The key to planning, devising and implementing a successful turnaround is having the right team in place to properly assess all relevant information, circumstances and risks.
A turnaround manager is a specialist advisor or consultant engaged by a company at a time when the company is in or nearing financial distress. The turnaround manager’s role is to assess the company’s financial circumstances, address short-term cash flow issues, manage stakeholders (including creditors, suppliers and employees), scrutinise and test the existing business model, identify opportunities for growth and then to implement positive change.
More often than not, turnaround managers come from an accounting or finance background with a particular focus on distressed businesses, as their role typically requires them to undertake a detailed examination of the company’s financial information to assess the company’s solvency and the relative strengths and weaknesses of the likely underperforming business.
It is critical to the success of the turnaround however, that the turnaround manager is well supported by a competent and capable team with skills and experience across key areas such as accounting, legal, corporate, finance, change and people management and with industry specific market and asset experience.
Legal issues for turnaround managers
To successfully implement a turnaround, it is critical that the turnaround manager understands the legal framework within which a turnaround is implemented, including:
- how to identify insolvency;
- how to manage the risks and consequences of insolvency;
- the advantages and disadvantages of operating in an informal and/or formal insolvency environment;
- the nature, extent and risks of the company’s contractual rights and obligations (eg. financier/ trade creditor/supplier/ employee); and
- the options for and implications of a financial restructuring,
so that they may minimise the risk to the turnaround and also their own personal liability.
We look at some of the more common legal issues a turnaround manager may encounter below.
Specific issues before a turnaround manager is appointed
Terms of retainer and indemnity: the turnaround manager’s powers, responsibilities and scope of appointment should be agreed and recorded upfront. A failure to do so can lead to a misunderstanding of duties and responsibilities, which can expose the turnaround manager to personal liability for negligence and also jeopardise the turnaround project.
Turnaround managers will also typically seek an upfront indemnity from the company or a key stakeholder. A key consideration will be the scope of the indemnity and the extent to which it will be permitted by law.
Solvency assessment: the starting point of any turnaround is for the turnaround manager to undertake a detailed assessment of the company’s financial position to assess its solvency. The assessment of a company’s solvency (the ability to pay its debts as and when they fall due) is both a legal and accounting exercise, involving the application of legal tests and considerations to actual and forecast financials and having regard to existing facts and circumstances.
To minimise his or her own personal risk (including for insolvent trading as an officer or shadow director), the turnaround manager should obtain appropriate legal advice on the question of the company’s solvency and also on the risks of implementing the turnaround through either an informal and/or formal insolvency framework.
Specific issues once a turnaround manager is appointed
Financial instruments: the future of a distressed company is often dictated by the interests of its secured creditor(s) or large creditor groups (eg. bond/note holder groups). The turnaround manager must consider and understand the nature and extent of the company’s financial and security rights and obligations, so that he or she can manage the repayment timetable and any existing or looming defaults, including the risk of cross-default across the company’s corporate instruments.
To facilitate a turnaround, the turnaround manager will typically negotiate and document a formal forbearance or standstill arrangement with the main creditors, whereby those creditors will forbear from exercising their enforcement rights for a defined period of time on certain conditions such as an upfront goodwill payment or an early repayment plan. The terms of such arrangements need to be carefully drafted to ensure that the company is not trading while insolvent, the company’s rights, interests and entitlements are protected and that the position of those creditors is not unreasonably advanced to the company’s detriment.
Trade creditors and suppliers: a turnaround manager will need to ensure that the company’s business continues during the turnaround, so the continued terms of supply and trade are critical. A review should be undertaken of the company’s key supply and trading contracts to understand its rights and obligations with suppliers and creditors. This will allow the turnaround manager to determine what arrangements to continue, revise, compromise or terminate.
A review should also involve an assessment of the company’s compliance with thePersonal Property Securities Act 2009 (Cth), to assess whether the company’s rights and interests in its property and goods are adequately protected. For example, a review may find that the company has not registered its security interests, holds property it considers its own but is secured to third parties, or its trading terms are insufficient to create registrable security interests, all of which would leave the company exposed to forfeiture of property.
Employment issues: employees can be difficult to manage during periods of corporate financial distress because job security and entitlements become uncertain. A review should be undertaken of the company’s employment contracts, so that the turnaround manager understands staffing requirements, ongoing liabilities and termination rights and consequences. The turnaround manager should also consider the adequacy of the existing contracts with key employees, possibly with a view to re-negotiating new terms to ensure continued service during the turnaround.
Financial restructuring: to put the company in the best possible position to grow and avoid any relapse in the deterioration of its financial position, a successful turnaround will typically involve a complete financial restructuring, the objective being to better structure and manage the company’s cash flow and debt levels going forward. A financial restructuring will typically involve a careful consideration of legal, regulatory and tax issues and may include recapitalisation, asset sales, debt for equity swaps and even pre-packaged transactions through a formal insolvency administration.
Key lesson for turnaround managers
With any distressed situation, early intervention is critical.
In our view, the key to planning, devising and implementing a successful turnaround is having the right team in place to properly assess all relevant information, circumstances and risks, so that the turnaround manager can make informed decisions at the earliest possible time and with the least amount of personal and project risk.