Chris McCullagh – PKF Corporate Recovery & Insolvency
Prior to the arrival of Covid-19 in March 2020, the hospitality industry was already facing serious challenges. Increases in property values had led to significant rent, rates and OPEX rises; the Christchurch and Kaikoura earthquakes had raised insurance and building compliance costs (which landlords are still looking to pass on to tenants); supplier and fit-out costs had already increased, and rising inflation and fuel prices will add to this exponentially; and despite many businesses and business groups urging the government to defer the minimum wage rise, it increased to $21.20 on 1 April 2022 (up 20 per cent on the pre-Covid rate). It is a perfect storm for hospitality business owners, to put it mildly.
While the government’s financial support helped businesses to survive, in many cases it was just a holding pattern. Business owners are now having to dust off their crystal balls to make hard decisions on their future trading prospects.
There is no realistic way of passing on to customers the lost revenues resulting from the lockdowns, and reduced trading due to staff and customers self-isolating. To counter increased costs, price increases seem inevitable, but it is a double-edged sword as it takes time for customers to adjust to new price points. Even more so under the ‘new normal’, where discretionary spending is expected to decrease, due to the recent rapid rise in the cost of living in NZ. Will punters pay $20.00 for a green bottle beer in a bar? Or $30.00 for eggs benedict at Sunday brunch? These prices may become the new norm in time, but how do businesses survive until then? You can’t stop paying suppliers or employees, or servicing loans or finance, as business very quickly grinds to a halt.
Inevitably, the first creditor to stop being paid is IRD as it can be many months before arrears are followed up, by which time the tax, penalties and interest have increased the outstanding amount significantly. Directors should also be aware that failure to pay PAYE is a prosecutable offence, and over the past few years, custodial sentences have been dished out to company directors who default. If your margins are already tight, then a repayment plan may not actually be the best option, as it often puts unsustainable cashflow strains on the business.
Owners now, more than ever, need professional expertise with budgeting, forecasting and strategic planning. While accountants and lawyers are usually seen as a grudge-spend, the cost of not using them is much greater. There are a number of options to save a business if you act early, but as time goes on those options disappear, resulting in closure.
More importantly, many business owners themselves will be unable to draw a reasonable salary. If that is the case, and you could earn more elsewhere as an employee without the stress and responsibility, then it makes sense to consider pulling the plug. You do not want to dig a deeper hole for yourself, especially if you have guaranteed business debts, or risk increasing your exposure against the family home. Not to mention breaching your director’s duties under the Companies Act, which can carry significant personal liability.
What are my options?
Debt negotiation
If a particular creditor, such as IRD, a landlord or a major supplier, is pursuing the company, then you will almost certainly need professional assistance to negotiate an outcome. Creditors are more likely to believe and accept the views of an independent expert, and insolvency practitioners have a different skill set from general accountants or lawyers, although we usually work together to get the best outcome for the business. If disputes are not handled by the right people, then situations can be irreparably worsened. It goes without saying that when a creditor receives a letter from an insolvency practitioner, they take notice.
Creditors’ compromise
Compromises with creditors can either be informal or formal. We usually recommend a formal process under Part 14 of the Companies Act, as it is binding on all creditors who are notified. Normally, this process offers creditors a fixed percentage of their debt (such as 20c/dollar) as a one-off payment, or in a series of payments over time. It can allow the company to ring-fence its debts, but continue to trade without the director breaching their duties. The compromise proposal is voted on by creditors and if more than 50 per cent of creditors holding at least 75 per cent in value of claims vote for the proposal, then it is binding.
An informal creditors’ compromise may be perceived to be a cheaper or less public option, but it requires 100 per cent of creditors to vote in favour of the proposal, so is much harder to achieve. In our experience, it is often a false economy attempting this option.
Voluntary administration (VA)
This provides a statutory framework for directors of a company to reorganise, restructure and refinance the business. The objective of VA is to enable an insolvent company, or a company that the directors believe may become insolvent, to:
- maximise the opportunity for all or part of the business to continue trading, normally through a compromise with creditors or
- if is it not possible for the business to continue, develop a plan to dispose of the business that will likely provide creditors and shareholders with a better outcome than a liquidation.
If used the right way, VA is a powerful and useful tool to save a business. In a similar way to a creditors’ compromise, creditors have the option to vote on a VA proposal (known as a Deed of Company Arrangement or DOCA), as an alternative to putting the company into liquidation.
Liquidation
All liquidators of insolvent companies must be licensed insolvency practitioners. There are two ways for a company to be put into liquidation:
1. Court liquidation (Creditor initiated)
If a creditor issues a statutory demand to your company and the debt is undisputed and unpaid, then they can apply to the high court to have a company put into liquidation. The creditor normally nominates the liquidator, who the court then appoints.
2. Voluntary liquidation (Shareholder initiated)
Shareholders can choose to put a company into liquidation. This requires 75 per cent or more shareholders to sign a resolution. As soon as the form has been signed and dated, the company is in liquidation and the liquidator takes over control from the directors. While the directors still need to assist the liquidators (such as with providing records and information), their rights cease. This also means that directors or management no longer need to deal with upset creditors. Often a lot of stress is lifted from directors as soon as the liquidation starts. The liquidator will contact all creditors, bank, landlord, employees, IRD and any other relevant parties.
The liquidator’s role is to sell the assets and recover any amounts owing to the company, then distribute the proceeds to creditors. The ranking of creditors is set out in Schedule 7 to the Companies Act. Liquidator’s fees and expenses are paid out of the assets in priority to creditors. If there are no secured creditors, then employees rank second for any unpaid wages or holiday pay. The liquidator must advertise their appointment in a local newspaper and the NZ Gazette. There are also initial and six-monthly reporting requirements which update the creditors and shareholders on the liquidator’s progress. Copies of these reports are filed online with the Companies Office.
Receivership
If your company is unable to pay its debts to a secured creditor (generally a bank or financier), it may be put into receivership. The right to appoint a receiver is contained in the lender’s security documents. A receiver’s role is similar to that of a liquidator, but their primary duty is to recover the debt owed to the secured creditor. A receiver can be appointed over the whole company, or only specific assets, depending on the security. Receivers are governed by the Receiverships Act 1993, and have duties to file initial and six-monthly reports with the Companies Office.
What should I do?
Help is only a phone call away. Insolvency practitioners do not just bury companies: we have a broad tool chest and years of experience dealing with distressed companies. Steve Lawrence and I are the principals of PKF Corporate Recovery & Insolvency, and together we have more than 50 years’ experience in business work outs, restructuring and insolvency. We are passionate about the hospitality industry and over the years have assisted with turning around numerous businesses. We have also helped directors and their families through the stress of business failures. We can help you to see the wood from the trees and assist with a turnaround strategy or an orderly wind down.
We offer Restaurant Association members two hours of free initial consultation and follow-up time, with no strings attached. At PKF, we pride ourselves on giving the best possible guidance to clients, even if that means there is no role for us in it. This may include referring you to a specialist lawyer, or an accountant, to help with your financial management. Communication with creditors, bankers, landlords and other stakeholders is paramount, and if you have not done that, we will often give you some pointers before following a formal process.
The most important thing is that you seek assistance sooner rather than later, as most often there are solutions available. It is always more satisfying for us to save a business, than to be the ambulance at the bottom of the cliff.
Chris McCullagh is a licensed insolvency practitioner, RITANZ member, and director of PKF Corporate Recovery & Insolvency (Auckland) Ltd, a member firm of the PKF International network of legally independent accounting and business advisory firms.
The Restaurant Association is running a workshop (which can be attended in person or via live stream), 2pm, 24 May, 2022, on business turnaround and insolvency. Learn tools and strategies to assess the viability of your business and navigate through these difficult times. Find out more about the workshop here.
This workshop is being held in person (free to Auckland businesses) thanks to the support of Activate Tāmaki Makaurau.