Government’s Business Debt Hibernation Scheme Is A Watered-down Version Of Voluntary Administration
The government has made positive plans to reignite the economy post lockdown.
An example of this is the Business Debt Hibernation scheme. This is designed to increase the survival potential of a viable business that may be faltering because of the lockdown. The scheme allows affected companies to defer some of their current obligations to their creditors. It’s not law yet, but Finance Minister Grant Robertson and Minister of Commerce and Consumer Affairs, Kris Faafoi, have provided an outline of how it may work.
The new scheme is a diluted version of Voluntary Administration law. Both the scheme and VA have the objective of helping businesses deal with issues that are interfering with their ongoing viability. The law can and should provide means to intervene in such circumstances.
The Business Debt Hibernation scheme is not intended to prevent the collapse of a business that was failing before the crisis. Rather, its purpose is to assist a viable business that is under threat because of the crisis. Businesses that had issues before COVID-19 and are now seriously affected because of it will be able to use the full Voluntary Administration programme for rehabilitation.
If the Business Debt Hibernation scheme is accepted by the company’s creditors, some of the financial obligations of the business will be able to be deferred. To what proportion and for how long will be the subject of agreement between the company and its general body of creditors. If the required voting threshold is met, then the terms will apply to all creditors, whether they agreed to them or not.
Many businesses will take advantage of the scheme because of the low entry criteria and the significant benefit of increased liquidity. But there will be some challenges to this new law when it is made.
A healthy economy is based on the circularity of its cash flows. This means that currency must keep moving from buyer to provider. If a large portion of the economy uses the scheme, this link will be broken. A business’s inability to generate sales because of the lockdown will be swapped for an inability to collect accounts receivable that were generated before the lockdown.
Without some strict rules around entry criteria, large business could take advantage of smaller business owners who do not have the vote power to change the potential for an adverse outcome. This commercial effect already prevails, but the scheme will make it easier for more powerful businesses to obtain increased liquidity at the expense of smaller businesses.
Businesses will be encouraged to use this scheme and obtain the one-off “sugar fix” of increased liquidity. However, that benefit will be short-lived when they become affected by one of their debtors initiating the process. Recall the sticker that would arrive on monthly statements some 20 years ago, when debt collectors were more polite and less direct than they are today, which said something like “when you pay me, I’ll pay him, so he can pay you”. This again notes the need for circularity for any economy to survive.
The scheme can be implemented with just half the creditors agreeing. The rules are that approval will be granted if a majority of the creditors who vote represent a majority in the value of the claims of all those that vote. With that low threshold a few larger creditors in the pool can easily control the outcome. In Voluntary Administration, 75 per cent of the creditors are required to support the proposal. This threshold prevents control being centred around a small pool of creditors.
The effect of the low threshold will mean that half the creditors, who may have dissented or not voted, will have the terms of the moratorium forced upon them. This may prove fatal to the creditor company that is also dealing with the impacts of COVID-19, and now, as a result of the proposal adopted, are no longer able to collect their debts.
Despite these challenges the scheme has merit. It is simple and quick to implement and has self-help attributes designed to save costs.
However, while the programme may be easily started, its approval may be a different matter. To achieve that, the creditors that are just as keen to be paid as the proposer is to delay them, must agree on a way forward.