News

Lessons from recent retail insolvencies 

In recent months our office has become involved in the collapse of several significant companies operating in the clothing and food retail industries and there appears little sign of relief in this struggling business sector. 

In all cases, the businesses were hopelessly insolvent by the time of our appointment and the losses suffered by suppliers to the companies has been significant.

The factors leading to the significance of the losses include:- 

• The brand/identity that the business had invested so much money in developing, has very little value in an insolvency
• The stock has little value when sold in an insolvency and often by the time of the ultimate appointment the stock is an assortment of oddments or out of season items
• Successful retention of title claims by suppliers are often the only significant means of recovery that creditors generally receive, and
• Landlords crystallise significant residual claims following the termination of leases and the lack of capacity for landlords to re-lease vacated premises increases the level of debt. 

These recent failures highlight for us a number of issues for proprietors of retail businesses to consider in order to mitigate the fall-out from the current difficult trading environment:- 

• Where possible limit the extent of personal guarantees that are provided to landlords. With vacancy rates continuing to remain high, the negotiating position of landlords has diminished, allowing property leases to be entered into without direct personal exposure
• Planning and knowledge of cycles is key – don’t over stock
• Think about profit, not turnover, and don’t spend what is not there to be spent, and
• Be innovative in ways that increase the use of the internet and reduce reliance on a physical footprint. 

We understand that retail is one of the toughest business segments to participate in, so the best way to survive and thrive is to be smart, forward-thinking, nimble enough to adapt to changing retail conditions and conservatively geared so that profits are not all tied up in debt servicing. 

Phoenixing and employee entitlements 

Directors and Officers of companies need to be aware of the potential for incurring personal liability under civil penalty provisions for contraventions of the Fair Work Act 2009 (Cth) if they are involved in transactions that are intended to defeat the payment of employee entitlements.

This potential was exposed in the Federal Court matter of Automotive, Food, Metals, Engineering, Printing and Kindred Industries Union (AMWU) v Benyon ([2013] FCA 390). 

The AMWU and AWU brought a civil claim against the director and secured creditor for being knowingly involved in a contravention of Section 550 of the Fair Work Act. The claim made was for the full amount of redundancy entitlements that were left owing in an insolvency. 

In this case, the company was facing financial difficulties and attempted to reduce working hours but the Union would not agree. The director and an insolvency practitioner met several times and discussed, amongst other things, how the company might address its surplus of labour. The insolvency practitioner was appointed as a receiver and manager and sought to sell the business. After the receiver’s sale campaign closed the director was the only party expressing any wish to buy the business. The employees ceased work and picketed the site and the receiver treated them as having been made redundant. The company paid no redundancy entitlements to its employees. 

Whilst ultimately the claim failed, the importance of the application to Court should not be understated. 

To be liable under the Fair Work Act a person must have knowingly and intentionally participated in the failure to pay employee entitlements to staff. 

Thinking about how this may apply in reality draws our attention to the backroom discussions and dealings with companies that enter into insolvency and arise again with the same ownership, in what are called phoenix companies. 

In these matters, insolvency practitioners and directors could be personally liable for a contravention of the Fair Work Act where they participated in the contravention intentionally and had knowledge of the facts constituting the contravention. 

Entrepreneurs and insolvency 

We often see and read about iconic and well-known businesses that have failed, and we pause to think why? 

In our experience, many of these well-known companies are businesses that have grown from a small base to a large operating concern under the free entrepreneurial spirit of the owner/founder. This skill set ultimately becomes a noose when business conditions turn downward and a more disciplined and conservative operating management is needed. 

Observations we have made from matters we have seen in our office include:- 

• Many entrepreneurs are too slow to admit that they have a problem and that the business needs to change
• Some bad business decisions can be traced back to a lack of attention by management
• Management persists too long with a belief that the current problem is only temporary and it can be resolved easily
• As businesses grow, so does management complexity and not giving experienced management the chance to manage creates an unhealthy environment, often resulting in an exodus of management
• Not being close enough to the financial detail to see and accept that inadequate working capital exists in the business
• Once the problems are recognised, being unrealistic about the expectations of assets or equity value resulting in workout paralysis, and
• Failure to talk to key stakeholders, suppliers and financiers leading to a breakdown in trust. 

So, the lessons learned from this are: 

• Take advice from staff, management, independent accountants and industry experts
• Have confidence in management to manage
• Bring your financiers ‘inside the tent’ and let them be part of the solution with early engagement
• Be vigilant in the monitoring of business key performance indicators, understand projected cash flow and read and understand the financial statements
• Continuously plan and involve management in the process, and
• Build a brand that is the company and not the proprietor. 

PPSA - are your clients registered?

The transitional period set out in the Personal Property Securities (“PPSA”) legislation has now expired. We are seeing an increased number of creditors in our jobs assuming they have the protection of retention of title claims that are now no longer valid without registration on the Personal Property Securities Register. 

This is just one example of the complexities of this legislation and should you have any queries or concerns about the application of the act to your clients, you should contact Mark Lieberenz of this office. 

We also have a presentation covering off on the key elements of the PPSA that we are happy to present to you. Should you wish to take advantage of this, please contact Mark. 

Can a secured creditor be paid from an unfair preference recovery? 

Insolvency practitioners have long considered that the fruits of an unfair preference recovery in a liquidation were for the benefit of unsecured creditors. 

In 2010 that thinking was challenged in the matter of Cook v Italiano Family Fruit Co Pty Ltd (in liquidation) (2010) 190 FCR 474 (Italiano) and again in 2013 in the matter of Re Damilock Pty Ltd (in Liquidation) (2012) FCA 1445 (Damilock). 

In the Italiano case, the court determined that the liquidator had made payments to employees out of funds from asset realisations that were covered by the bank’s security. In this matter, the liquidator paid out a dividend to employees prior to succeeding in the recovery of monies from unfair preference claims. It was demonstrated that if the payments to employees had been delayed until after the preference recoveries had occurred, the dividend could have been paid from this source, leaving the asset realisations to the bank. 

In the Damilock matter, the facts were similar and employee entitlements were paid out of asset realisations that were covered by the bank’s security. In a directions hearing pursuant to section 511 of the Corporations Act, the court found that the facts in Damilock were the same as in Italiano and again the bank benefited from the unfair preference recoveries. 

In recent months a more broad application of the two cases is being tested in the Federal Court of Australia in Adelaide (“Federal Court Proceedings”), in a matter where a receiver has paid employee entitlements from asset realisations that were covered by the bank’s security and a liquidator has recovered sufficient unfair preference claims to have made the payments to employees from these recoveries. In this matter, the liquidator is seeking directions concerning whether the bank has an entitlement to participate as a priority creditor in the liquidation due to rights of equitable subrogation. 

Whilst the facts are similar to Italiano and Damilock, it’s the receiver’s right to equitable subrogation that appears to be the key issue in contention. In a receivership, sections 433 and 556 of the Corporations Act, provide that wages, superannuation, leave and severance entitlements that accrue before the date of the appointment of a receiver are to be given priority over debts owed to a secured creditor under a floating charge.

In the matter of McEvoy v Incat Tasmania Pty Ltd (2003) 130 FCR 502 it was held that a receiver only had an obligation under section 433 of the Corporations Act to pay entitlements to employees whose employment was terminated before the appointment of receivers. This line of argument has been followed in more recent cases. If this reasoning is followed in the current directions being sought in the Federal Court Proceedings, the bank would not benefit from the preference recoveries as the payment of employee entitlements were made for commercial reasons, rather than pursuant to a strict legal obligation and not, therefore, qualify for equitable subrogation. 

In our office, we are dealing with the same issue in three significant insolvency matters and we await the outcome of the directions hearing in Adelaide as the analysis above highlights that matters with no commercial difference and a minor legal difference can create vastly different outcomes. 

What is clear from the above is that the old notion that secured creditors cannot participate in unfair preference recoveries is outdated and unsecured creditors can no longer necessarily assume a liquidators recoveries will be for their ultimate benefit in all cases.