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Publication
Keeping your dawn raid guidance current
Unannounced inspections or ‘dawn raids’ are used by antitrust authorities to obtain evidence when there are suspicions that individuals or businesses have infringed the antitrust rules.
Australia | Publication | October 2020
This article focuses on those franchisors whose corporate operations have been particularly impacted by COVID-19, to the point that a consideration of insolvent trading and external administration is warranted. For those less significantly impacted franchisors, there might still be a lot to be done to effectively manage cash flow and reduce non-essential spend. Even for franchisors in that category, a basic understanding of these matters might be helpful should your corporate position change.
As many franchisors will know, insolvent trading occurs when a company cannot pay their debts as and when they fall due. The COVID-19 hiatus period can create a false sense of security by allowing franchisors and franchisees to trade in a cash flow neutral situation due to forbearance in payment obligations for rent, outgoings or taxes, or income from Government support. However at the end of the COVID-19 period, these deferred obligations may suddenly become due and payable.
Directors have certain obligations when a company is suspected to be trading insolvent which include a duty to prevent insolvent trading and a duty to consider the interests of creditors. These duties must be taken seriously, as directors can be personally liable where they have failed to meet the burdens placed on them under the Corporations Act 2001 (Cth) and impactions can include becoming personally liable for debts of the company, being disqualified from acting as a director for a period of time, fined, and even imprisoned for very serious breaches.
In response to the effects of COVID-19, the Australian Government has introduced a temporary six-month moratorium on insolvent trading liability for directors with the passage of the Coronavirus Economic Response Package Omnibus Act 2020 (Cth) on 24 March 2020. Part of the effect of the Omnibus Act is to give temporary relief to directors where their company might for a time fall into insolvent trading because of the economic disruption caused by the economic impact of the virus (‘Safe Harbour’ regime).
This means directors can have some confidence in continuing to trade in the face of potential insolvency. However, accompanying media statements and releases from the regulators make clear that the Safe Harbour regime is not a blanket licence for reckless trade where there is no realistic prospect of a company being able to trade out of its current difficulties once the interim demand and supply chain disruptions subside. This will mean that directors who allow debts to be incurred in cavalier manner (which potentially exploits employees and other creditors) can still face investigation for a possible breach of their core obligations to the company under the Corporations Act.
The Government protections concerning leasing impose good faith negotiation obligations that need to be met. Franchisors cannot allow problems to fester yet still expect to be able to take advantage of the safe harbor protections. The safe harbor provisions are intended to provide time for future planning, and the establishment of a future for the business post COVID-19. They are not intended to allow companies or directors to avoid their obligations to creditors or at law.
It is also important to note that a key element of the safe harbor protections is that directors obtain external expert input to any plan. We can assist to refer you to an appropriate expert who can assist you to develop a plan, at relatively modest cost.
As noted above, companies and directors need to be particularly vigilant to their circumstances at the end of the COVID-19 period. Contingent liabilities that have been deferred during the COVID-19 period may become immediately due and payable, with the possible impact that the company is no longer able to pay its debts as and when they fall due.
Unless franchisors are in a strong financial position that enables them to weather the COVID-19 storm and absorb all additional liabilities, or they are able to ensure their ongoing solvency in the post-COVID-19 period by reaching binding agreements with landlords and other suppliers, they may need to restructure to be able to continue. One step the may need to consider is entering a temporary period of voluntary administration, so that they can emerge fit to take advantage of future opportunities without the burden of the past.
In brief, voluntary administration involves the appointment of an independent and registered insolvency practitioner to take control of the company to try to save the business. VA is open to a company which does not have insolvency related proceedings already commenced against it. An Administrator will generally need to be appointed by the directors of the company of their own volition, or prompted by a request from a major secured or unsecured creditor such as a bank.
If the company is found to be insolvent, the Administrator will assess whether the company can be salvaged and on what terms. The Administrator can assist the company to better its position to allow management of the company to be handed back to the directors. Ultimately the Administrator has to decide whether creditors would be better if the company is liquidated, or a restructure occurs. In the context of a franchisor entity where assets are often largely intangible, and key assets such as intellectual property may be held by other entities, liquidation is likely to generate minimal return for creditors. A Deed of Company Arrangement that offers some form of a deal to creditors – cents in the dollar, terms payment arrangements, future contracts etc – may well yield a superior outcome.
There are some key benefits and pitfalls of the Safe Harbour regime and voluntary administration which franchisors should keep in mind:
Benefits | Pitfalls | |
Safe Harbour regime |
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Voluntary administration |
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The Safe Harbour regime and, in particular, a voluntary administration process are complex matters which franchisors should not rely on or take lightly. We recommend any franchisor faced with financial stress because of COVID-19 and its economic impact seek expert advice before implementing any proposed strategy.
Publication
Unannounced inspections or ‘dawn raids’ are used by antitrust authorities to obtain evidence when there are suspicions that individuals or businesses have infringed the antitrust rules.
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