Weathering the storm and preparing for blue sky in the property development sector

By Damian Pearce - July 8, 2019

It seems there isn’t a day that passes without the media reporting on the troubles besetting the property development sector and in particular high density apartment developments. Right now the future seems more uncertain for the industry than it has been in the past, and the impact and length of changing construction cycles still tends to be underestimated. Earlier in the decade the sector kept liquidators busy in the 2012 and 2013 years as the post Global Financial Crisis stimulus launched by the Rudd-Gillard governments unwound.

It’s the grinding cyclical lag that can eventually catch up with those poorly prepared.  During this period, struggling businesses, particularly builders, can encounter risks such as creditor recovery action. The ATO is proficient in winding up companies and using specific recovery powers at its disposal, and banks can get nervous.  The use of bank guarantees is common to secure contracts and managing bank relationships can be uncomfortable. 

Unscrupulous predatory advisors can contact vulnerable business owners and tell them what they want to hear.  All too often they recommend transferring the assets, business and contracts to another company, leaving unpaid creditors wallowing in the previous shell with little hope of payment.  This is known as a form of phoenixing and the construction sector has a poor reputation for this practice.

If failure ultimately occurs, builder liquidations leave directors particularly vulnerable to large personal insolvent trading claims.  Combined with personal guarantees, director bankruptcy is common.

For the developer, contract clauses commonly allow them to terminate upon the liquidation of a builder (referred to as ipso facto clauses) which triggers a process of valuing unpaid works that is then combined with the bank guarantee to set-off against losses.  Despite these protections, often the costs of a new builder, legal fees, interest and site security (among other costs) often leave projects in the red for the developer. 

Greater support in avoiding business failure in 2019

The encouraging news is that 2019 sees a different environment to previous cycles, with a combination of factors making it more encouraging for companies and directors to be proactive in avoiding collapse. Of particular note is that the legislation, banking and ATO environment is more aligned than ever in supporting robust informal workout plans to avoid business failure. Firstly, banks have shown a willingness to work with customers in executing such plans, particularly where a reputable advisor is involved. 

Secondly, the ATO is increasingly more sophisticated in conducting its due diligence in deciding and agreeing to repayment arrangements. Similarly to the banks, the ATO takes comfort where suitably qualified advisors are assisting the taxpayer in ensuring effective financial reporting and corporate governance is in place. 

Thirdly, changes made to insolvency laws have been made to encourage business recovery. These include:

  • For any contract commenced since 1 July 2018, the use of ipso facto clauses to terminate contracts is restricted.
  • New Safe Harbour provisions provide protection to directors from insolvent trading claims where a course of action is taken that is reasonably likely to result in a better outcome than immediate liquidation or administration. Safe Harbour is not a formal insolvency process, such as liquidation, and therefore avoids (mostly) the very public process that can irreparably damage businesses.

To be effective, Safe Harbour requires prudent steps to be taken including lodging tax and BAS returns,  paying employee entitlements on time and appointing an appropriately qualified entity or advisor. 

The path leading away from business failure is always different

In general, every business experiences different problems and these require different solutions.  At one end of the scale, some will need to take immediate steps to improve efficiencies and rationalise resources. Adopting these strategies will require time and could simply involve the cash flow assistance of negotiating temporarily relaxed payment terms with creditors.

Heading towards the other end of the scale, directors may need to downsize their operations and navigate the cost and time burdens to achieve this including redundancies, sub-leasing space and asset sales.

In both scenarios, seeking advice and acting early is crucial.  When developing a plan, it should be articulated in writing and the barriers to success realistically addressed. Explaining the plan to someone impartial and trusted will help to determine what outcome is realistic. The time afforded by Safe Harbour can be used to coordinate the steps addressing cashflow needs and maintaining communication with stakeholders. 

Preparing for the opportunities presented by a rebound

The following are some additional housekeeping steps to consider taking, regardless of the current position of any business in the property sector:

  • Ensure bank guarantees for completed projects are returned in line with the contract.
  • Carrying out your own ASIC searches on contractors can provide useful warning signs such as wind-up applications or company name changes (a common sign of phoenix activity).  Wind-up documents are required to be served on the ASIC registered address of a company, as are ATO director penalty notices. Ensure these addresses are current for your companies.  A Personal Properties Securities Register (PPSR) search can identify the extent businesses are engaging new suppliers and potentially not paying previous ones.
  • Check your businesses’ recent financial statements and accounting records and note the existence of any related party loan accounts.  If an insolvency administration appointment occurs, loans owing between related parties can cause a cascading collapse.
  • Review your current business structures and finance to consider:
    • Are your risks and wealth adequately separated?
    • Who are the directors of each company?
    • Which entities or individuals have provided security or guarantees to support loans?
    • How can funds be accessed should cashflow become tight?

The above represents some of the broader issues being faced by distressed businesses and some mitigating actions.  In reality, all of these steps should be taken by a business owner and will be beneficial in the case of a growing business. If there is one thing the GFC taught us is that recovery can be swift and those prepared for the rebound can take advantage of some fantastic opportunities.

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