Unfair Peferences, When to Cease Trading, Retail Woes and PPSR Timing Issues

Unfair Preferences and Insolvency

Most readers will be aware of the corporate insolvency focus of our practice but we are increasingly being engaged for our expert accountant skills in litigation and commercial matters.

Our unique perspective of unfair preference and other voidable transaction claims, and of insolvency generally, gives us the ability to add value to the defence of such claims.

In recent months we have been involved in the commercial negotiation and resolution of several unfair preference claims that have been issued by liquidators.  In each of these cases the claim has ultimately not seen the light of day in Court.  Of course, if the claim has progressed to the stage where formal legal proceedings have been issued, formal legal representation would have been necessary.

Often we have found that claims have been formulated without the liquidator having access to accurate books and records or a clear understanding of the facts of the transactions in question.  Our appreciation of both sides of the transaction, give us a perspective that helps identify the key issues and gets problems resolved.

If you or a client is in receipt of an unfair preference demand issued by a liquidator, we can assist with advice, or if necessary, negotiation of a resolution to the claim.

Another of our accountant roles we have been fulfilling recently is the role of the independent accountant in matters involving disputes between directors.

Experience has shown us that in these situations there is often deep seated mistrust towards the perspective of the advisers for both parties, and having a third party interpret transactions, comment on viability or express a view on solvency has been found to be helpful by bringing focus to negotiations.

Business disputes and unfair preference recoveries will always happen, and we are available to help with an independent view, advice or opinion aimed at achieving resolution to these very stressful situations.

Breaking up is never easy

In our role as insolvency practitioners, and in our discussions with business advisers, we see and hear of a staggering number of businesses that continue to trade despite facing insurmountable debts owed to creditors; in most cases to the ATO.

This often prompts the question of why is the company continuing to trade?

In the early 1990’s, when the voluntary administration regime was being introduced, the popular catch cry to induce businesses to restructure rather than to continue on trading in insolvency, was that the legislation provided for a carrot and stick approach. The carrot was a restructure through voluntary administration and the stick was threat of prosecution for insolvent trading.

Clearly the stick no longer carries the same fear as it was once perceived, as the threat of being prosecuted for insolvent trading is no longer driving responsible business decision making. This is no better illustrated than by reading reports in the mainstream media that the ATO is owed almost $20 billion by tax payers with small business taxpayers accounting for 60% of the tax owed. So, when faced with looming insolvency, when is the right time to stop trading?

Putting aside the legally correct concept that the right time to stop trading is when you are insolvent, we get down to a consideration of the commercial and personal values judgement decisions that directors of insolvent companies struggle with.

On the harsh commercial side of the decision, the conclusion is fundamentally based on an analysis of whether it’s better to get out today or to stay and fight another day. 

To perform this analysis directors must consider a range of competing issues.  They include:

  • Management skill – does management understand the cause of the financial problems and have the strategy and leadership ability to drive the solution;
  • Market position – has there been an irretrievable loss of market position i.e. has the market moved on whilst the business stood still;
  • Financial capacity – does the business have the cash resources to reinvest and restructure; and
  • Non business factors – is the financial predicament a result of the business underperforming or the result of other non-business decisions (e.g. lifestyle expenditure).

All of these statements require a rational and dispassionate assessment of business and management strengths and weaknesses.

Continuing to trade when there remains no going concern value of the business (i.e. when all goodwill has been lost), or when wages can’t be paid, or critical supply can no longer be sourced is way too late. All too often this is when the businesses appear on our door step and our options to create value are limited.  

On the director values side, we understand that fear of the future is what drives inaction by many struggling business owners.

Business owners' lives and sense of self-worth are intrinsically tied to their business success. Often directors have a deep sense of guilt towards their employees who they feel they have let down or there is the inevitable understanding that personal guarantees will be called on, so continuing to trade seems a good way to delay these problems. Trading under this sort of pressure is deeply depressing for directors and they often need help to see the light.

In our experience ceasing to trade is the key first step towards moving forward and re-starting a better phase of life.  All directors have skills in areas like sales, administration, project management etc. and focussing on these skills helps them find new employment.

Yes, there are always the guarantees and other residual financial implications, but these are far easier to address when the director is back in employment. with a clearer head and a certain future.

Retail is getting hard

We are sure that we did not need to remind you of this, but the landscape for retail (and in particular fashion retail) is looking rocky.

Recent high profile retail collapses include Dick Smith, Laura Ashley Australia, Man To Man, Marcs and David Lawrence, Payless Shoes, Pumpkin Patch, Rhodes & Beckett and Herringbone.

Significant retail failures are not just a local phenomenon, but the trend is being seen around many parts of the world as the nature of retailing changes.

So what is causing it? From a bottom line perspective sales are not keeping up with cost increases and this is driving increased trading losses. Therefore, managing the problem must be by an attack on multiple fronts – revenue, margin and overheads - and the ability to do that is quite a challenge.

With stagnating sales caused by increasing competition it’s hard for businesses to find the capital to reinvest in differentiation and innovation, and that is where the downward spiral starts.

Retailers must keep up with the changing demands of the consumer and that involves understanding the customer needs.

It is reported that Amazon's strength was its ability to build a deep understanding of individual customers by using data and analytics to provide a personalised shopping experience.

It is our experience that retailers are not effectively using their data to drive improved customer experience, rely on increasingly outdated sales methods and continue to compete on price; but without a low-cost business model to do it.

Unless there is change, then there are ever increasing chances of business failure. 

That said, a struggling retail business also has quite poor exit options.  In many of the high-profile failures quoted above, the businesses had been "up for sale" for quite some time but there has not been the appetite to purchase and restructure risky retail businesses. 

That same risk adverse attitude also exists towards the many small retail businesses we have in South Australia.

The recommendations we bring for retailers are to be innovative with retailing methods, constantly seek ways of better connecting and understanding customer needs, don’t rely on discount sales to drive turnover and if a business divestment is considered necessary, be prepared that the time to sell may be quite long. 

PPSR registration timing continues to frustrate suppliers

We regularly make comments in our client updates of the difficulties encountered by suppliers to insolvent businesses who have made technical errors in the registration of their security interests.

In the very recent judgment of the Supreme Court of NSW in Re OneSteel Manufacturing Pty Limited (administrators appointed) [2017] NSWSC 21 the Court has determined that a financing statement (in this case a $23m rental agreement) registered on the ABN instead of the ACN was an omission that rendered the purported registration ineffective under s 165 of the PPSA when the company passed into voluntary administration.

The Court felt strongly that the defect was seriously misleading and also because the registration was ineffective, the financing statement was not registered within the appropriate time frames.

The current position under the Corporations Act is that a security interest will vest in the grantor if the company is placed into voluntary administration and the security interest is registered after the latest of:

  • six months before the commencement of a voluntary administration;
  • 20 business days after the security agreement became enforceable; or
  • a later time fixed by the Court.

As a result, the relevant security interest was unperfected when the grantor entered voluntary administration and the security interest vested in the grantor under s 267 of the PPSA.  In addition, it was not possible to correct the defective registration with leave of the Court given the grantor was already in external administration.

This is yet another example where the failure to dot the i’s and cross the t’s for the purpose of the PPSR has resulted in unfavourable outcomes for suppliers.

A risk management suggestion we make is that it may be appropriate for clients to seek independent confirmation of the correctness of their PPSR registrations on key debtors/contracts to ensure that the terms of the PPSA are complied with. Applications to correct inadvertent errors are possible, but only before the grantor passes into external administration.