Restructuring in the Not-for-Profit sector Part 1: Voluntary administration

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co-author: Eshan Khot - Graduate]

Introduction

The voluntary administration process can be an effective restructuring tool for Not-for-Profit ('NFP') entities that are facing financial difficulties.

This article will focus on the need for directors of NFP entities that may be verging on insolvency to look at the advantages of appointing a voluntary administrator.

The appointment of a voluntary administrator may limit the risks of the director being personally liable when a NFP entity continues to trade while insolvent, as well as provide some breathing space for the NFP entity to restructure its affairs through the imposition of a statutory moratorium.

In Part 2, we will set out in more detail the restructuring outcomes of the voluntary administration process.

The position of directors of a Not-for-Profit that may be insolvent

A director may be confronted with their NFP entity having significant difficulty in paying their debts as and when they fall due. It may be that the NFP is insolvent.

Directors of a NFP entity that is a company limited by guarantee who are facing this situation must understand the insolvent trading provisions of the Corporations Act 2001 (Cth) ('Corporations Act').

Briefly, these provisions set out:

  • the duties of the directors of the NFP entity;
  • personal liability of directors;
  • possible defences to the insolvent trading provisions; and
  • a statutory defence to insolvent trading claim for directors, who, after suspecting the company’s insolvency, start developing one or more courses of action that are reasonably likely to lead to a better outcome for the company (the ‘safe harbour’ protection).

Furthermore, if the NFP entity is a registered charity with the Australian Charities and Not-for-Profits Commission (ACNC), the directors are also subject to ‘Governance Standards’ that charities must comply with in order to become registered, or remain registered, with the ACNC.  These duties are largely consistent with the Corporations Act and include a duty to ensure that the registered charity’s financial affairs are managed responsibly and not to allow the registered charity to operate while insolvent.

A NFP entity may face financial difficulties due to various factors.  Whatever the cause may be, the directors of a NFP entity have a two-fold duty.  Namely:

  • to prevent insolvency; and
  • to act diligently and properly if insolvency does occur.

    More significantly, if the directors of the NFP entity do not take any action to manage the financial difficulties of the company, they are at risk of breaching their duties to prevent insolvent trading and could become personally liable for debts incurred by the NFP entity.

Voluntary administration

As a result of amendments made to the Corporations Act which came into effect in September last year, directors can now (additionally) manage their insolvent trading risk by instigating a safe harbour procedure, which effectively requires the implementation (in consultation with professional advisers) of a corporate turnaround plan.  There are, however, certain prerequisites which apply to this process and it may not always be a prudent option.

A more traditional option, and that discussed in this article,  is to appoint voluntary administrators under Part 5.3A of the Corporations Act.

Voluntary administration can be an effective statutory process that facilitates the restructuring and reorganisation of the NFP entity’s business, property and affairs.

The object of voluntary administration is to ensure that the business, property and affairs of the NFP entity are administered in a way that:

  • maximises the chances of a NFP entity’s operations continuing; or
  • results in a better return for the creditors and members than from the immediate winding up/liquidation of the NFP entity.

Key benefits of the voluntary administration process

Key benefits of the voluntary administration process include:

  • the statutory moratorium afforded to the NFP entity.In the absence of the voluntary administrators’ written consent or a court order, the voluntary administration process prevents any creditor from commencing or proceeding with any legal proceedings or execution process against the NFP entity or in relation to its property (for example, a landlord re-entering into possession).
  • that claims under any personal guarantees given by the directors for debts due by the NFP entity are suspended.This is to encourage directors to assist with the voluntary administration process.
  • the ipso facto protections which apply to contracts entered into from 1 July 2018.In essence, these reforms restrict a contracting counterparty from terminating a trading contract merely as a result of the company’s insolvency. Importantly, however, the ipso facto protections are only available to companies in administration or that enter liquidation as a result of an earlier administration.

Warning signs of insolvency

The following issues may result in the directors of a NPF entity resolving to place the NFP entity into voluntary administration:

  • continued losses over successful financial reporting periods;
  • inability to borrow funds or obtain any loan approvals;
  • poor state of internal controls;
  • inability to produce timely and accurate information on the NFP entity’s performance and financial position; or
  • over-reliance on state and federal government funders (for example, the National Disability Insurance Agency) and inadequate internal processes to allow for timely claim-based funding.

Although the NFP entity may have a strong balance sheet, it may still face severe liquidity issues due to delays in receiving external funding.  This may result in the NFP entity being unable to meet its debts as and when they fell due.

To avoid any risk of insolvent trading, the directors of a NFP entity may wish to resolve to place the NFP entity into voluntary administration.

How can the voluntary administration process assist?

Generally, the voluntary administration process concludes within 25 business days.  This timeframe can be extended by court order or by the creditors (where appropriate).

Given the statutory timeframes and reporting obligations associated with the voluntary administration process, the voluntary administrators must quickly diagnose the operational problems of the NFP entity.

The moratorium provides the necessary breathing space for a NFP entity to reallocate limited cash resources for restructuring its operations and to identify any operational problems.  This can enable the voluntary administrators to undertake activities such as:

  1. securing and reviewing the books and records of the NFP entity, including reviewing and assessing the viability of the NFP’s units and preparing financial statements;
  2. complying with statutory obligations such as preparing reports to creditors as well as liaising with statutory authorities such as the ATO and ACNC;
  3. communicating with government authorities and government funding organisations and receiving assurances of funding support;
  4. communicating with the employees and various stakeholder groups to verify and reconcile any entitlement claims;
  5. procuring funding from mainstream financial institutions on favourable financial terms in keeping with the NFP entity’s purpose;
  6. enabling the continued operation of the NFP entity’s businesses from existing premises despite termination of leasing arrangements of those premises;
  7. engaging external experts to review the NFP entity’s internal controls and implementing measures to ensure the future integrity of the NFP entity’s systems; and
  8. preparing and implementing an expression of interest campaign to divest of any non-performing assets, including real property and/or parts of the NFP entity’s service offerings.

Conclusion

The voluntary administration process generally affords directors of possibly insolvent NFP entities protection from personal liability.  In addition, the statutory moratorium imposed by the voluntary administration process allows the voluntary administrators to take over control of a NFP entity’s operations and afford temporary relief to the NFP entity by protecting it from creditors’ claims.

It may also afford an opportunity for the voluntary administrators to create temporary cash flow improvement to facilitate a possible restructuring of the NFP entity’s existing arrangements.

An example of an effective restructure may be if the NFP entity remains as a standalone entity continuing its operations, or is merged with a larger compatible NFP entity.

The underlying theme of this paper is to highlight the flexibility afforded by the voluntary administration process which may well allow the NFP entity to sustainably continue serving its purpose.

In Part 2, we will examine the three possible outcomes of the voluntary administration process for the NFP entity:

  • the voluntary administration process ending and control reverting back into the hands of the directors of the NFP entity; or
  • the NFP entity entering into a creditor-approved deed of company arrangement; or
  • the NFP entity being placed into liquidation.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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