Pre-insolvency advisers and intangible assets – Muddy Waters

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What is the role of a pre-insolvency advisor in Australia?

Pre-insolvency advisors have not always had the best press in Australia: Registered insolvency practitioners (i.e., liquidators and voluntary administrators) are usually not interested in giving pre-insolvency advice: If they advise pre-insolvency, they will lack the required independence for a lucrative formal insolvency appointment.

This has left the space open for some unscrupulous phoenix operators who have advised company directors to offload assets to a new company (either directed by them or an associate) for below-market prices, or even for free. The original company is then wound up leaving creditors out-of-pocket.

Of course, not all pre-insolvency advisors are like that, with the majority being well-meaning small-time accountants, miscellaneous business advisors and the odd insolvency lawyer (guilty as charged!). The ABRT is working to develop these professionals into effective and ethical operators whose mission it is to help small and medium-sized businesses.

A pre-insolvency advisor in Australia will usually do the following:

  • Assess the cash flows and balance sheet of a financially-troubled business to work out whether it is insolvent, or likely to soon become that way
  • On the basis of that analysis, come up with some options for turning the business around, or, if the business is fundamentally unviable, the best way of ending the business.

A crucial component of this is identifying and valuing intangible assets.

Why are intangible assets so important for pre-insolvency advisors?

When corporate insolvency law, as we know it, emerged in the 19th century, the company balance sheet was dominated by tangible assets, including land and buildings, equipment, plant, inventory, and cash. Much has changed since then.

In Australia, much manufacturing now occurs offshore, with service businesses now dominating the economy. This, in turn, means that the assets of those businesses are largely no longer physical, but intangible, assets. In a service business, this includes:

  • Patents, trademarks and copyrights,
  • Domain names
  • Licenses
  • Branding
  • Trade secrets
  • Non-compete agreements
  • Client lists, and
  • Goodwill — the rest of the intangible assets of the company that are simply impossible to pin down, including the reputation and customer base that allow the business to make the revenue it does.

Perhaps most significantly, as the Australian economy is dominated by small companies where the owner-operator drives the business, it is the ‘know-how’ of this individual that is the main intangible: Whether a small construction contractor or a retailer, once the owner-operator is out-of-the-picture, the business is usually toast.

This means that a modern corporate insolvency in Australia has to work out how to deal with intangible assets.

Again, why are intangible assets so important to pre-insolvency advisors?

Intangible assets matter in pre-insolvency advice as:

  • An advisor may look into ways to monetize or sell intangible assets in order to raise cash and pay down debt. For example, a company may look at licensing its intellectual property to someone else.
  • The predominance of intangibles may mean that there is likely to be few assets to distribute in a liquidation. If a company leases its premises and equipment, and receivables and inventory are subject to personal property security interests, there may be nothing on the final balance sheet but intangibles.
  • A successful restructure might depend on securing those intangibles: For example, physical company assets might be sold on, but an owner-operator could be contracted to the new company to assist for a set period of time.

What challenges do intangible assets bring for pre-insolvency advisors?

Intangible assets really muddy the waters for pre-insolvency advisors. The key challenges they present are:

  • Identification. It’s not always easy for a business to tell which valuable intangible assets it holds. For example, a restauranteur may have their own distinct recipe which is the secret to his success. But it has never occurred to him to write it down or treat it as an asset. A pre-insolvency advisor needs to seek out these kinds of assets in order to come to a proper valuation. Or on the other hand, the trade secret may not have value to anyone else.
  • Valuation difficulties — it is hard enough to ascertain the value of intellectual property like patents and brands. But with the Goodwill of the company, it is all but impossible: The Goodwill of the company is often unique, making market comparisons difficult. It also requires extra expertise to arrive at a proper valuation that may be hard to come by. At the same time, an accurate valuation is essential;  otherwise, as recently confirmed in Intellicomms Pty Ltd (In Liquidation) & Ors v Tecnologie Fluenti Pty Ltd [2022] VSC 228, any transfer of the intangible prior to liquidation could be voided as a creditor-defeating disposition.
  • Uncertain ownership. Just because the owner-operator brings their know-how to their company, does this mean that the company owns that know-how? What if there are multiple owner-operators? How can the Goodwill contributed be apportioned between them?
  • Impossibility of sale — some intangible assets may not be able to be sold. For example, non-compete agreements held by the company against former employees might cease to apply once the company is wound up. This means that this asset is of no value in a liquidation. Similarly, some intellectual property might be licensed and not be available for resale.

The difficulty of assessing intangible assets in a pre-insolvency situation makes a strong case for restructuring the business, wherever possible. This might be achieved through the new small business restructuring process, an informal arrangement with creditors, or a pre-packaged insolvency arrangement using the ‘Safe Harbour’ in the Corporations Act 2001 (Cth).

The other alternatives, liquidation or voluntary administration (which almost always, itself, leads to liquidation), may kill the business proposition for good, as well as leaving virtually nothing for creditors. 

Can pre-insolvency advisors un-muddy the waters?

It is crucial for pre-insolvency advisors to ferret out and assess any potential intangible assets held by the distressed company. This will be essential for working out what the potential returns of a liquidation might be, and in order to avoid a potential claim for creditor-defeating dispositions.

The challenges that intangibles present may mean that it is often preferable for distressed smaller business to attempt a turnaround, that is combined with a small business restructure or pre-pack insolvency arrangement – rather than a voluntary administration.  

Thanks to Ben Sewell – a key ABRT supporter and Restructuring and Turnaround Practitioner.

Ben Sewell BA, LLB, LLM, MBA, MIPA, RTP® Principal of Sewell & Kettle Lawyers.

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