NT CONSTRUCTION INDUSTRY UPDATE

Transcription

1 NT CONSTRUCTION INDUSTRY UPDATE Presentation for MBANT members 21 April 2015 Presented By Blair Pleash & Joanna Gawlak Hall Chadwick Nicholas Samios Hermes Capital Cris Cureton Squire Patton Boggs

2 2 Contents Housing Forecasts for the NT... 3 Receivables Finance... 4 Methods of Recovering a Debt... 7 NT Security of Payments Legislation Key Indicators of Business Success & Warning Signs Restructuring Options ATO/ Director Penalty Notices ASIC NT Company Statistics Graphs Appendix: Warning Signs... 1

3 3 Housing Forecasts for the NT The Territory property market is experiencing increasing sale volumes, home purchase prices and rents. Overall sales activity in the Territory has been trending upwards since the December quarter 2011; Territory dwelling sales (houses and units) increased by 1.9% in the year to March 2014; In 2013, annual land sales in the Territory increased by 25% ; The Australian Property Monitors reports that Darwin had the second highest median house price ($655,615) of all capital cities in the June 2014 quarter, behind Sydney; and The Australian Property Monitors further reports that Darwin is the most expensive capital city to rent a three bedroom house in the March 2014 quarter. NT forecasts anticipate a decrease in investment and new houses leading into 2014/15 which is predicted to be followed by significant increases over 2015/16 and 2016/17. The NT housing market can ocilliate erratically between these states, presenting a unique challenge to local business in the industry. Rapid growth to accommodate peaks in demand can become problematic when downturn occurs. Source:

4 4 Receivables Finance The underlying basis of business is to manage the cash flow cycle so that it becomes self generating. The challenges presented by cash flow management include: - Direct costs such as labour are payable regardless of cash inflow; - Overhead costs such as rent, electricity, leasing charges are payable regardless of the level of sales generated; and - Accounts receivable may remain outstanding outside trading terms. A misalignment of any one of the elements of the cash flow continuum will produce cash flow difficulties and stifle budgeted growth or perhaps, in chronic cases, even threaten the ongoing viability of a business. A solution to the cash crunch can be debtor factoring or discounting. Factoring vs Discounting Factoring is the purchase by the factor/finance company and the sale by a business of book debts for immediate cash. The factor will manage the collection of the accounts receivable. Invoice discounting is the purchase by the discounter of book debts on a continuing basis for immediate cash. The debtor collection functions are retained by the business and debtors remain unaware of the existence of the discounter. It is primarily due to this confidentiality that discounting currently accounts for 85 percent of total debtor finance turnover in Australia. The benefits of debtor finance include: - Availability of cash within hours of invoice issue. Typically, discounters will provide percent of the face value of the invoice upon issue. The remaining value of the invoice (referred to as hold back) is provided upon collection, less a factoring fee and interest charges. - It is the ready availability of cash that is the advantage of debtor finance, as it eliminates the vagaries of collection periods and allows businesses to accelerate growth. - The ability to utilise cash flow to obtain early payment discounts from suppliers. - Debtor collection controls are generally improved with the introduction of a debtor finance facility, which will reduce the amount of managerial time spent on collection administration. - Flexibility in financing needs can be incorporated in a debtor financing facility to reflect increased orders and growth. A traditional overdraft model based upon real property security is less adaptable to increases in turnover. It has to be acknowledged that debtor finance does not come without its drawbacks: - Cost - Factors/discounters do charge a service fee which will erode the return of a debt which would have been received if a facility was not in place. - Interest - Lending against cash flow is inherently more risky than more traditional real estate based security. Accordingly, a higher interest rate may apply to reflect the debt financiers risk profile. - Recourse - If a debt is not collected within a specified period (i.e. the non recourse period) the factor/ discounter may require the customer to repurchase the debtor, with resultant adverse cash flow implications. - Security - Depending upon the risk profile of the business, debt financiers may require additional security beyond the debtors ledger acquired. This could include charge security, deeds of cross guarantee from related entities or real property security.

5 5 - Collection periods Debtor finance is essentially a transaction based form of lending. That is, a facility constantly rolls over with the collection of debts enabling further funds to be drawn down through the purchase of new debts. If a business has delinquent or slow paying debts, it will find itself constantly at its facility limit, as the facility will not turn over as often as it should. The Ideal Candidate - debtor finance is suitable for a business with some of the following characteristics: 1. It is a credit based business there is no place for factoring in a retail environment. 2. Has rapid sales growth. 3. The debtor s ledger should have a high turnover level to avoid upward pressure on facility limits. 4. The business exceeds its current overdraft levels. 5. Current funding facilities are unable to respond to rapid sales growth with the result that the business loses possible opportunities associated with large orders and seasonal demand. 6. The business should have a spread of customers and not be overly reliant on one or two accounts. 7. Where there is a dominant customer relationship, not only is the success of the business inextricably linked to the continued viability of the customer but a dominant customer tends to set payment terms be it formally or informally. While we have seen instances of cash flow finance applied to the instalment contracts characteristic of the construction industry, the possibility of dispute with customers will unfortunately lead to tension in the financing relationship and the prospect of recourse. Case Study 1 Situation: Industry: Background: Pain Point: Growth Construction Steel fixing / concrete reinforcing - The client had been operating for nearly 20 years in the concrete reinforcement/ steel fixing industry; - The business by nature of the industry was labour intensive and carried a large payroll; and - The business won work on two large projects. The client s bank refused to provide a desperately needed overdraft and the business was at risk of becoming a victim of its own success. Hermes Solutions: Hermes Progress Claim Finance Hermes uses its unique experience in the construction and civil contracting industries to tailor debtor finance for progress claim billings. Runway provided: $500,000 Outcome: The business was able to undertake the new projects and has won further major works as a result. Case Study 2 Situation: Industry: Background: Informal re-structure Construction - Concrete pumping - The business had been established for seven years and mostly traded profitably in that time; - A large customer collapsed the non-payment of a major job tipped the business into insolvency; and - Business advisors sought to restructure the business as part of a business turnaround strategy.

6 6 Pain Point: The bank refused to support the restructure and sought instead to appoint receivers. Hermes Solutions: Hermes Disclosed Invoice Finance under this facility Hermes advanced 80% of invoice values as they were raised and remitted the other 20% (less fees) as customers paid. Runway provided: $3M Outcome: Hermes replaced the secured creditor (the bank) before a receiver was appointed and provided cash flow funding during the voluntary administration (VA) period. The business successfully emerged from the VA and was able to restore its sales volumes by funding its growth via the Hermes facility. Between 2000 and 2014 industry turnover increased from $10 billion to $62 billion (graph), which reflects a slight reduction to the industry high of $65 billion in , , , , , , , Annual Turnover $ Billion (Calendar Year) Discounting Factoring Cash flow financing is only relevant to businesses which sell on credit terms on a business to business basis. A breakdown of industries utilising cash flow financing indicates that the wholesale trade and manufacturing industries account for over one half of industry turnover. Wholesale Trade Manufacturing Labour Hire Business Services Transport & Storage Other Agriculture & Mining Construction

7 7 Methods of Recovering a Debt Contract Law - A contract is a promise or agreement made voluntarily between two or more parties. A contract is legally enforceable only if: - agreement has been reached between the parties; - a consideration has been given by at least one of the parties; - the parties have legal capacity and intend the contract to be legally binding; and - formalities (written or oral form of the contract) are complied with. Constructions contracts will normally set out the main payment parameters of: - the amount to be paid; - whether there are progress payments and if so, how they are to be calculated (valuation of work done, reaching of pre-agreed stage, etc.); - who will determine the amount of the payment; - when the payment should be made; - whether retention moneys or other offsets can be withheld; and - how disputes will be managed. Security of payment Clause - the contractor may insist that the contract includes for the principal to provide security for its payment obligations, particularly where the principal is not a substantial company. Security may be provided by way of cash, bank guarantees or insurance bonds. Methods of recovering/pursuing debts (after exhausting the contractual arrangements): 1. Instructing debt collectors - can be effective at motivating debtors to pay their debts, especially if it is sent by a law firm that has experience and a proven track record in debt recovery. The process can be summarised as follows: - The debtor fails to pay the creditor on time; - The creditor attempts to recover the debt by communicating with the debtor (phone calls, s, etc); - The creditor sends the debtor a formal correspondence (letter, ) threatening "legal action" if the debt is not paid within a given time limit; - The creditor takes "legal action" by contacting a debt recovery specialist; - The debt collector sends a Letter of Demand advising the debtor that legal proceedings will commence if the debt is not paid in full within a given time limit (7, 14 or 21 days); and - If the Letter of Demand is not complied with, the debt collector may issue Summons and seek a Judgement Order.

8 8 Debt collection flowchart: Source:

9 9 2. Subcontractor Charge - This was a charge available to contractors over the payments for construction works done under the Workmen's Liens Act 1893 (SA) - This legislation has been repealed, as not being effective and the Construction Contracts (Security of Payments) Act came into force. 3. Commercial Arbitration The arbitration agreement can be set out in the construction contract. It creates and defines the powers of the arbitrator and, with the Commercial Arbitration Act, the procedures of the arbitration. The determination of an arbitrator is called an 'award'. An award is final and binding and has the effect of terminating the arbitral proceedings. Each party is under an obligation to comply with the terms of an award. The Commercial Arbitration (National Uniform Legislation) Act 2011 Act provides that an award is binding and, on application in writing to the court, may be enforced as a Judgment of the court. 4. Negotiation/ Mediation/Expert determination - a process where an independent expert decides a dispute between the parties. It is not governed by legislation. The adoption of expert determination is a consensual process by which the parties agree to take defined steps in resolving disputes. As a result, the decision of an expert, although stated to be final and binding, can be challenged. 5. Issuing Garnishee Notice such notice may be issued following Judgment being issued by Court. 6. Legal action: - issuing Statutory Demand; and - proceeding to Winding Up the debtor. A Statutory Demand can only be issued to a creditor if: - the debt or debts owed total more than $2,000; and - there is no genuine dispute about the existence of the debt or debts. If the debt is based on a court judgment, there is an automatic presumption that there is no dispute as to the existence of the debt. A statutory demand may not include a claim for unliquidated damages. The courts have held that businesses that use statutory demands must ensure the demand is expressed in clear, correct and unambiguous terms. The demand must be in writing and in the prescribed form and it must be accompanied by an affidavit supporting the demand that would verify the debt is due and payable, where there is no court judgment in respect to the debt. Statutory demand must be served upon the debtor by delivering it or posting it to the company s registered address or delivering a copy of the document personally to a director of the company. A debtor has 21 days from the date of service of the demand to either pay the money owed or to make an application to set aside the statutory demand. This time frame is strictly enforced by the courts. If the debtor fails to comply with a statutory demand or have the demand set aside, a presumption can be made that the debtor s company is insolvent (section 459C(2) of the Corporations Act 2001). A creditor can than proceed to issue a Winding Up Application to liquidate the debtor s company. It will also, under the rules, file with ASIC a Notice of Intention to Wind Up a company, this then becomes public information. Issuing a statutory demand can be one of the quickest and least expensive avenues of recovering money owed by corporate entities. It is also one of the most effective ways of enforcing a judgment of the court if the judgment debtor is a company. An application for Winding Up is made to the Supreme Court together with an affidavit. The affidavit verifies that the debt is due and owing, and the Statutory Demand was served and remains unsatisfied.

10 10 Failure to comply with the Statutory Demand by the debtor, forces the Court to presume that it is insolvent and, unless the debtor can rebut the presumption of insolvency, a Winding Up Order is made by the Court and a Liquidator appointed over the debtor s business assets. In order to rebut the presumption of insolvency, the debtor will need to provide considerable evidence to its financial position to the court. In most standard construction contracts Winding Up will crystallise a termination of the contract. A winding up application (with affidavit) and statutory demand are technical documents and you should seek legal assistance in preparing, filing and serving them. Preferred option for debt recovery A. Manage your debtors to ensure they do not owe you too much over too long a period of time. Otherwise you could find yourself carrying out a quantity of work that may never be paid for. B. As a builder, this may mean keeping a tight rein on contract administration. C. Seek evidence of an owner s capacity to pay. D. Ensure that you have documentation of variations. E. Be prepared to suspend works under the contract, or issue a notice of default, if payment is outstanding for too long.

11 11 NT Security of Payments Legislation Tight margins and relatively low capital backing mean that cashflow is the lifeblood of the construction industry. The Construction Contracts (Security of Payments) Act ( the Act ) and accompanying regulations came into force on 1 July The Act has been recently amended, but those amendments simply refine a few issues arising from experience with the operation of the Act, rather than undertaking any great revolution in the security for payment scheme. The Act repealed the application of the antiquated Workmen s Liens Act (1893) (SA), that was part of the received law in Northern Territory. In doing so it got rid of the security that was afforded unpaid contractors and subcontractors under that regime. That security included being able to register a lien (that acted as a caveat) and prevented transactions over the owner s title and interest in the land upon which the construction work was performed, and for subcontractors to be able to charge money otherwise payable by a principal to a head contractor to be diverted to the unpaid subcontractor s account. There is no real security for payment under the Act as such (which makes the Act fairly useless in securing payment in insolvency scenarios). The main object of the Act is to facilitate the timely payment between contracting parties and to establish a statutory system for rapidly resolving payment disputes. What the Act does do is to: 1. make void certain provisions that may be in construction contracts for construction work in the Northern Territory; 2. vary certain provisions of those construction contracts; 3. supplement by implying in certain contractual terms where a parties contract does not include those terms in writing; and 4. provide for adjudication of payment disputes arising under Construction Contracts. The Act provides that where a construction contract does not have a written provision about the amount the contractor is to be paid or means of determining the amount, there is an implied term that the contractor is entitled to be paid a reasonable amount for the obligations performed. The Act: 1. Declares void: - "pay if paid" and "pay when paid" provisions which provide that payment to a contractor is dependent on the payee being paid by another person; and - clauses allowing payment to be made more than 50 days after payment claims are made (these clauses are to be read down to require payment within 28 days). 2. Implies terms into construction contracts where the contract does not contain written terms relating to: - being progressively paid the reasonable (contract) value for works executed; - being paid for variations; - making progress claims and mechanisms for payment claim; - the timing and mechanism of responding to a payment claims (must be a Notice of Dispute compliant with the requirements of the Act given within 14 days of the payment claim); - being paid interest on overdue payments; - ownership of goods/ duties as to unfixed goods on insolvency; and - return of security/retention money. 3. Implements a rapid adjudication process for determining payment disputes under construction contracts. These features can assist the contractor's cash flow and ability to prosecute underlying payment disputes to final resolution by the courts or other contractual dispute resolution process.

12 12 Under the Act, the term 'construction work' is given an extensive definition to include: 1. reclaiming land, draining land or preventing the subsidence, movement or erosion of land; 2. installing, altering, repairing, restoring, maintaining, extending, dismantling, demolishing or removing any works, apparatus, fittings, machinery or plant associated with any work mentioned in paragraph; 3. constructing the whole or a part of any civil works, or a building or structure, that forms or will form, part of land or the seabed; and 4. fixing or installing on or in anything mentioned above and any fittings forming, or to form, part of the thing. What rights does the legislation confer on contractors? 1. The right to be paid; 2. Right to interest on overdue payments (if not in contract, the Act implies the interest on overdue payments); and 3. Right to ownership of goods (Where a construction contract is silent as to the passing of ownership of goods related to the construction contract, ownership will only pass to principal when the contractor has been paid or when the goods become fixtures. The principal/client has a duty to make sure the good are not becoming a fixture if not paid for.) Dispute/Payment Claim PaymentClaim under the Contract (express or implied) term Response (e.g. Progress certificate or Notice of Dispute) under Contract or non payment If Dispute unresolved, apply for Adjudication (within 90 days of payment dipsute) Respondent to provide written response (10 working days) Adjudicator to dismiss or determine outcome (10 working days) A payment claim must accord with the written terms of the Construction Contract. If there are not written terms then the implied terms under the Act require the payment claim: - be in writing; - be addressed to the party to which the claim is made; - state the name of the claimant; - state the date of the claim; - state the amount claimed; - if the claim is made by the contractor, itemise and describe the obligations the contractor has performed and to which the claim relates in sufficient detail for the principal/client to assess the claim; - if the claim is made by the principal, describe the basis for the claim in sufficient detail for the contractor to assess the claim; - be signed by the claimant; and - be given to the party to which the claim is made.

13 13 The party receiving the payment claim must provide the response mechanism (e.g. progress certificate) provided for under the contract. Again, if none is provided for in the written terms, the terms implied by the Act require that within 14 days of receiving the payment claim, issue a notice of dispute to the claiming party and pay the amount of the claim that is not disputed. A notice of dispute must: - be in writing; - be addressed to the claimant; - state the name of the party giving the notice; - state the date of the notice; - identify the claim to which the notice relates; - if the claim is being rejected because it is not made in accordance with the contract, state the reasons; - if the claim is being disputed identify each item of the claim that is disputed and state, for each item, the reasons for disputing it; and - be signed by the party giving the notice. If the implied terms operate and the payment claim is not disputed by the giving of the notice of dispute within the 14 days provided, then the principal must pay the whole of the amount of the claim within 28 days from the date of receipt of the payment claim. Small Payment Disputes The Community Justice Centre Act 2005 came into force on 22 February Part 4 of this Act allows for determinations of payment claims for less than $10,000 for a fixed fee of $500. If a contractor or subcontractor has a payment dispute for less than $10,000, instead of serving their application for adjudication upon an appointer listed in regulation 5 of the Regulations, they can serve their application for adjudication upon the Director of the Community Justice Centre, who will act as an appointer and appoint someone to determine the dispute. The person appointed may not be a registered adjudicator, so long as the Director is satisfied that they have qualifications and experience relating to adjudication of disputes (in other words, the qualifications and experience relied upon by the Director, will not necessarily match the qualifications and experience prescribed for the purposes of section 52 of the Act. The parties share the payment of the application fee. Apart from these features, the adjudication process is governed by the Act. The Territory is the only jurisdiction to introduce a scheme for small contract payment claims. Adjudication of payment disputes The adjudication process is intended to resolve payment disputes fairly, quickly, informally, and inexpensively. The adjudication process relates only to payment disputes, which is where a payment is not made or security/ retention is not released as required under the provisions of the construction contract. A party may apply for adjudication of a disputed payment claim. A payment dispute arises when an amount is claimed under the construction contract s mechanism for payment claim (either express or implied) is due to be paid under the contract, but has not been paid in full, has been rejected or wholly or partly disputed. It is therefore the contract (which may have terms implied by the Act operating within it) and not the Act that determines when a claim is due and when a payment dispute can arise. Remember, even where the contract contains no terms about the contractor s entitlement to be paid, the entitlement to progress payments, how payment claims are to be made, responded to and paid, the contract still determines those matters because the Act fills the gaps by implying terms into the contract rather than by simply legislating what those terms will be.

14 14 Adjudication procedure To apply to have a payment dispute adjudicated, a party to the contract must, within 90 days after the dispute arises prepare a written application and serve it on the other party to the contract and the adjudicator (if one has been agreed by the parties in their contract) or a prescribed appointer. Sometimes construction contacts specify the prescribed appointer of the adjudicator. The application must: - set out the name and contact details of the appointed adjudicator or prescribed appointer; - set out the applicant's name and contact details; - set out the name and contact details of each other party to the contract; - include the construction contract involved (or relevant extracts); - include the payment claim that has given rise to the dispute; and - state or attach the information, documentation and submissions on which the party making it relies in the adjudication. The party that has received an application for adjudication must prepare a written response within 10 working days and serve it on the applicant and the adjudicator. The response must: - set out the name and contact details of the appointed adjudicator or prescribed appointer; - set out the applicant's name and contact details; - set out the respondent's name and contact details; - set out or attach details of the rejection or dispute in relation to the payment claim; and - state or attach all the information, documentation and submissions on which the party making it relies in the adjudication. The adjudicator must, within 10 working days of being served with a response to an application, or within 10 working days of the last date on which a response should have been served: - dismiss the application; or - determine, on the balance of probabilities, whether one party is liable to pay and in what amount or whether security or retention should be returned. Adjudicators can extend the period in which they provide their determination, with the Construction Registrar s consent. Parties cannot however get any extension of their time for application and response. Adjudicators can also award interest. Costs are to be borne by each party, unless the adjudicator is satisfied that a party has unnecessarily incurred costs because of a frivolous or vexatious application by the other party. The adjudicator must dismiss the application without considering the merits of the application if: - the dispute does not fall within the Act; - application was lodged after 90 days from when the dispute arose - the contract is not a construction contract; - the claimant has not complied with the procedures under the Act; - an order, judgment or other finding has been made about the dispute that is the subject of the application; - the adjudicator is satisfied that it is not possible to fairly make a determination due to the complexity of the matter or because the prescribed time is not sufficient. If the adjudicator makes a jurisdictional error, that is his or her initial assessment that the application ought not to be dismissed on one of the above grounds is wrong and the adjudicator goes onto a substantive determination when he technically does not have jurisdiction to do so, then the adjudicator s determination can be reviewed and set aside by the relevant court. This is how most adjudication determinations are attacked by parties aggrieved with the determination.

15 15 Adjudicators, in making a determination, are to act informally. They are not bound by the rules of evidence and may inform themselves in any matter they think fit. They can request further written submissions, request the parties to attend a conference and, unless the parties object, are entitled to inspect the work the subject of the dispute and to engage an expert to report. Generally however, adjudications are conducted simply on the papers and without any personal attendances before the adjudicator, to save cost and time. There is also now established in some recent court decisions a basic right to natural justice afforded parties in adjudication. This is starting to impact the process, as the adjudication procedures inherently do not, oft times, provide parties natural justice. For example the applicant has no right of reply to anything that the responding party puts before the adjudicator in its response. Unless the adjudicator asks for further submission an applicant has no right in the adjudication procedure to put, of its own volitation, a reply before the adjudicator. Once made, an adjudicator's determination is final and binding. There is no right of appeal on the merits of the determination. Essentially adjudicators can (and do!) make errors of fact or law in their determination. If they are no jurisdictional errors and there wasn t a substantial denial of natural justice that might have affected the outcome, then the determination is enforceable and the determination amount payable, on account, under the contract. The adjudicator's determination is enforceable by way of registration as judgement of the applicable court. Court warrants of execution can be enforced against non payers. There is also the prospect that a successful applicant with a determination (and preferably, a court judgment) can serve a notice of statutory demand under the Corporations Act as that party has a judgment debt. There are however complications with this procedure, as the statutory rights of set off under the Corporations Act are broader than common law or equitable set off that an adjudicator may have contemplated in the determination. Additionally, where an adjudicator has determined an amount is payable to the contractor and that amount is not paid, the contractor may suspend works under the contract until paid, whereupon it must get back to work no later than 3 working days after the amount is paid. The purpose of the adjudication process is to grant expeditious interim relief. In particular, the Act will enable unpaid contractors to receive payment of disputed claims expeditiously to prevent dire financial consequences. Payments pursuant to an adjudicator's determination are on account only. The parties are free to take their disputes to whatever forum is appropriate, court, or if they have agreements in their construction contracts to arbitrate, mediate, go to expert determination, etc then those right can be pursued. The determination amount must, however, be paid on account in the interim. Those involved in administering construction contracts should keep good records and ought to abide the contract payment terms carefully. If experts are needed for the dispute, then the timeframes demand they be briefed as early as is practicable. Where appropriate, you need to prepare your expert evidence as soon as possible. List of registered adjudicators can be found at: MBA is a prescribed appointer under the Act and the appointer of choice for members and contractors generally. Some MBA members are accredited adjudicators, but they are of course impartial when adjudicating. The WA/NT model of security for payment has been perceived to be more impartial than the East Coast model that has been asserted to be pro-claimant.

16 Key Indicators of Business Success & Warning Signs 16 The Current Ratio is mainly used to give an idea of the company's ability to pay back its short-term liabilities (debt and payables) with its short-term assets (cash, inventory, receivables). The higher the current ratio, the more capable the company is of paying its obligations. A ratio under 1 suggests that the company would be unable to pay off its obligations if they came due at that point. While this shows the company is not in good financial health, it does not necessarily mean that it is insolvent. It is useful to track accounts receivable turnover on a trend line in order to see if turnover is slowing down; if so, an increase in funding for collections may be required, or at least a review of why turnover is worsening. To calculate receivables turnover, add together beginning and ending accounts receivable to arrive at the average accounts receivable for the measurement period, and divide into the net credit sales for the year. For example, the controller of ABC Company wants to determine the company's accounts receivable turnover for the past year. In the beginning of this period, the beginning accounts receivable balance was $316,000, and the ending balance was $384,000. Net credit sales for the last 12 months were $3,500,000. Based on this information, the controller calculates the accounts receivable turnover as: $3,500,000 Net credit sales ($316,000 Beginning receivables + $384,000 Ending receivables) / 2 = $3,500,000 Net credit sales $350,000 Average accounts receivable = 10.0 Accounts receivable turnover Thus, ABC's accounts receivable turned over 10 times during the past year, which means that each account receivable was collected on average in 36.5 days. Source: A company's Gross Margin is its total sales revenue minus its cost of goods sold, divided by the total sales revenue, expressed as a percentage. The gross margin represents the percent of total sales revenue that the company retains after incurring the direct costs associated with producing the goods and services sold by a company. The higher the percentage, the more the company retains on each dollar of sales to service its other costs and obligations. Your gross margin can be compared to other businesses operating in the same industry to offer insight into the effectiveness of your pricing strategies. It is important for Directors to understand and be aware of the early warning signs of an insolvent Company, so that if some of these signs are identified, remedial action can be taken to avoid terminal insolvency, i.e. a winding up. It is a truism that the earlier solvency difficulties are acted upon, the more likely a successful turnaround can be implemented. The longer such problems are allowed to fester, the more likely the condition will become terminal. A top ten of warning signs of insolvency, are as follows: - 1. Non-payment of Tax Liabilities A Company will often forgo the payment of its tax liabilities to ensure that it has sufficient cash flow to meet its wages and critical supplier payments. This may be considered by many to be an effective use of cash resources in the short term, however in the long term after those tax liabilities have continued to accrue penalties and interest are then imposed.

17 17 Companies should seek financial advice, as a restructure may be able to be effected and a repayment plan entered into with the ATO to avoid the issuing of any penalty notices. 2. Continuing Losses Companies with continuing financial losses for the past 2 years should review the asset and liability position of the Company. Idle or non-performing assets may need to be sold, in order to purchase new assets that will generate income for the Company. Financial advice in the form of an investigative accountants review could also be sought, in order to determine if there are any non-value adding processes in place that could be stopped and/or that a reduction in overhead costs and employee costs could be achieved. 3. No access to credit In the event a Company has attempted to secure new lines of credit or to extend existing lines of credit, it may be necessary to engage an investigative accountant to consider alternative arrangements to be made, in terms of repayment of debts due, to achieve some breathing space and to free up some cash in order to continue trading. 4. Outside trading terms with creditors and supply on Cash on Delivery ( COD ) When trading terms with creditors are well outside normal trading terms, i.e days and creditors are demanding that supply be made with COD, it is time to seek some financial advice in order to get trading back on track. 5. Receiving demands and/or other legal notices When creditors are pressing for payment in the form of final notices and issuing legal demands, it will not be long before they receive a judgement order for their debt and proceed with winding up proceedings. 6. Sales are decreasing If trading has been reducing over a period of time, it may mean a company needs to free up some cash to promote its product and/or service, or the company needs to diversify. Financial advice should be sought to determine the company s place within the market and identify its strengths, weaknesses, opportunities and threats and to develop a plan for the future. That plan for the future may be in the form of an orderly sale of the business and a wind down of the Company. 7. Unfunded superannuation When businesses have been utilising the funds earmarked for employee superannuation contributions, in order to continue trading. Superannuation payments are to be remitted quarterly and are required to be paid within the month after the end of each quarter. In the event the funds are not paid to the respective super funds within the specified timeframe these amounts fall due as a debt due to the Australian Taxation Office, under the Superannuation Guarantee Act. In addition to the debt due, penalties and interest are applied. These amounts may also be included in the penalty notice issued by the ATO and as such, Directors may find themselves personally liable for these debts as well. 8. Excessive reliance on related parties Without any formal loan agreement and/or repayment plan, Companies have been borrowing funds from related entities and/or family members.

18 18 In the event the Company is wound up, these debts will rank equally with all other unsecured creditors and if insufficient assets are realised, may not receive any dividend. 9. Low stock turnover When a company s stock is not moving and the majority of stock on hand is extremely old and in some cases, obsolete. This will affect the value of this asset that Companies have recorded in the balance sheet and after adjustment of the stock value, a negative balance sheet position may result. Financial advice should be sought and perhaps an independent valuation undertaken, to assess the true value of the stock on hand. 10. High Accounts Receivable The debtors of the Company are just not paying and the Company does not have an accurate figure on the total amounts owed or the collectability of those receivables. A company may need to introduce a more effective debt collection process going forward. Further, an increasing number of SME s are utilising invoice discounting or other forms of cash flow financing to ensure continuity of cash flow and to streamline the debt collection function. There is no hard and fast rule in determining the insolvent state of a Company and if any of these signs are appearing, financial advice should be sought. Accountants have the expertise to conduct investigative reviews of a company s financial position and to prepare a solvency report on a company s business. Accountants are also placed to identify opportunities in the market place and the possibility of diversification. Alternative methods of finance may also be introduced to the company, in order to maximise cash flow. The earlier these symptoms are identified, the more restructuring options are available. With the current position of the economy, particularly in respect to the lack of availability of credit, all sectors are vulnerable. Those particularly at risk are traditional SME s in the construction industry, as: - developments have been commenced on the expectation of rising property prices; - price sensitivity analysis; - projects which were marginal and commenced on the basis of rising property prices are now at a loss; and - there is not the market (lack of funding) for property sales. Restructuring Options Workouts If action is taken early, an informal workout may be able to be effected, without the stigma of a formal appointment, which could reduce the value of the assets of a company or the loss of confidence of investors and/or customers. Furthermore, generally a formal appointment will involve additional costs, adverse publicity and result in an independent practitioner controlling the company s business, property and affairs. The advantages of a workout are as follows: - Reduction in costs; - Directors retain control of the business; - The company s reputation is preserved; - Directors can avoid insolvent trading and other voidable transaction recoveries; and

19 19 - It is not a creditor driven process. The disadvantages of a workout are as follows: - Directors may be found during the process to have breached their directors duties; - Any standstill and workout agreement requires the agreement of all creditors, i.e. without such agreement the non-consenting creditors are free to pursue their normal legal remedies and this can jeopardise the objectives of the workout. This is contrasted with a VA, wherein the decision of the creditors present, and voting at the Section 439A meeting, binds the entire body of creditors. Hence, formal administration provides for more certainty than an informal workout; - Financiers can potentially fall foul of the Corporations Act provisions with respect to insolvent trading by shadow directors; and - Directors may be held liable for insolvent trading. Voluntary Administration The objectives of the voluntary administration are stated in Section 435A of the Corporations Act, as follows: the object of this Part is to provide for the business, property and affairs of an insolvent company to be administered in a way that: (a) Maximises the chances of the company, or as much as possible of its business, continuing in existence; or (b) If it is not possible for the company or its business to continue in existence results in a better return for the company s creditors and members than would result from an immediate winding up of the company. The voluntary administration provisions allows for a short moratorium, which allows a company and its directors the opportunity to formulate a proposal to creditors, which will deal with the debts incurred prior to the voluntary administration and continue to trade in the future. The advantages of a voluntary administration are as follows: - An independent insolvency practitioner is appointed who controls the company s assets and reports to creditors on the financial performance of the company and its prospects for the future; - Administrator has the advantage of seven day rent free period in respect of property owned by others; - Directors have the opportunity to put forward a proposal to ensure the business and the company continues in existence; - The appointment of an Administrator avoids personal liability in respect of unpaid tax liabilities; - The process is relatively short, a standard administration lasts approximately 5 weeks; - It is a creditor driven process and they have the power to decide the future of the company; - Any dividends payable occur faster than if the company was placed into Liquidation; - Creditors and other stakeholders benefit from the company continuing in existence; - In the event a proposal is accepted by creditors, voidable transaction and preferences are not pursued; and - Creditors are unable to pursue personal guarantees during the administration process. The disadvantages of a voluntary administration are as follows: - It is a creditor driven process and they may reject the proposal being put forward and place the company into Liquidation; - The appointment is advertised; - The directors conduct and personal financial positions are reported to creditors; and - During the administration, directors are no longer in control of the company s business, property and affairs. Again, it is imperative that early advice be sought so that the options available increase. In the event early advice is not sought, directors may find that the only option available is a formal appointment and one that results in an orderly winding up of the company.

20 20 Liquidation The advantages of Liquidation are as follows: - An independent insolvency practitioner is appointed who controls the company s assets; - The appointment of a Liquidator avoids personal liability in respect of unpaid tax liabilities; and - Avoids the expense of a Voluntary Administration; The disadvantages of Liquidation are as follows: - Directors do not have the opportunity to put forward a proposal to ensure the business and the Company continues in existence; - The appointment is advertised; - Any dividends payable occur slower than if the company was placed into Administration; - The Company is being wound up with no prospect of a turnaround; - Fire Sale conditions may occur; - Creditors and other stakeholders lose out as the Company will not be continuing in existence; - Insolvent Trading and Voidable Transactions provisions are available and the director and other related parties can be exposed. Receivership A Receiver or Receiver and Manager may be appointed by the court or by a secured creditor. A secured creditor has the capacity to appoint a receiver and manager by virtue of a charge or mortgage over the assets of the company. The charge can be fixed and floating over specific assets or floating over all the assets of the company. The advantages of Receivership are as follows: - Avoid the expense of an Administration; - Receiver does not need to report to all the other creditors of the company, only their appointer; and - Receiver has advantage of seven day rent free period in respect of property owned by others. The disadvantages of Receivership are as follows: - The moratorium provided for in a Voluntary Administration is not available to a Receiver and thus unsecured creditors are free to continue with recovery/enforcement action; - During the receivership the director is no longer in control of the company s business property and affairs; - Unsecured creditors do not get to control the process; and - After discharge of secured creditor debt the company is returned to the director and the company may be vulnerable to some other form of insolvency administration.

21 21 ATO/ Director Penalty Notices On 29 June 2012, the Tax Laws Amendment (2012 Measures No. 2) Act 2012 received Royal Assent. The Bill extends with retrospective effect in an attempt to crackdown on phoenix operators. Previously, a director of a company had a fallback position before the Commissioner of Taxation could enforce personal liability in circumstances that the company has an unpaid Pay As You Go ( PAYG ) liability. The Commissioner of Taxation had to send a Director Penalty Notice ( DPN ) under Section 222AOE of the Income Tax Assessment Act 1936 prior to making Directors personally liable. The Notice provided that the penalty would be remitted if: - the company s liability has been discharged; or - the company is under Administration; or - the company is being wound up within 21 days from the date of issue of the Notice. Directors have been known to liquidate a company to avoid paying amounts owed to the Commissioner of Taxation. In the past the ATO has often been a source of cash flow funding to Company s struggling to pay their debts with the ATO often being the largest and only creditor of a Company in a Liquidation scenario. These amendments look to make paying amounts owed to the Commissioner of Taxation a primary consideration. The major change in the legislation is that the tax office has now been given the power to collect unpaid superannuation from Directors personally, and Directors are now provided a tight timeframe to avoid personal liability for outstanding superannuation and PAYG tax. The following is a summary of the changes and how the law will practically apply. The Tax Administration Act 1953 has now been amended to extend the director penalty regime to include outstanding liability under the superannuation guarantee charge (SGC) The legislation now extends a director s liability to unpaid superannuation guarantee charge whereby a director is liable to a penalty if the company has not lodged its superannuation guarantee statement and paid the superannuation guarantee charge by the end of the lodgement date. The Commissioner will enforce liability by way of a Director Penalty Notice, providing a period of 21 days before commencing proceedings. The liability will be remitted if the directors take one of the three actions described above (subject to those actions occurring within the new timeframe as discussed in point 2). Directors in certain circumstances will no longer be able to avoid personal liability However, the legislation provides that where 3 months has lapsed after the due date and the liability remains unpaid and unreported, the penalty will not be remitted as a result of placing the company into administration or liquidation. If the liability has been reported, Directors will still be issued with a Director Penalty Notice allowing them 21 days to take certain actions and avoid personal liability. The following is an example of the new timeline for company Directors to avoid personal liability for a typical company in the first quarter of the year, being 1 January to 30 March. For illustration purposes, let s say the company reports their PAYG tax on a quarterly basis and the PAYG becomes due and payable on or around the 28 th day after the end of the period (28 April). Also, superannuation under the superannuation guarantee charge becomes due and payable on the 28 th day after the end of the relevant quarter (28 April). Therefore, the critical day for both PAYG and SGC in this scenario is 28 th April and Directors have three months from this date to take certain actions to avoid personal liability.