Options for directors in times of business uncertainty

Boards and management teams are navigating unprecedented economic and social uncertainty. They are grappling with business hibernation and fluctuating timeframes for reopening, a deep recession, the risk of subsequent COVID-19 outbreaks and shutdowns, along with the impact of financially stressed customers and suppliers.

In a recent webinar poll by McGrathNicol, half of the participants said the outlook for their organisation was either “challenging” or “disastrous”. One third specified that they were still formulating a strategy for their ‘new normal’ and another third indicated that they would need to restructure or complete a transaction to survive.

Given the current environment, Directors have various options at their disposal. They can get involved and allow management space to manage the crisis or put their heads in the sand.  We have recently seen examples of Boards steering somewhere between the first two options, meeting more frequently and getting more involved in targeted sub-committees.

Right now, Directors need the best analysis they can find and should be developing contingency plans. It is essential that they update business forecasts regularly, even though forecasting has probably never been more difficult, with little visibility regarding the timing and shape of the recovery.

Regular forecasts are needed to assess funding options. We suggest structuring trading forecasts to allow for sensitivities on key revenue, cost and margin assumptions.  Modelling downside scenarios at different risk levels highlight the potential range of outcomes and the runway for executing a restructure plan and accessing external funding if required.

Companies are availing themselves of short-term cash flow support, most notably from the government stimulus but also in the form of temporary relief from landlords and lenders. Many have implemented temporary salary reductions, emergency cost-cutting initiatives, and payment deferrals with suppliers and other creditors. Tapping into this support is necessary but it can mask underlying longer-term profitability and cash flow issues that may be building during the hibernation period.  In many cases, rent and other expenses that have been temporarily deferred will translate to increased monthly costs once the deferral periods expire.

The Federal Government’s easing of insolvent trading laws has reduced the sense of urgency for some businesses. Originally slated only to run to the end of September, it is now expected that the moratorium will be extended beyond this date.  Such an extension will be welcomed by many Directors across Australia, however they will be mindful that they could be facing a liquidity brick wall whenever the support programs start winding down. Directors must also remain acutely aware of the duties to good faith and due care that still apply regardless of any insolvent-trading exemptions.

What should directors consider?

Safe Harbour provisions (which is current law, put in place long before COVID-19) are now a real consideration for many companies. Directors contemplating a restructure should start thinking about how long they will need and whether invoking Safe Harbour protection from insolvent-trading claims would be prudent.

To seek protection under the Safe Harbour regime, Directors need to have started developing and implementing a restructuring plan.  This typically involves entering discussions with shareholders, financiers, suppliers, landlords and employees in a bid to reduce or defer costs or payments.

If these conversations result in an impasse and stakeholders insist on holding out for more, the restructuring process may need a Deed of Company Arrangement (DOCA) or Scheme of Arrangement, both of which are common creditor-approved outcomes of a Voluntary Administration (VA) process. They usually represent an agreement to repay outstanding debt to various creditor groups at a lower amount and/or over a period of time.

In our experience a successful DOCA has two elements: a realistic plan for the restructured business to continue trading (which may include getting rid of unprofitable business units, locations, contracts or other overheads) and funding.  If VA looks likely, Directors should be careful not to exhaust all dry powder during the solvent restructuring phase, because DOCA funding is most often sourced from existing shareholders or other investors known to the company.

Above all, Directors should remain pragmatic, objective, open to advice and seek the best information possible from their management teams. Based on our experience of distressed situations playing out, companies that engage expert advice early in situations generally have more options in play for longer.