets in the way though is the notion of control. Directors are naturally sensitive about getting someone in when this may evolve to passing control to a person they have only just met.
A way to approach this natural reservation is to address the issues in an organised way. The first step is to have the needs defined (in the context of a restructuring plan) and then have solutions identified with objectives described. When this is on the table there is something that can be looked at and considered. Additionally, the process will provide a sense of clarity and a road map toward a better outcome than the one currently being confronted.
Bringing in the administrator: 6 ways Voluntary Administration provides a chance at survival
The VA model is passive law, but when coupled with a competent administrator and willing directors, it comes alive. It is particularly powerful when it is used to address existence threatening business situations. Six significant features to assist in that outcome are described below.
- Enabling Voluntary Administration law
The objective of VA law is to avoid immediate liquidation. Creditors will feature in this situation and will need to be consulted. Voluntary Administration provides the forum and processes to facilitate negotiation and settlement with creditors so that the affairs of the company can be reconstructed through a binding recovery plan.
- Director engagement: Restructure over destruction
Directors are vital to the reconstructing process being successful. The appointed Administrator does have ultimate control, but engagement and participation from the directors is essential if any sense of recovery is to be achieved. The Administrator is an additional team member that will bring skills on reconstruction in insolvency circumstances – the job of the Administrator is not to displace current management but to provide solutions and work them out through the current management structure.
- VA moratorium: Creating breathing space
Relief commences immediately an appointment is made. Creditor action (except for secured creditors having a general security agreement) is stayed for twenty working days while a recovery plan is developed. The moratorium provides much-needed breathing space so this process can evolve without threat of disruption by creditors. The moratorium can be extended with Court consent on the merits of the need.
- Guarantees stayed
Guarantees cannot be called upon during the VA period. It is normal to have shareholders and directors act as guarantors for their company. VA law recognises that there is little point in exposed guarantors passing the baton for the company and then being pursued in their personal capacity for the same debt. Guarantors are safe from action during the VA process.
- De-escalation and diplomacy
Unsecured creditors will be exposed and likely have a strong view of the circumstances they have unwittingly been caught up in. To this potentially hostile situation the Administrator should bring moderation and objectivity. This should result in a reconciling perspective so that the focus comes upon on business recovery. The outcome for the creditor may not be as it would be wished, but the facts are known now, and sensible decisions can be made when considering them.
- Smart steps to director risk mitigation
Appointing an Administrator is a risk-mitigating step for directors. The law recognises an appointment made by a director as a responsible action to take and will avoid any creditors’ claims from the appointment date forward. Recent Court decisions suggest that directors must be mindful of the risk to personal exposure.
Voluntary Administration will not be for every company experiencing economic challenges. But if harsh and unyielding creditor pressure is threatening the survival of a potentially viable business, then it is the option to consider.
Bryan Williams of BWA Insolvency is a Registered Insolvency Practitioner specialising in Voluntary Administration.