Leon Zwier
Directors in the twilight zone
The appointments of insolvency practitioners to Allco and their mooted appointment to ABC Learning heralds a new phase in the current difficult economic cycle.
The first phase of any serious market dislocation like the current one is traditionally a "work out" phase with financiers focused on asset preservation, value enhancement, debt reduction from orderly sale of non-core assets, the avoidance of costs and expenses of formal insolvency appointments and the crystallisation of contingent liabilities (such as employee entitlements).
In order for the work out phase to be successful financiers require a great deal of transparency between the company and the financiers. The financiers retain insolvency experts to advise them and so too does the company. In this early phase financiers work cooperatively with distressed companies and their boards.
The interests of distressed companies and financiers align. They both want to maintain, or financially engineer, a viable and profitable positively cash flowed business. And if the business enterprise needs to be modified to achieve those ends then the financiers and the company work cooperatively to do so.
The company and financiers will consider ways of raising capital and reducing debt. It requires boards of larger companies to be well led by their chairmen and for the directors to be focused on what is best for the company in the near and longer term.
The work out phase is good for all stakeholders because if the objectives can be achieved the business will remain in existence and all stakeholders will achieve a better return than that which could be achieved from an immediate insolvency appointment.
The "work out" approach is stressful for the company for many reasons.
First the directors of a company in the 'twilight zone' of insolvency owe a duty to the company to have regard to the interests of all its creditors. This duty cuts both ways. It is no answer to shut up shop and throw the keys to an insolvency practitioner to take control of the company if all the stakeholders would be better off working out the financial problems of the company with financier support.
Secondly, the directors also must ensure that the company does not incur debts when the company is insolvent. This requires the board to look some way into the future. The test of the boards conduct is subjective and objective. It is hard to do so. Boards look at issues in prospect. Judges judge them in retrospect.
Thirdly, as a result of the Sons of Gwalia decision, and as night follows day, as soon as a large listed company is in the work out phase inevitably the class litigant lawyers and their funders will be spruiking opportunities to shareholders or former shareholders to sue the distressed company for inadequate market disclosures. This creates additional legal cost. It also creates a new contingent liability that must be considered in the context of all others. It adds to the anxiety of the board and its stakeholders. It reduces the opportunities to raise fresh capital.
Fourthly if the company has a diversity of bilateral financiers they each may have different interests making it hard to determine whether support will be ongoing.
In the "work out" phase financiers like the company genuinely wish to avoid formal appointments. The financiers may extend facilities and may make additional secured financial accommodations available to the company. Without that support the company cannot survive.
The board of the company can properly grant such securities if the company is solvent and the board believes that it is in the best interests of the company to do so. The boards of the company invariably obtain legal and financial advice from experts to assist them in their deliberations. The Bell Group ruling raises the spectre that if boards breach their duties in granting financiers security when the company is insolvent then the security can be set aside. This is not a controversial proposition.
The mooted appointments to Allco and ABC Learning are arising because the "work out" process has not been able to successfully save those companies. It is likely to lead to more appointments not only in large companies but also SMEs.
The challenge for all stakeholders, including businesses, financiers, overseas financiers, governments, unions, employees, suppliers, landlords and shareholders is to focus on the big issues and thereby maximise the chances of businesses remaining in existence. A little help from government by reversing the Sons of Gwalia decision would be welcome relief.
Leon Zwier is a corporate recovery services and litigation lawyer and partner with Arnold Bloch Leibler.
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