This episode was recorded on the land of the Wurundjeri people of the Kulin nation. We pay our respects to their elders past, present and future.
Richard: Hello, and welcome to another episode of Precisely Property. I’m your host, Richard Temlett. I’m excited to have you with us today.
If you’re here for the first time, thank you for joining us. I encourage you to listen to our previous episodes where we discuss all things property with a focus on dynamic discussions with industry leaders. In this episode, we’ll be discussing insolvency in the property and construction sector with Jonathon McRostie. So sit back, relax and let’s get started.
Based in Melbourne, Jonathon McRostie is a special counsel in Clayton Utz’s restructuring and insolvency team. Jonathon specialises in complex litigation with a focus on corporate insolvency and reconstruction matters. Jonathon acts for insolvency practitioners, banks, company offices, secured and unsecured creditors, and has worked on a broad spectrum of commercial litigation matters. Jonathon has been voted by peers as one to watch in insolvency and reorganisation law and litigation in Best Lawyers Australia. In today’s episode, we’re going to talk about insolvency in the property and construction sector. We’ll discuss the key concepts that everyone needs to be aware of and also explore what is happening on the ground in this space. We’ll also dive into the lessons that the industry needs to be aware of at this point in both economic and property cycles.
Welcome, Jonathon.
Jonathon: Hi, Richard.
Richard: Jono or Jonathon, the listeners will probably know in due course that you and I used to work together and practice law together. And I appreciate your full name is Jonathon, but I’m going to be calling you Jono moving forward because that’s how I’ve always known you. I hope that that’s alright. Jono, with all guests this season, I’d like to kick off with a question. Is there a recent story or trend that’s caught your attention and why?
Jonathon: Absolutely. Some of your listeners might have seen in the paper some statistics published on the ASIC website about insolvency appointments, and some articles, particularly AFR and The Australian talking about the rise in corporate insolvencies across Australia, a particular focus on the construction industry.
Probably one thing to say about that is the figures reported in the media are accurate from the ASIC reports. But perhaps when a reader reviews the numbers, it comes across as being quite diabolical, which is maybe not quite the case. Particularly, I think some of the media reporting is talking about, so this wave of construction insolvencies and trying to stem the tide of the failure of the industry. I think that’s not quite an accurate depiction of maybe what’s happening on the ground. That’s not to say that there aren’t significant problems in the sector, which I can get to.
But when you look at the numbers, particularly in Victoria, it’s been reported that over the last year there’s been a 45% increase in construction insolvencies. Now, that seems quite dire. And the numbers across all sectors I’ve reported has been quite sky high. But when you look at the actual historical numbers, we’re actually in a trend that’s lower than the historical average. So over the last 20 years, the current rate of corporate insolvency is actually less than it has been from the early 2000s up to the early 2020s.
So perhaps when listeners are looking at the media articles, whilst I think all of them are perfectly accurate in terms of what they report and what numbers are being published, there’s an underlying analysis of the numbers that doesn’t flow through. In particular for construction insolvencies, one thing to keep in mind is that there’s some factors that I think might skew the numbers a little bit higher than what they would in other sectors. So, for instance, the change in the model that a lot of construction companies and entities use, particularly the use of special purpose vehicles, means that once the actual project gets completed, the company, that’s the vehicle through which the project is run, is wound up. So it has served its purpose and it’s no longer needed for the project. But that gets added on to the insolvency numbers as being a winding up. So, it’s completely voluntary and in fact, probably a solvent winding up with a company with no assets and no liabilities. So, on that basis, there’s probably some numbers there that probably skew a little bit higher than what they otherwise would. Also, the nature of the industry now is less focused on one contractor doing all the work. It’s now your head contractor and then a delegation to arrange a subbies to basically perform aspects of the project.
And what that basically does is mean even if the head contractor is actually solvent, that project carries the risk that any one of the number of subbies who aren’t necessarily connected to the head contractor suffer financial distress and might be subject to an insolvency appointment. But it doesn’t necessarily mean that the project as a whole or the head contractor themselves are also suffering that financial distress. So, there’s some numbers there that I think, maybe, need to be understood in their context.
Richard: That is an absolutely fantastic answer. And, for those of you that have heard me present, I always say that often what’s put into the media needs to be critically analysed and critically scrutinised, and it’s not always reflective of every subsector or every submarket. And, I’m really pleased to hear that those numbers aren’t as high as they have been portrayed in the media because it does look quite dire, and it does flow through to very negative sentiment. So, thank you for giving some line of sight, particularly on those, the special purpose vehicles that do get wound up. It almost sounds a bit silly in hindsight that that’s being recorded as a proper insolvency event because when I hear or read an insolvency event, my mind goes to the worst-case scenario. And that’s also part of why I’m keen to have you on today is to talk a little bit more about what those different scenarios are to educate the audience.
Before we get into the main part of this session, could you for those that aren’t familiar with the Clayton Utz, explain a little bit more about who Clayton Utz is, and where you and the team that you’re in fit into the wider firm.
Jonathon: Yeah. Sure. So, Clayton Utz is an Australian owned, commercial law firm. We have head offices in six major cities in Australia. And we’re Australian owned, so there’s no international connection in terms of our partnership and our structure. Our firm has close to 200 partners, and probably triple that in lawyers. Our firm practices in a range of commercial law, so from litigation, tax, environment, planning, property, the full spectrum. We don’t do any criminal necessarily, or any family law.
In terms of where I sit in the firm structure, I’m in the restructuring and insolvency team at Clayton Utz, special counsel there. We sort of shuffle between two major practice groups. We’re both on litigious side, so in the corporate litigation, as well as the banking and finance team. So, depending upon the nature of the work that we’re doing on a day-to-day basis, I might be working quite closely with our transactional, insolvency and banking team. Or I might be in court doing various court related things, Richard, which you know all too well. We’ve got a relatively large team nationally, and a market leading one in terms of our competitors as well. So, that’s where we sit.
Richard: Right. Well, look, I knew a lot of that, obviously because I have previously worked with you back in Adelaide, and I remember those days fondly. We went through the GFC together. And why I reached out to you is because I feel that there’s quite a few similarities to the GFC as to now. There’s obviously differences. But in terms of the requirement for the industry to understand some of the scenarios that they might find themselves in either directly or indirectly and what the tools or steps are that they could take to make sure that they actually are looked after or get the best outcome, that is possible. And so the first part of the session, I’m keen to explore with you in a little bit more detail. When I was preparing for this, I see that compared to 15 years ago when you and I were practicing together, there seem to have been a number of changes to that legislation or the amounts that are required to for example, wind up an entity. I’m keen to start to demystify an area of the market that, in my mind, a lot of people don’t want to talk about. But at the point that we are in with both the economic and the property cycle, and I’m seeing a number of these even come across my desk from a valuation perspective, there’s a lot of distress in the market, but that does not mean it’s fatal or catastrophic. There are a number of steps, and I know that you’ve been involved in giving advice on what those steps are or acting for various consultants or the financiers. So I’m keen to explain to the industry what they are. And the context of this is and for the listeners, you’d be opening up the papers and often you’d see, as it applies either to property or to building and construction, you’d see, unfortunately, a developer or a builder perhaps pulling out of Victoria, and there’ll be words like it’s gone into administration or a deed of company arrangement has been signed or directors are liable for the actions of insolvent trading and things like that of a company.
And in my mind, even though I do have the legal background, I read a lot of these and it is alarming to read them. But I’m keen to talk through and have you explain to update myself, but then also update our listeners on what some of those terms are so that they know what to look out for because I think right now it is about risk mitigation. So, I’ll hand over to you.
Perhaps let’s start with liquidation. There’s obviously been a number of those terms floated around and, certainly, when I hear that, I think oh, that’s the end of the world. It’s like death. But I’m kind of in your hands. So let’s start with the liquidation definition.
Jonathon: Yeah. Sure. So, to preface that before we launch into liquidation, the one comment to make is the term external administrator tends to get thrown as a blanket over a number of different types of appointments. And whilst there’s a significant overlap between them and some of them have similar duties and roles, the reported outcomes and what they are able to achieve is actually somewhat different. And even from a legislative perspective, the roles actually have very different powers and objectives. So, it’s probably for the person on the street that doesn’t do this every day, you might see an external administrator and think one particular thing, when there’s other times it might actually be referring to a different type of appointment.
So, I could probably start with, if you like, I can start with liquidation. So essentially, a liquidation is the endpoint for a company. A liquidator will be appointed either by a creditor on an application to the court, a secured creditor, or by resolution of the directors of the company who have formed an opinion that the company is or is likely to be insolvent. It basically spells the winding up of the company, and it’s literally what it is in the section of the Corporations Act. For those that want to Google it, it’s the winding up. It is designed to effectively bring an orderly winding down of the affairs of the company, and the distribution of the company’s assets to its creditors and with some hope, its shareholders, if there’s any value left.
A liquidator is charged with a number of quite compelling powers at law. The liquidator steps in and is effectively able to take control of all the assets of the company, and recover debts owed by the companies, they are able to negotiate termination of contracts, pursue claims in particular against creditors for unfair preferences, which I can explain, its a bit of an amorphous concept to a lot of people I know. And I often get questions from clients about what exactly it is and how they deal with it. I can maybe deal with that in a separate part, if you like, Richard.
And, one of the other things that liquidators have a primary duty to, is to investigate the reasons for the failure of the company, and in particular, whether the directors have any culpability in relation to that downfall, and also whether or not there’s any particular transactions that were entered into by the company prior to its winding up that led to the insolvency. One of those is often the uncommercial transaction regime, which gives the liquidators power to bring claims against other parties to transactions that were uncommercial and not in the best interest of the company, and led to the company’s insolvency.
A liquidator has also got wide powers of investigation. Under the Corporations Act, a liquidator on appointment is able to summons for examination the directors of the company, to be questioned on the affairs of the company, and what led to the winding up. There are a number of different reasons why a liquidator might do that. It’s often an information gathering exercise as might be predicted to your listeners. If a company’s in dire financial trouble, one of the things that often occurs is a real failure to keep proper books and records. So, the liquidator walks in and based on what they’re seeing, they’re either unable to decipher the books or locate them. So one of their first ports of call is gathering all the relevant information.
A liquidator is also able to apply to court to examine non-directors, so third parties. That might be employees or anyone connected with the affairs of the company. That might be related entities. It could be banks, financiers, anyone involved in the company. So, they’ve got very wide-ranging powers of investigation. And ultimately, their duty is to recover funds and assets for the benefit of distribution to creditors, which I know your listeners will say that often, to report that people get cents on the dollar, and unfortunately, that is just the simple reality of what happens in liquidation because it’s there because the company is insolvent. It can’t pay its debts as they fall due, which means it’s a very unlikely scenario that creditors, in particular, unsecured creditors, are going to be able to recover much of anything from their unsecured debt.
The position vis-a-vis a secured creditor is a bit different. A secured creditor is one with security over the assets of the company. And they take a different priority and a different ability to recover their assets in the course of it winding up. I can go into it, Rich, but there’s a waterfall of priorities under the Corporations Act. When the liquidity gathers in all the assets, the assets distributed in a particular priority, those with the first ranking priority are effectively the secured creditors and the employees. I know it’s a lot, and I’m saying to you offline, Richard, that people study liquidation in a course of a semester at university or in their post grad. So there’s probably a lot to grapple with, but, and I don’t want to blind your listeners for science either.
Richard: No. No. That’s fine. Let’s shift gears then into administration and a deed of company arrangement. And why I say that is because our listeners would be well aware there have been a number of either builders or developers in Melbourne that have ultimately pursued this path. And what then is the difference between a liquidation and then an administration and a deed of company arrangement being entered into?
Jonathon: Yeah. Sure. So, the primary difference is the purpose of the appointment. So, unlike a winding up where the appointment of the liquidator is to wind down the affairs and ultimately to deregister the company and distribute its assets. The primary objective of a voluntary administrator is to try and attempt a recovery of the company as an alternative to the immediate winding up. So, an administrator will come in, take control of the company. The directors are basically put to one side, or they’re not removed from power, but they basically can’t exercise any powers during the course of the administration. The goal of the administrator will be to firstly investigate the affairs of the company and the reason for their appointment, which, most commonly is because the directors have decided and resolved that they think the company is always likely to become insolvent, and so they have appointed the administrator to put a stop on the ongoing bleeding of the company. And then for the administrator to provide a report to creditors, which gives an analysis of the financial affairs, and then to provide a recommendation to the creditors about whether or not there’s a viable exit for the company to keep it alive. Or if otherwise, anyone has proposed what’s called a deed of company arrangement, which is effectively a compromise of creditor claims of which there are a number of different outcomes that can result in the company’s assets being sold. It can result in the transfer of shares of the companies to a new entity, who then basically continues the business as a going concern. Or it might be an immediate winding down of the company as well. So, the main difference is that voluntary administration is there to try and save the company.
Richard: Gotcha. Yep. That’s what I wanted our listeners to be aware of because, again, you might read some of those terms and you just go, “oh, it’s fatal. It’s the end of the world.” It’s not necessarily the case. It seems to be that there’s a more commercial arrangement that’s entered into, as you’ve just said, to try and allow the company to survive.
Can I ask, one of the things we’re talking about offline, and it’ll be one of the lessons we talk about today, is getting advice before we get to these points. And I’m seeing it, especially as it applies to both property and construction, and particularly in Victoria. There’s a number of companies that are struggling to pay their debts when they fall due. What are some of the director’s duties of those companies? And in particular, what are these Safe Harbor provisions? And I must admit, I don’t know when they came in, but I’ve not heard of them. And so I’d love you to educate everyone on what they are and also when people should start thinking about them.
Jonathon: Yep. Sure. So, in terms of your overarching question, the directors of the company have a fiduciary obligation to the company as its shareholders to act in the best interest of the company. That’s a statutory obligation as well as one that’s a common law. It’s quite an onerous duty, and a part of their duties is also to act in a manner which avoids the company trading whilst insolvent. So, the law is structured in a way which if a company is insolvent at the time it incurs a debt, a director is potentially personally liable under the insolvent trading provisions for that debt incurred whilst the company is insolvent, or became insolvent as a result of incurring that debt. So, there’s quite significant and onerous obligations imposed on directors of companies and one that shouldn’t be taken lightly.
In terms of The Safe Harbor regime, The Safe Harbor regime was introduced, I think, back in 2017, and is a mechanism under the Corporations Act where the company can enter what’s called a Safe Harbor plan. There’s a lot of nuances to it, but essentially what it is – is the engagement of an appropriately qualified professional, often an accountant or ideally an insolvency practitioner or a liquidator, to work with the company to develop a plan which is reasonably expected to be a better outcome than an immediate insolvency appointment. What that does is that from the time that the directors in the company institute that plan and develop it, there’s a protection during that period to the directors for insolvent trading. The rationale being that it’s to encourage directors to try and not put their head in the sand about what the asset position is of the company, and to try and develop a plan to raise the company out of its financial woes. It requires a whole range of things to be done, though, in order to take the benefit of that exception to insolvent trading. So, there’s things like your tax lodgings need to be up to date. There has been an ongoing compliance with the director’s duties, and there’s a whole list of things that need to be ticked off. But I suppose for your listeners, the important thing is that, as soon as the directors have even at least an inkling that perhaps the company might be insolvent or maybe become insolvent, it’s really important to seek advice very quickly. The quicker that you seek either your advice from your accountant, your financial planner, or maybe ideally your lawyer, the quicker you can work out what your options are, and what sort of steps can be taken to stop the company from becoming insolvent in the first place. It doesn’t mean that by seeing an adviser, you have to immediately tip the company into liquidation. That’s not the case. But the earlier that you seek advice about what your options are, the better place you’re going to be to avoid the more dire outcomes, and mitigate your risk, particularly if you’re a director, in terms of your duty to prevent insolvent trading. The penalties that can arise are both civil in terms of actual claims for the debt as well as potential criminal penalties as well. There’s some very significant outcomes there to protect yourself from as well as the company and its creditors as well.
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Richard: Jono, I know you act for a lot of financiers. What is a receiver?
Jonathon: A receiver is a bit of an amorphous concept, but basically, and I’ll deal here with only privately appointed receivers, not court appointed receivers, which is a different sort of beast. But a privately appointed receiver is someone appointed by a secured creditor to take possession and realise particular assets that are subject of a creditor’s security.
So, that’s a long-winded way of saying, for instance, a bank or a financier loans a particular sum, there’s a default, there’s a non-payment of the debt, there’s an amount owing. The bank has a right to appoint a receiver, which has to be under the Corporations Act, a registered liquidator to step in and take control of either, depending upon the nature of the security, either the asset itself, or the business, with the goal of realising the assets or trading on the company for a period to repay the secured credit of the amount owing. Once the amount’s paid, the most common thing that occurs is that the receiver retires and steps away and hands back control of the company, if it takes control of the business.
And, there’s often an unfortunate interweaving of the appointment of a receiver and the other related insolvency appointments. Because, obviously, if the financier or the bank is taking those steps, it probably means there are other issues going on. So quite often, you’ll see, dual appointments. You’ll see a liquidator appointed, then a receiver is appointed over the top to try and secure assets, whilst the liquidator also undertakes their investigations.
Richard: Great. Well, look, there’s probably other terms that I’ve missed or that you might want to delve into. We can start delving into them when we start talking about what you’re seeing on the ground right now. And I suppose compared to 12 months ago versus now, how have things changed? What are you seeing in this space?
Jonathon: Yeah. Sure. In the construction sector in particular, whilst I said before that there’s maybe a slight skewing of the numbers, there still is some major issues with the construction sector.
So, one of the more common themes that you see on any of the construction appointments that I’ve been involved in is the cause of the insolvency is multifaceted but can probably be attributed to some major factors such as the squeezing of margins on contracts. There’s historical usage of fixed price contracts, which then basically meant that any cost overruns increase in supply, an unavailability of labor to meet deadlines means it puts an incredible squeeze on the contractor and their margins. That combined with what most insolvency practitioners have conveyed to me is an inherent issue in construction companies, which is a lack of real laser focus and precise scheduling and cash flow projections. It really comes down to organisation and management of ensuring that the stages of implementing funds and capital into projects is well managed. And the runaway of the project doesn’t get away from you in terms of being able to catch up to what you need to do.
There also seems to be a bit of a pattern of construction companies taking deposits for sales on particular lots or parts of the development. And instead of using those funds to further that particular development, they’ve utilised those funds on the next project. So they sort of roll from project to project to project. Now, the problem with that is that as soon as one of those projects starts to suffer cash flow issues, it then basically has a contagion risk throughout all their others. And then you run the risk of basically not being able to meet deadlines or payment obligations, and you’re basically moving money around the different projects to try and achieve and keep the creditors at bay.
Richard: Can they actually do that?
Jonathon: Well, at least in Victoria, unlike the proposed legislative reforms that had been proposed a couple years ago, where payments up to the head contractor were meant to be, or proposed to be held in a statutory trust for the benefit of subcontractors. That hasn’t been implemented in Victoria. So effectively once you to get paid, it goes to their bank account, and they can use that for… whatever they like…
Richard: Oh my goodness,
Jonathon: There’s been a lot of reporting recently on the statutory trust. I think it might have been something in the paper about a week or two ago, where I think the Albanese government had rejected that proposal. There was some feedback from the industry about that. And the main risk there is, obviously, to the subcontractors. The subcontractors do all the work, head contractor gets paid. Under the statutory trust, it’d be deemed to be held on trust for the benefit of the subbies to ensure the subbies get paid. That’s not yet been implemented in Victoria.
Richard: Jeepers. Okay.
That’s a little bit in the building and construction space. I know you act for a lot of the financiers. What are you seeing in that space?
Jonathon: Real hyper focus on retail. So the financiers are quite nervous about any funds that have gone out to particularly the bricks and mortar retail sector.
Richard: Okay.
Jonathon: There is serious stress on the industry, and I think, probably a lot of my colleagues would say probably even more so than what I’ve referred to in the construction industry. It’s not spread evenly across retail. It tends to be more focused on what you would probably call the more discount or mid-level retail brands. So, Mosaic recently, Jeanswest earlier this week.
Richard: I saw it.
Jonathon: Who really have a heavy reliance upon their bricks and mortar stores. Lots of food traffic, lots of discretionary spending with the current economic climate. People are basically deciding that buying that cheap t-shirt from the retail store is not saying that it’s an essential thing, and they’re putting their money elsewhere. And unfortunately for those types of retailers, they’re really suffering. Now, whilst that’s quite significant for the retail sector, it also has a flow on effect to the other parts of the broader economy. So, in particular landlords. The landlords of the bricks and mortar stores obviously rely on their tenants being profitable, and they are to pay their rent. I get inquiries speaking internally at Clayton Utz from our property team constantly about them acting for landlords and having lots of issues with getting payment on time with their tenants. One thing that you notice is quite often the landlords are having to resort to doing things like calling on bank guarantees given by the tenant. And whenever it comes to rental increases under the lease, the landlords are trying their best to mitigate their risk as much as possible. And one of the things they are doing is increasing rents, increasing security deposit bonds, much tighter terms on termination, anything that they can think of to sharpen the focus of the tenants to pay their rent. And obviously, what that means is there’s a bit of a push and pull by landlords at the moment to decide, well, if I’ve got a tenant in a commercial premises on a three or four or five year lease, but they’re constantly late on terms, and I’m always $50-$100 grand in arrears. Am I better off exercising my rights and terminating that lease and getting a new tenant in? But the problem is at the moment, who are you going to get in? Who’s a better tenant than who you’ve already got? Particularly in the retail space at the moment, and the tough competition.
So, at least from the bricks and mortar side, that’s what we’re seeing. There’s also flow and effect to online retail. You might have seen, I think maybe a couple weeks ago, Wesfarmers have pulled out of their catch.com.au business.
Richard: I saw that. Yes.
Jonathon: Marked down primarily due to really fierce online competition. So, you see even really well-established, well-resourced businesses such as Wesfarmers pulling out of that sector. Just the simple profitability of that is really tough. And you’ve got lots of disruptors now in the market, particularly online, who don’t have the overheads of the bricks and mortars. They were able to operate on very thin margins without all the same level of risk as what the major retails, Myer, David Jones etc, and acting as a disrupt in that market too.
Richard: That is fascinating to hear. I’d heard similar comments about retail, but certainly you’ve unpacked them and your lens you’re at the coalface. So to hear that, I think there’s a number of our listeners in that retail space. I hope that they are listening and do reach out to you.
You made a number of comments about risk and identifying risk and mitigating risk right now. Based on where we are in the market cycle, is that something that you’d be advising your clients or I suppose anyone right now?
Jonathon: That’s, probably 9/10s of my day to day. Depending upon the circumstances, all the clients want to know about is, what’s my risk? What’s my exposure?. How do I minimise that exposure? If it’s already going south, how do I cut it off at the knees to stop the bleeding? It really is a fact dependent scenario, but taking an example, if you’re acting for say a financier, a private lender, the steps you have to take are ensuring you’ve got really robust security. If you’re going to be lending any form of capital, get your lawyers to check where do you rank in terms of your security interests? Is there a major bank or financier ahead of you that might sweep the cash or sweep the asset before you’re able to even enforce? Because your security only is as good as your ability to enforce it and recover.
What do your contract returns look like? How can you accelerate repayment of the money that you put in? Is there a default that you can craft that are more favorable to you as a financier? Is there cashback guarantees that you can get? Is there other security that might be on offer? There’s a whole range of things you need to consider.
But in terms of the risk mitigation, it’s first on the list of pretty much every matter that we work on, whether or not you’re acting on director side, company side, whether or not you’re acting for a bank, financier, and even on a day to day basis on any of my insolvency files acting for the liquidators and administrators and receivers. It’s all about focusing on where to avoid pitfalls and avoid the unwanted claim or repercussion at the end of the chain.
Richard: You made a comment about the quality of the security, and I wanted to pick up on that a bit more because I’ve had a couple of clients, and they would have been the unsecured creditors, and they’re going, “Richard, I’m not that worried because if this company defaults, I’ve got such a high interest rate that I’m going to get a lot of money. So, I don’t really mind if they default.” But your point being that it’s well and good if you even charge them 20% interest, but if you can’t or if you don’t have good security, it’s worth nothing. And I suppose that’s something for people to keep in mind because if I’ve heard it once, I’ve heard it a dozen times over the last couple of months where people have gone, I’ve got interest rates at 20% or 25%, so that’s fantastic. If they don’t pay, it’s just ticking over 25%, and I’ve gone, guys, I’m no longer a lawyer, but, you need to go get legal advice because how you enforce that and then you get that money back, if at all, is absolutely critically important.
Jonathon: Yeah. Well, it’s probably a bit of a combination of getting legal advice as well as expert advice about what is the actual value of the secured asset, and what does it look like? What’s its realisable value? As you say, Richard, you’ve got a parent interest rate of 20% on your facility. That’s fine because it might increase the volume of your debt. But ultimately, if the asset that you’re looking to appoint over has no equity in it, or its value is dropping, or the market conditions change such that if you were to enforce, you’re not getting all that money anyway. It’s all probably fine and well to have quite robust and aggressive default terms and interest. And so I might make the money up on the back end, but you can’t always rely on that being the case.
It’s doing that due diligence prior to putting the capital out to work out, well, if I do get this security, if I do get a mortgage over that particular property, what does a default look like to me? What steps would I take to ensure that the net realisable value of the money that I put out is actually recoverable? Something we see quite often is receivers being appointed, but then ultimately having to battle to try and get cents on the dollar on a particular asset or parcel of land. And the bank or the financier having to take a haircut because the nature of the security whilst maybe bulletproof in terms of securing the debt, is in terms of its value not good enough.
Richard: Jono, the last point that I wanted to make from my end today, and I’m obviously keen to give you the opportunity to make your last couple of points, but it occurs to me where we are in the market cycle, where we are in the property cycle, there’s actually no shame in going and getting advice to the status of your financial affairs. I think being in the industry more broadly, especially the developer side of things, everyone likes to talk about success and doing so well, and it’s almost like a sign of failure or weakness when you’re not doing so well. And I’ve seen over the last 12-18 months, particularly in Victoria, some of my closest clients have been very lovely, and they’ve shown me some of their projects and the fact that they’re not financially viable. And there’s almost like an element of shame as if they’re a failure. And I think for the most part it’s very different to the GFC (Global Financial Crisis) where there were different reasons for the GFC, of course.
Right now, with the impact of the pandemic and that domino effect, that flow on effect in particular in Victoria with the devastating lockdowns, I don’t believe that there’s any shame in going, you know what? We do have cash flow issues. We do need to get professional advice because what I’ve heard from you today and had confirmed is that there’s a number of steps before liquidation that people can take, and it’s in their best interest as well as the company and the creditors’ interest for that to be taken because it can minimise the potentially devastating impact of putting your head in the sand.
Jonathon: Absolutely. The one thing I’ll say is whenever a client comes to me relatively early on and they say, look, I’ve identified some problems, I need to get some advice about how we restructure things. I need to get some advice about what my risk is as a director, or what the risk is to the company, what the risk is to the particular project or the property that we might be developing, whatever it might be. The sense that I get is that person is incredibly sensible. And I don’t think anyone looking back would ever say there’s any point of shame there. In fact, I think it’s actually the opposite. I think there’s, probably rightly, the shame attached to those that do nothing, let their debtors rack up, unrecoverable, let their creditors keep knocking at the door, don’t pay the ATO (Australian Taxation Office), don’t pay PAYG, that’s when you get your name in the paper. That’s when things start to look like you don’t know what you’re doing. And so many of those things can be mitigated or perhaps even avoided by reaching out to professional advisers that can assist you with that. Like I said, whether or not that be your accountant to put in the right direction first, or whether or not that be a lawyer or even seeing an insolvency practitioner, there ought to be no stigma attached to that.
In particular, a point to make is whilst insolvency practitioners have that moniker, one of their primary job is actually to restructure and recover businesses. So, giving pre-appointment advice and assisting a business to identify what the cash flow issues might be, what restructuring might need to occur, what things need to be sold, what things need to be recovered. And it’s through that they provide such great value to any corporate entity with financial difficulties. And, frankly, cash flow is not an uncommon problem throughout any industry, so there should be no stigma attached to it. You should feel free to open up to your trusted advisers to get that help.
Because what we see often is the companies that can’t recover, they get put into liquidation, it’s almost always because of poor management decisions. And a part of poor management decisions is not identifying those risks and those problems and seeking advice at the appropriate time. I think the worst thing you could ever do is put your head in the sand and try and get to the next project or hope that the particular creditor doesn’t send you a demand letter, or hope the ATO doesn’t issue you with a notice. Because, unfortunately, those things are happening. And the more that you can do to intersect those things, the better you’ll be. It’s not just from a personal risk perspective, but the viability of the company. If you leave it too long, they will get to a point where even the best adviser or the best accountant would say there’s literally nothing that can be done, and you need to wind things up.
Richard: Great. Well, Jono, we’ve got through a huge amount today. I wanted to thank you for letting me pick your brain and obviously educate the audience. Are there any other final points that you wanted to make, in the context of education and knowledge sharing?
Jonathon: I think the take home message is if you are running a company or project, if you’re a CFO or you’re a COO, and you’ve got any concerns about any of your ability to manage either risk or your financial performance, seek that advice as soon as you can. Speak to your other directors, speak to them, raise it with them. Ensure that everyone knows what’s going on. One of the major pitfalls is when someone in the business notices something and doesn’t say something about a particular cash flow problem or whatever it might be. Because ultimately, when it gets back to the directors or management, the feedback is, well, it’s too late now. There’s no point telling me about a cash flow problem that we had six months ago that now has led to us not being able to complete a project or meet a particular deliverable. And now that means that there’s no option for the company to tip. So, in terms of any take homes, it’s reach out to those that can help you, because ultimately, those around you, your business will thank you for identifying it, and taking a proactive step.
Richard: Great. Well, look, thank you again for your time. I will put your details in the show notes. And everyone, I hope that you’ve learned a lot from Jonathon today, and please do reach out to him. He distills concepts that are extremely difficult, extremely complicated, I think very well. And I know that he’s also put out a number of articles. You can jump on the website, so we’ll grab a couple of links to them. I’d encourage you also to read them because it’s important now, one of the themes being risk identification, risk mitigation, and moving forward. And, certainly, for the next 12-18 months, I think that there’s a lot more that everyone needs to be doing in that space so that we can all get out of the point in the market cycle that we’re at now, and there’ll be more upsides as the market starts to improve. Thanks very much, everyone.
Hi, everyone. I hope that you really enjoyed listening to Jonathon’s view of the world from a legal and a risk perspective. I find it incredibly insightful, and it’s really important to keep in mind at this point in both the property and the economic cycle that these are discussions that we need to start to have and considerations that need to be made.
The three findings from today that I’d like everyone to go away and have a bit of a think about and then potentially reach out to myself or to Jonathon are as follows. The first one is the insolvencies, and Jonathon’s comments about the media reporting on the level of insolvencies and whether they are being accurately reported. I thought that that was a very telling finding. I’ve said for a while now that often the stats don’t always tell the full story or whether the devil’s always in the detail. And certainly, listening to him talk about what those insolvencies are, how they’re recorded, gave me some really good insights into areas of more or less risk. And I think at a headline level, as I’ve said to you previously before, don’t read everything in the media and take it as gospel. You need to critically analyse to see what’s actually below the surface in all of these issues. So that’s the first point.
The second point, and I think it’s really important again for where we are in this property and economic cycle, please don’t put your head in the sand. I can’t emphasise that enough. There are a number of steps that can be taken prior to any sort of event that involves liquidation or bankruptcy. And the sooner you do it, the better. I can’t help thinking and I know that it’s very difficult and people do perceive it as almost like a sign of failure or weakness to go and get help or to seek this type of advice. But I can’t emphasise enough from a risk perspective and a risk mitigation perspective, and then your own brand and your own reputation or your company’s brand and your company’s reputation, going and getting that advice as soon as possible, I really think can result in a better outcome for all parties.
The third one, and I thought it was really interesting to hear Jonathon’s comments about the issues in the retail sector. I must admit, I was a little bit surprised at that. Not so much that there’s issues in the retail sector, because I know that there are and I’ve spoken to him as well as a number of the retail REITs or even some of the super funds, and they have said that the issue is in the retail sector. I think when I’ve reflected on this, perhaps some of the clients at Clayton Utz are the larger ones that would enter into either retail or a commercial office market, and there’s certainly issues in both those markets. But please also keep in mind and don’t underestimate the issues that are on the residential sector right now. A lot of the focus certainly in my work is on the residential sector, and a lot of the findings that Jonathon spoke about today or the themes and so forth, apply and are absolutely critical now for the residential sector.
Finally, the point that I’ll leave everyone off with is the type of security against the asset. Again, this is absolutely critical, and that security obviously is very different if it’s a retail or a commercial asset that’s already been completed versus a development that has not been completed. The level of security and what is required, is absolutely essential to understand it, to price into the risk.
And, again, Jonathon’s comments about looking at what that security is, what the value is, how it’s secured. The terms and conditions are absolutely critical. This was not even relevant a few years ago prior to the pandemic, but now, and this is where it comes down to that good risk identification and risk mitigation. So, again, I hope that today’s session was enlightening. I appreciate it might be a bit confronting for a few people. But, property development and investment does have risk. It does move in cycles. And at the point we’re in, these are some of the conversations that we need to be having. Thanks very much, and hope you enjoy your day.
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