Well it depends. Insolvency usually gives rise to both legal and financial issues.
The company's external accountant is often the first person a director will approach for advice if insolvency looms on the horizon. Sometimes the accountant can provide sufficient advice to assist in the survival of the company. In my experience, when insolvency seems inevitable, many accountants will refer the director to:
- An ARITA member;
- A pre-insolvency advisor; or,
- A lawyer.
Sometimes a mix of these advisors become involved.
ARITA is the insolvency industry's professional body. The ARITA code of conduct and the Corporations Act strictly limit the extent to which ARITA members can receive referrals, advise directors, maintain their independence and then be appointed in a formal insolvency role, such as a liquidator or voluntary administrator.
Formal disclosures of referrals and other matters affecting their independence must be made in a document called a DIRRI (and lodged with ASIC after 1 March 2017). ARITA members seeking a formal appointment are limited to giving advice to the Board as a whole on the company's financial position, its solvency, the consequences if it is insolvent and the options available in insolvency. Once appointed, the appointee will also be required to act for the benefit of creditors. So whilst creditors may be well served by this party, directors should obtain separate advice about their own position.
If the ARITA member does not wish to be formally appointed, then they can give more detailed insolvency advice to a director on their personal situation. This advisor's disadvantage is that their advice will not be privileged, unlike a lawyer's confidential advice on legal issues.
A pre-insolvency advisor is an industry name commonly given to non-lawyers and non-ARITA members who advise directors about company insolvency issues, but who are not seeking the formal insolvency appointment. They are not constrained in advising the directors by the ARITA conflict rules mentioned above.
There has been some public criticism of these advisors, especially if they are not a member of a professional body. There were also some well publicised raids by ASIC and the ATO of some advisors' offices late last year, allegedly relating to possible phoenix company advice. They also cannot offer the "privilege" protection that lawyers usually can, when the lawyer provides confidential legal advice.
Members of the Turnaround Management Association include ARITA members, lawyers, private equity, bankers and other advisors. As the name suggests, these members concentrate on business turnaround assistance. They tend to advise larger companies.
Legal advice is sometimes viewed as unnecessary for a possible insolvency, given that the problem seems to be a financial one. Also, instructing a lawyer can be seen to be adding to the costs, when cash is tight. These views ignore the fact that insolvency often involves legal issues. Lawyers can also provide appropriate referrals where other advice is required.
Directors should be wary of receiving personal legal advice from the company's lawyer prior to insolvency. Whilst that lawyer can advise the Board as a whole, legal advice given to the directors by the company's lawyer under the company's retainer could be privileged for the company, but not the individual directors. And conflicts can arise. That advice could therefore be accessible by any formal insolvency appointee to the company, in the event such an appointment occurs.
A separate, independent lawyer should be engaged by each director if they want confidential legal advice about their own circumstances. That advice will usually be privileged in favour of that director. Some such advice costs may be covered by a D & O insurance policy after a formal insolvency appointment, if a claim has been threatened, or an ASIC or public examination enquiry involving the director has started.
Typical issues on which a director may need independent legal advice are:
- The extent of any insolvency practitioner indemnity requested to be given personally by a director at their appointment time. If that indemnity is open ended, it might be used to fund a legal action against the director.
- The personal effect on them of the various alternative insolvency regimes;
- In a voluntary administration:
- whether to formulate a Deed of Company Arrangement (DOCA proposal) and if so, what to offer, whether to negotiate it and how the proposal should be drafted; and,
- liaising with the Voluntary Administrator (VA) on this and information requests.
- Creditors meetings protocols;
- Proof of debt and voting rights – if they are also a creditor;
- Personal guarantee obligations;
- D & O insurance rights;
- Insolvent trading or other claims;
- Related party claims;
- Breach of duty claims;
- Co-director contribution claims;
- Public examinations; and
- ASIC enquiries, examinations or claims.
These are all matters that require careful consideration at a time when stress levels are usually high and available funding is low.
In our experience, obtaining legal advice sooner than later, in connection with potential insolvency issues, will save time and anxiety by identifying clear options to guide making good decisions.
The author has 30 years of experience in independently advising directors on such issues.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.