Australia: The collapse of ProBuild - how mitigating risks early can save a company
The collapse of national construction company ProBuild sent shockwaves through the industry with flow-on effects felt by many stakeholders. What role can early risk identification and mitigation play in saving a company from entering administration?
When a principal contractor or senior builder enters administration, there are a significant number of risks which, if navigated property, can be mitigated to minimise loss.
Chances are, if you are involved in any capacity in the property and construction industry, you have heard that ProBuild, a Tier-1 Victorian builder with projects around the country with an annual revenue of $1.4 billion, recently entered into voluntary administration.
Whilst collapses of large construction companies occur from time to time (for example the Hastie Group and Walton Construction*), when a construction company the size of ProBuild enters administration, it inevitably sends shockwaves through the industry.
The first wave is often felt by the company's employees, but at least it is likely that they will receive some protection from the Commonwealth Government's Fair Entitlement Guarantee Scheme.
The second wave is felt by the company's unsecured creditors, particularly mid-sized subcontractors, including suppliers and consultants, who would have been engaged to undertake large parts of the company's various works.
Of course, this is not a complete breakdown of all of the stakeholders in any company's administration. For example, the position of any secured creditors will also be highly relevant, but for the purpose of this article, we will focus on the subcontractors.
What are the risks for subcontractors?
The primary risk for subcontractors is the immediate cessation of work.
A national company like ProBuild, which has entered into voluntary administration, is protected by the statutory moratorium provided for under that process so that current liabilities do not need to be paid immediately.
Subcontractors however will need to continue to meet their current obligations if they intend to keep trading.
The unfortunate reality is that the cessation of work might often lead to subcontractors suffering cashflow crises which, if not managed properly, can lead to insolvency. It is often the case that projects for subcontractors are running on small profit margins and beholden to secured lenders and suppliers, often with personal guarantees having been provided by their directors. During this time it is not unusual for subcontractors to receive statutory demands or notices of default from their own creditors. (See our August 2021 article Statutory demands and offsetting claims - what is best practice?)
Directors' duties and prospective personal liability
Faced with a cashflow crisis, it is very important for directors to be acutely aware of the risks that they personally face as a consequence. If a company becomes unable to pay its debts (that is, becomes legally insolvent) as and when they fall due, a director might find him or herself personally liable for debts incurred by the company whilst it was insolvent.
In Australia, under the Corporations Act directors of companies have ongoing obligations to prevent their company from trading whilst insolvent, and have statutory and fiduciary duties to act in its best interests. These duties are often misunderstood, largely because of their breadth, and to any person without a law degree they might sound like white noise. There is a large body of case law on the circumstances where a director may breach their duties, some of which include:
transferring assets, including real property, out of the company without proper consideration: see Kijurina (in their capacity as liquidators of ET Family Pty Ltd (In Liq) v Taouk (2015) 105 ACSR 686;
paying personal expenses of the director without authority and disclosure, or the making of unauthorised and unsecured loans to another related company: see Patterson v Humfrey (2014) 291 FLR 246;
failing to keep accurate financial records: see Re Lawrence Waterhouse Pty Ltd (In Liq); Shaw v Minsden Pty Ltd (2011) 29 ACLC 11-064; and
failing take reasonable steps to assess the company's financial position and performance and to assess material adverse developments: see Re One.Tel (In Liq); Australian Securities and Investments Commission v Rich (2003) 44 ACSR 682.
If a director is found to have breached their duty, they might be liable to be sued personally by the company, through its liquidator, or indeed its creditors, or in some circumstances find themselves being prosecuted by the corporate regulator, the Australian Securities and Investments Commission (ASIC).
Obviously, consideration has to be given at this point as to whether or not the company stops trading. If it stops trading, then it is not incurring liabilities, even if it has become insolvent as a consequence of a head contractor falling over.
Early advice and its role in mitigating risk
It is not all doom and gloom and it is not inevitable in these scenarios for companies to be forced into administration. However, the risks that present themselves are complex and often only identified and avoided after receiving sound financial and legal advice.
Obviously, there are other risks and options for risk mitigation that can be explored that aren't considered here - there is no one-size fits all approach. However, the mantra for every company has to be, when faced with a cash flow crisis, early advice is key.
If a view is formed that the company is insolvent or likely to become insolvent, then a strategy needs to be considered as to how that is to be addressed. In order for a director to avoid personal liability, this strategy has to be one which takes into account the size of the debts, the relationship with creditors and the ability to come up with a potential alternative proposal to save the business. Sometimes this is best dealt with through the voluntary administration and deed of company arrangement (DOCA) process.
There are a number of instances in which construction companies have gone through the voluntary administration and DOCA process and come out the other side stronger than they were when they entered into it.
If the company's liabilities are less than $1 million, then there exists the option to explore a small business restructuring plan (SBRP), which is an alternative process that does not involve the company entering into administration and coming under the control of an insolvency practitioner.
If utilised properly, an SBRP is a cost-effective, advantageous alternative to administration. The director remains in possession of the company and, with the assistance of an insolvency practitioner, can seek to compromise debts with its creditors, subject to their approval. The process is substantially streamlined compared to the ordinary administration process and if the company qualifies (it must also be up to date on its tax lodgements) it is an extremely useful restructuring tool.
Importantly, a DOCA or SBRP presents an opportunity to protect the company's director(s) from personal claims by a liquidator and/or the company's creditors.
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