Demystifying funding of companies in voluntary administration

Establishing a clear purpose and use for any funds provided is critical to formulating the parameters and terms of the arrangement. Common reasons to fund a company in administration include:

• Working capital funding where cash on hand is insufficient in the short-term. For example, debtors are not due, upfront inventory purchases are required for trading, or suppliers demand payment of pre-appointment debts to secure ongoing supply
• Funding short-term trading losses, e.g. bridging finance ahead of a DOCA or sale transaction
• To complete capital works to add value to the business ahead of an asset sale
• To facilitate the continuation of supply of critical goods or the performance of critical services, and/or
• To support an insolvency practitioner to accept an appointment where there is a risk that asset realisations could be insufficient to meet administration costs.

The structure of the facility should be aligned to the purpose.  In addition, an administrator will want the company to be in a positive working capital position to mitigate the risk of funding shortfalls and personal liability exposure.

A working capital need can sometimes simply be solved by a customer agreeing to pay invoices in advance (i.e. debtor finance).

An advance payment and ‘true-up’ mechanism may be appropriate where a funder has agreed to fund specific trading losses only. This provides the administrator with the necessary upfront cash flow but ensures the funder is only out of pocket for agreed losses.

A non-recourse loan is a flexible tool where the outcome of an administration or forecast financial performance is unknown. If there are sufficient funds at the end of the administration, there may be a repayment of the loan. However, if the administration fails to achieve the desired outcome (e.g. no viable offers to purchase the business), the company is not required to repay the loan.

To support an insolvency practitioner to accept an appointment where there is a risk that asset realisations could be insufficient to meet administration costs.

Administrators will likely propose a funding requirement based on the cash flow forecast for the administration period. The funding agreement may need to be flexible to account for unforeseen changes.  A capped drawdown facility may therefore provide the funder with a greater level of control if the company is able to self-generate more cash than initially anticipated.

A simple mechanism and approval process will allow for a timely release of funds.

The mechanism should be aligned to the funding purpose. Funding requests should be supported by appropriate documentation, such as cash flow, sales projections, financial results, and/or a debt recovery plan.

Often in an administration scenario, the company’s existing secured lender has security over the business and assets, leaving little collateral available to pledge against new funding. It is possible that the existing lender may be open to ‘new’ funding being granted ‘super-priority’ over existing debt, akin to the Debtor in Possession (DIP) funding model prevalent in Chapter 11 of the US Bankruptcy laws. However, based on our experience, secured lenders in Australia may be reluctant to entertain this option or it may take significant time to negotiate.

Therefore, holdbacks and debtor financing (of post-appointment debtors) may be worth considering if appropriate.

Administrators will also be reluctant or will refuse to provide guarantees or accept personal liability for repayment of the debt. 

It is for this reason, that a draw-down facility or imposition of stricter lending conditions and repayment terms may be appropriate to protect the funder.

The terms on which interest and other fees may be payable (if at all) will likely depend on the outcome of the administration. This may influence the funds a financier may be prepared to advance. However, an administrator may be open to capitalise interest where the unpaid portion of funding will remain in the company post-administration. Noting this would be subject to the administrator’s obligations to not unduly prejudice the interest of creditors.

Repayment of a loan under a funding agreement is not a given. Loans are generally provided on a non-recourse basis on the assumption that the funding will deliver a better outcome for all stakeholders than an un-funded administration.

If repayment is possible, the agreement should clearly stipulate the repayment terms. Where practical, these can be linked to trigger points, for example, receipt of sale of business proceeds, or execution of a DOCA. 

If funding is provided by a DOCA proponent, repayment can form part of the DOCA proposal. This can take a variety of forms so long as it provides a better return than liquidation and is approved by creditors.

Lenders may want to consider novel repayment arrangements that do not put additional cash flow pressure on a company as it emerges from voluntary administration. Where funding is proposed by a customer or a supplier of the company, funds advanced could be recouped over time though incremental trade discounts or price increases.

Consideration should be given to what happens to any funds drawn down that aren’t used as well as mechanisms to protect the lender if the loan remains in company post voluntary administration.  There may also be tax consequences that need to be considered – particularly if loans are forgiven.

Lenders should request regular reporting on the administration progress, cash flows and the estimated outcome to avoid any ‘surprises’ that might impact on the company’s ability to repay the loan.

Time is of the essence when it comes to putting funding agreements in place. Funders need to act quickly to support the business. Funding agreements are routinely agreed in principle in advance of an appointment. This means the directors are typically involved to schedule the appointment to coincide with the execution of a funding agreement - noting the agreement cannot be executed prior to the appointment as the administrator has no standing until that point.

Engaging advisors who have experience in negotiating these sorts of arrangements is helpful. Good legal representation is also crucial. 

It is common for administrators, pursuant to s447A of the Corporations Act 2001 (the Act), to make an application to court to support the proposed funding agreement, particularly in the event that repayment of the loan alters the priority of payments under s556 of the Act. This provides administrators with protection against any potential creditor scrutiny or recovery action.

Administrator entered into a new debtor funding agreement with the existing debtor financier, albeit it was a whole new facility and separate from the existing pre-appointment accounts.

Customers funded the trading of the company during the administration and the acquisition by the management team through a loan that was repaid over two years by reduced prices.

The administrators of a retailer had limited cash on appointment, but a going concern sale would provide the best outcome for creditors. A non-recourse loan with the existing secured lender was established that could be accessed if trading cash flows were insufficient to meet trading costs.