Martin: Welcome to the business owners podcast where we throw aside taboos and share strategies for growing, protecting and exiting your business. My name is Martin Checketts and I represent Mills Oakley’s Private Advisory Team.
Welcome everybody we’re now at the final episode of season 4. So as you’ll recall, in this season we’re interviewing some of the very best lawyers that Australia can provide, aka my fellow partners at Mills Oakley. And I’m delighted this time to be speaking with Ariel Borland. Welcome Ariel.
Ariel: Thank you Martin, thank you for having me.
Martin: Oh not at all. So just a quick introduction in relation to Ariel. Ariel is a partner in Mills Oakley’s insolvency team. We’ve got a very strong insolvency team at Mills Oakley. And whilst it might sound a little bit ghoulish it’s not about all kind of picking over the skeleton of the corporate carcass. Our team does a lot of wonderful work, both in advising directors and shareholders and helping in the pre-insolvency period and hopefully avoiding that situation. But also of course the contentious matters when things go wrong, and also acting for creditors of insolvent companies. And in the Private Advisory team we work very very closely with Ariel and our team for our clients in relation to all of these matters. So Ariel it’s lovely to have you here.
Ariel: Thank you Martin.
Martin: So hey Ariel, say if I bought a house for like $1 million and I borrowed $1 million to buy it. And then say if the valuation went to say $900,000 in the GFC or whatever, does that make me insolvent?
Ariel: Thankfully no it does not. You may have some balance sheet issues if that happened but provided you still had your job and were able to pay your mortgage and other debts as they came up you would still be happily solvent, although unhappily have your house worth slightly less than it was when you bought it. (Martin and Ariel laugh)
Martin: Yeah, and that light hearted example goes to a really important test doesn’t it Ariel, because it goes to the Corporations Act definition of whether you are or whether you are not insolvent. Can you talk to us about that?
Ariel: Yeah sure. So the Corporations Act, it applies a test that’s called the cash flow test which quite simply is whether a business or you personally can pay your debts as and when they fall due. It can mean that you can be balance sheet solvent, as in have a lot more assets than you do liabilities. But if they’re not liquid and not able to be sold readily you might have some solvency issues and whether they’re long term issues or issues that can be worked through reasonably quickly is what the Court generally looks to. But its normally whether you can pay your debts as and when they fall due.
Martin: Yeah so it’s a cash flow not a balance sheet type of test.
Martin: So Ariel, most directors of private companies I think would be acutely aware of their duty not to trade whilst insolvent.
Martin: And I know that a lot of the work that you do would be around advising directors as to whether or not they’re at that point.
Martin: Could you give me some comments about that?
Ariel: Yeah, so, I mean it is, you’re right Martin that it is a tricky issue for directors because it’s one of the few areas where the corporate veil can be pierced and directors can become liable for debts that are incurred by the company. So, ordinarily they wouldn’t be but if the company they’re a director of is not able to pass that cash flow test there’s a possibility that it’s insolvent. Well, it would normally be insolvent but if it’s a short term issue of you know a few weeks, that’s not an issue. But if it’s a long term thing that’s going on and there’s no solution on the horizon that’s when directors really need to consider carefully about what they should be doing.
The liability is only for debts incurred during that period. So one of the things we often advise directors to do is make sure they’re keeping up to date with their current debts.
Ariel: And are maybe putting some of the older debts on payment arrangements and those types of things to make sure that payments are getting deferred and by agreement with creditors. So that way the cash flow test is going to be satisfied and the directors exposure for debts incurred whilst there’s maybe a liquidity problem is minimised.
Martin: That’s such an important point I think for business owners Ariel. Let’s unpick that a little bit. So yeah, first big message is that it’s only the personal liability for the debts of the company and that’s a massive kind of scary spectre for directors. That’s only the debts that are incurred during the period of trading insolvently.
Ariel: Yes, so, if you think you’ve got a potential solvency issue your liability is really restricted to the fresh debts you are incurring from that period onwards. So, if you want to make sure you’re minimising your exposure you’d make sure that you’re keeping up to date, at least with your current creditors.
Ariel: And then try to put some of the older creditors who are causing the liquidity issues on payment arrangements so that you’ve got some agreed time frames or payment requirements to them that still allows you to meet your current creditors where you can.
Martin: Yeah, wow. That’s very very powerful and of course, yes by dealing with the older creditors in that way, avoiding that personal exposure.
Ariel: Yeah well, ultimately to resolve the personal exposure completely you obviously need to have the arrangement with all of your creditors.
Ariel: But in that critical period, where you think there might be a risk it’s very important to try and keep up to date with your current creditors as much as possible.
Martin: Yeah. Ok, are there any other ways that a director who’s concerned could mitigate their risk?
Ariel: Well there’s some strategies that most directors who seek advice on this would do at the outset which would be around asset protection and if you’re going to be putting yourself in a position of risk by being a director of a trading entity the advice is generally that if you have assets in your name that those be restructured and moved into a family trust or something like early, because by the time you get to a point where you’ve got potential personal exposure its far too late to do any of that. So it needs to be, if you think you’re going to be in a position of risk you need to have a think about whether you’re the best person to be holding your family home or any other important assets for your family. And that’s really a pre-planning strategy.
Martin: Yeah and to me that’s the really big message. You simply cannot do this on the cusp of being made insolvent right?
Ariel: No no, unfortunately by the time you get to a position where you may have some personal exposure and personal liability it is far too late to do any asset structuring or asset planning.
Martin: And can you just explain why that is Ariel.
Ariel: Yeah, the reason is because there’s obviously the Corporations Act that deals with companies and what happens they face solvency issues. For directors there’s there Bankruptcy Act and if you’re pursued for personal liabilities and you don’t have sufficient assets to pay them a bankruptcy trustee can look back in time at assets that have been disposed of up to sort of 10 years previously.
Ariel: And if they’ve been disposed of in circumstances where, you know, you’re trying to defeat creditors or in circumstances where you’re trying to avoid payment of creditors and you suspect you might be insolvent they’re very easy for a trustee to get those returned back.
Martin: Yeah, and in my experience a lot of business owners don’t understand that.
Martin: They think that there are things they can do, chuck it all into super the day before or transfer the home to the spouse, but…
Ariel: Yeah, unfortunately all those things have been tried before, (Martin and Ariel laugh) and they generally don’t hold up to much scrutiny if they’re ever before the Court so it’s important that if you are going to be going into a position of risk that you plan beforehand.
Martin: Yeah, that’s a huge point and I guess, you know, if I can make a brazenly self-serving comment about setting things up right that’s a wonderful reason to do so. And to think about these things at the earliest moment and the more time that passes between setting it up and the insolvency event the stronger the position you are going to have.
Ariel: Yes correct, that’s definitely true Martin.
Martin: Could you talk me through what happens as a practical matter if a company goes insolvent. What should a business owner expect?
Ariel: Well there’s a few different way that companies can enter into the insolvency system. One way is voluntarily, and that’s either by the shareholders or the directors deciding that really, and often this is something that is triggered by the directors personal risk for insolvent trading, they may decide to appoint an administrator because one of the ways that that insolvent trading claim risk can stop is by appointing an administrator. So if it goes through that process it’s at the choice of the business owner, being either the shareholders or the directors to start that process.
Martin: So that’s kind of a get out of jail free card. You appoint an administrator and you cannot have personal exposure for the insolvent trading.
Ariel: Yes after that date.
Ariel: Obviously if there was a period beforehand…
Ariel: Where debts were incurred that haven’t been paid then that’s a risk but one clear way of stopping any personal liability is to appoint an administrator. So that’s one way a company can enter the insolvency system. The other is if the creditor applies through the Court to have the company wound up. And that’s a process that normally takes a couple of months and you would get notice of, it’s generally commencing by serving a statutory demand. So, if business owners get those types of legal documents it’s very important that they get advice quickly because often it may be that the company isn’t insolvent or could resist a winding up application.
Ariel: Because often the creditors don’t know the full circumstances, all they know is that their individual debt hasn’t been paid. So, that’s a process that goes through the normal Court system and can be defended. But either way, once an administrator is appointed there’s meeting of creditors, there’s opportunities, normally the directors will need to provide a report to the administrator and the same for a liquidator, just setting out assets, liabilities, the financial situation, how it got to where it got to. And then the administrator or liquidator takes over control of the company. The directors don’t have any further day to day responsibilities, but they may have to obviously answer questions, you know, about where things are and which employees owed what and some of those practicalities they might still need to be involved with on a day to day basis.
Martin: Yep, ok, and maybe I’ll now flip it around because some of our listeners may have concerns about these matters, I guess we hope and expect that most of them won’t and they’ll be running healthy businesses. But what advice would you give to somebody who is for example, a creditor of a business that is actually insolvent or that they suspect might be teetering. What are some practical things they could do?
Ariel: Yeah, it is often a really difficult one but it is one we give advice on. There’s a few risks for people for creditors. One is obviously at the outset having that pre-planning, a bit like directors as well, you need to have good terms of trade. If you’re supplying goods you might want to consider having a PPSA security interest over the goods that you’re supplying, so…
Martin: And can I stop you there…
Martin: Can you explain what that means?
Ariel: Yeah, all it means is, your listeners might be familiar with the idea of a retention of title type arrangement.
Ariel: Where you retain title to goods that are delivered until you’ve been paid for them. And there was some legislation introduced in 2012 which has given exciting new name to all these things but they are effectively the same. They are basically saying that you still own the goods you supplied, even when they are in the possession of your customer, until they’ve actually paid you.
Ariel: So having the contractual terms that support all of that and your registrations in order give creditors a fair amount of bargaining power and give them a little bit more control over when they get paid.
Martin: Yeah, and it might just be worth drilling down into that a little bit more if that’s ok, because it certainly is a new world isn’t it, post the PPSR or post the personal properties securities register. And I think a lot of business owners, and indeed practitioners have struggled with what that means in terms of getting some good protection because it’s not like, you know, in the old money as you say, we talked about it an ROT, a retention of title clause, that was just something you chucked in the contract and you know, all good, you were protected. But it’s not quite the same anymore.
Ariel: Yeah, there’s a couple more hurdles now and you’d still need the basic contractual terms in your terms of trade. So that’s still really important. Ideally now instead of just putting it on the bottom of an invoice you’d want to actually have terms of trade that are signed off by your customer. And over the last few years I’ve seen commonly businesses are getting better and better at that but it’s still something a lot of businesses still fall back on, just putting a little line on the bottom of their invoices.
Martin: Yeah, so and sorry to interrupt but this is an important one. So getting it signed, that’s a key?
Ariel: Ahh, it helps.
Ariel: There are other ways that you can prove that you’ve got the security interest and that your customer has agreed to give it to you.
Ariel: But, the best way is having it signed, so.
Martin: And how many businesses would do that, you know. (Martin laughs)
Ariel: Oh, in appearing since this legislation came in, they’re getting better. When it first came in pretty much no one was doing that unless they were very big suppliers. But it is becoming more common and so you’ll probably find as well your customers will be more used to being asked to sign these terms of trade.
Ariel: So, you know, often they’re included in say a credit application, or you know, if you’re getting paid on 30 day terms, they might just be included in the original customer detail form that’s filled out.
Ariel: So it’s very important to have that contractual basis for your claim. And then you need to register and the idea is to, the registration system is designed so people can register for themselves. It’s a relatively straight forward tick box field system that you go on and it’s very important that you register if you’re supplying goods before you deliver them. You only need to register over each customer once. So, once you’ve got your terms of trade signed and you’ve got your registration on that will continue to cover you for all your future supplies to that same customer.
Martin: Ok, so this to me, it really speaks of a subject that’s dear to our heart and particularly in the context of exit planning, which is around strong systems and procedures.
Martin: To get that right.
Ariel: Yeah, and its very important that your credit staff understand and your sales staff who are going out and signing up new customers that they sort of understand those procedures because having that security in place at least means that, worst case scenario, if something happens to your customer you should be able to get the goods that you’ve supplied and haven’t been paid for that.
Martin: Yeah, and it’s certainly something that I’ve seen in the business exit context when people don’t get these things right and then you look to sell the company and of course there’s been a great big exposure.
Ariel: Yeah, and they can be hard to fix later.
Ariel: I mean generally if you, your registration only protects you moving forward. So, if you’re putting it on, you know, a long time down the track you’re at risk for what’s happened up until then.
Martin: And if you only register after delivery that’s a problem?
Ariel: Ahh…it’s better than nothing. (Ariel laughs)
Martin: Yeah. (Martin laughs)
Ariel: But it doesn’t give you the same priority. So, for example, if there’s a bank in there who’s also lent money to the company you wouldn’t have a priority over the bank. Whereas, if you register before you deliver, you are going to have a super priority that lets you have far less arguments with people to get your stock back.
Martin: Yes. Ok, any other advice, for businesses that are kind of concerned about these risks?
Ariel: Yeah, so the other I guess issue is when you become, if you become suspicious that you’ve got a customer who may be experiencing cash flow difficulties which often comes with late payment, asking for payment arrangements. You might have a customer who is paying you in lump sums rather than invoice amounts. Those types of things are sometimes things that might trigger concern. What business owners need to understand is that once you’ve got sufficient to ground a suspicion of insolvency in your customer, any payments you’re receiving from them are at risk of being clawed back if they go into liquidation.
Martin: And can you explain what that means.
Ariel: Yeah, there is something called a preference claim. And the idea is that any payments that are made to creditors who were aware or had a suspicion that the company was insolvent in the 6 months before a liquidator’s or an administrator’s appointed, the liquidator will normally come to them and say “I would like you to repay that money”.
Ariel: And it’s a very unfair, it often comes across as a very unfair provision but the idea is those creditors have been paid 100 cents on the dollar, whereas, all the other creditors who are left might be getting 10 cents on the dollar. So it’s designed to even up payments to everyone, so everyone’s getting the same but it can be very, it can have harsh consequences. So I guess the really important thing is if you suspect your customer is experiencing solvency issues, you might want to think about putting them on cash on delivery basis or something like that. So what you are supplying to them equals what they’re paying you moving forward.
Martin: Yeah, boy, that’s such an important point isn’t it. I can only imagine being wilfully blind to these matters probably doesn’t help. I mean can you put your head in a bucket of sand and pretend that you don’t know about these things? (Martin laughs)
Ariel: Unfortunately it is one of those areas where if you’ve got a particularly diligent credit officer who has taken very good file notes and sent lots of really good emails it doesn’t help in Court in defending a preference claim. (Ariel laughs)
Martin: Yeah, a sloppy kind of process might paradoxically assist. (Martin laughs)
Ariel: Yeah, it is one of those legal paradoxes where sometimes the sloppier creditors who haven’t kept as good a record have more of a basis to say they weren’t aware.
Martin: Wow! Well it’s been fascinating Ariel, thank you so much. I think for me the really big take outs, firstly for directors and to have the antenna up in relation to these kind of warnings of potentially trading whilst insolvent and the personal liability. But then these really practical ways as a creditor to protect yourself. I’ve found it fascinating.
Ariel: No, no thank you Martin. Thank you for having me.
Martin: And thank you very much for joining.