It’s the grinding cyclical lag that can eventually catch up with those poorly prepared. During this period, struggling businesses, particularly builders, can encounter many risks such as creditor recovery action, such as from the ATO which is proficient in winding up companies and using specific recovery powers at its disposal. Banks get nervous and managing relationships in a sector where the prolific use of bank guarantees are involved can be uncomfortable.
Unscrupulous predatory advisors can contact vulnerable business owners and tell them what they want to hear. All too often they recommend transferring the assets, business and contracts to another company, leaving unpaid creditors wallowing in the previous shell with little hope of payment. This is a form of phoenixing and the construction sector has a poor reputation for this practice.
If failure ultimately occurs, builder liquidations leave directors particularly vulnerable to large personal insolvent trading claims as debts are commonly incurred whilst insolvent. Combined with personal guarantees, director bankruptcy is common.
Contract clauses commonly allow developers to terminate upon liquidation (referred to as ipso facto clauses) which triggers a process of valuing unpaid works. This value is combined with the bank guarantee to set-off against losses. Despite these protections, the costs of a new builder, legal, interest, security and other costs often leave projects in the red.
The encouraging news is that 2019 is a different environment to previous cycles. A combination of factors is more encouraging of robust solutions to avoid collapse.
Firstly, banks have shown a willingness to work with customers in executing an informal workout plan (aimed at avoiding business failure), especially where a reputable advisor is involved.
Secondly, the ATO is more sophisticated in conducting due diligence in considering repayment arrangements and, similar to banks, takes comfort where suitably qualified advisors are assisting the taxpayer, and effective financial reporting and corporate governance are in place.
Thirdly, recently changed insolvency laws include:
- For any contract commenced since 1 July 2018, the use of ipso facto clauses to terminate is restricted.
- New Safe Harbour provisions were introduced to provide protection to directors from insolvent trading claims where a course of action is taken that is reasonably likely to result in a better outcome than immediate liquidation or administration. Safe Harbour is not a formal insolvency process, such as liquidation, and therefore avoids (mostly) the very public process that can damage businesses irreparably.
To be effective, safe harbour requires positive conduct including lodging tax and BAS returns, paying employee entitlements on time and appointing an appropriately qualified entity (advisor). Of note is that the legislation, banking and ATO environment is more aligned than ever in supporting informal workouts to avoid business failure.
Each situation will be different. Some may need to improve efficiencies and rationalise resources so adopting strategies to buy time could simply require negotiating temporarily relaxed payment terms. Others will need to downsize their operations and cost burdens by way of redundancies, sub-leasing space and asset sales where again, time will be critical.
Acting early and seeking advice is crucial. A plan should be articulated in writing and the barriers to achieving it addressed. Explaining the plan to someone impartial and trusted which will help to consider what outcome is realistic. The time afforded by Safe Harbour can be used to coordinate steps with cashflow needs and communication with stakeholders.
Simple steps to get your house in order and avoid unintended consequences
The following is some further housekeeping to consider regardless of the current position of any business in the property sector:
- Ensure bank guarantees for completed projects are returned in line with the contract.
- ASIC and PPSR (the national securities register) searches on contractors can provide useful warning signs such as wind-up applications or company name changes (a common sign of phoenix activity). Wind-up documents are required to be served on the ASIC registered address of a company and the ATO’s director penalty notices are issued to the director’s address details with ASIC, so ensure these are current for your companies. A PPSR search can identify the extent businesses are engaging new suppliers (and potentially not paying previous ones).
- Check recent financial statements and accounting records and note the existence of any related party loan accounts. If an insolvency administration appointment occurs, loans owing between related parties can cause a cascading collapse.
- Review your current business structures and finance to consider:
- Are your risks and wealth segregated?
- Who are the directors of each company?
- Which entities or individuals have provided security or guarantees to support loans?
- How can funds be accessed should cashflow become tight?
The above represents some of the broader issues being faced by distressed businesses and some mitigating actions. In reality, these actions should be taken by all businesses and can prove beneficial in the case of a growing business. If there is one thing the GFC taught us it's that recovery can be swift and those prepared for the rebound can take advantage of some fantastic opportunities.