The feasibility study for the transition into fully automated stores of SmartMarkets Pty Ltd (SM) indicates that several million dollars will need to be invested in the first three years on software and hardware development as well as plant and equipment. At the first meeting of the board of SM, the directors discuss the various options available to SM to fund that project. These options include:
You have been asked to advise the board of directors in regard to:
(i) What are the key differences and factors for SM to make an informed decision between debt and equity funding?
(ii) What legal considerations should the board of directors of SMbear in mind when issuing shares or securing a loan?
(iii) According to your professional opinion, which of these is the best course of action for SM to fund the project?
Issue: The issue relates to the key differences and factors that SM would need to consider when choosing between debt or equity financing, the legal considerations when issuing shares and the best course of action.
Rule: Companies within Australia are governed under the Corporations Act 2001. Specific provisions are included in Chapter 6D of the Corporations Act along with Section 9, which defines the term issue in relation to interests in a managed investment scheme.
Application: Debt funding primarily refers to the borrowing of money directly, whereas equity funding refers to selling a stake in the company for securing a financial backing. Debt financing typically entails the inclusion of interest charges that are liable to be paid along with the principal amounts. Equity financing, in terms of SM, would occur when its holding company SF subscribes for more shares within the company and infuses capital. The type of funding would largely depend on the amount and the specification of the transaction. While debt funding can be clear and finite and is retained by the owner, the repayment can be a financial burden. Moreover, debt financing could also involve agreements to provide collaterals, which could put the business assets of SM at risk. Compared to debt funding, equity funding would allow SM to distribute the risk exposure of the business in a more spread out manner with SF. Moreover, SF is already the parent company for SM, which only makes sense for it to invest further for the automation of stores.
In terms of the legal considerations that the board of directors of SM bear in mind when issuing shares or securing a loan, it would be important to refer to Section 6D of the Corporations Act 2001. The foremost requirement for the issuing of shares or securing loans is the necessity of disclosure documents, although specific exemptions like small scale offerings do exist. Section 588G also prevent any company from engaging in trading when it is insolvent. Naturally, an adequate fund pool would be very necessary along with healthy assets in order to ensure that the business is sustained and the loan is repaid. Term sheets that comprise of all the necessary information related to the issue of shares are also very important. Furthermore, the finalisation of the issuing of shares would require the company to get down with the shareholders agreement followed by notifications to the ASIC using prescribed forms.
Based on the discussions conducted, the professional opinion for SM in terms of securing funding would be to asking its holding company SmartyFoods Ltd (SF) to subscribe for additional shares over time. The primary limitation of equity financing is selling of the stake in the company. However, it would not be as significant in the case of SM since SF is already its parent company. Naturally, the funds would essentially stay within SF and simultaneously save SM from any external financing risks.
Conclusion: In conclusion, the differences and the factors between equity and debt funding were discussed along with the considerations for disclosure and solvency for issuing shares or securing a loan. The best possible option for SM was identified as asking SF to subscribe for additional shares within SM as it was the holding company and the funds would in essence stay within the business.
Playco Pty Ltd is a manufacturer of children’s toys. It owns a large factory and warehouse in Sydney. It owns machinery and plant required to manufacture toys and has about $100,000 worth of toys stockpiled in the warehouse in anticipation of the Christmas rush.
In 2018 it borrowed money from MacBank to upgrade its manufacturing processes to include mobile phones. Security was granted over machinery and stock. Playco’s main customer for the manufacture of mobile phones was Mobilco. As a result of legal action launched against Mobilco for breaching design and patent rights of its bigger rival Banana Phones, Mobilco did not renew its supply contract with Playco.
Because of the loss of its major customer Mobilco and a significant downturn in the market for children’s toys in the past 12 months, Playco has serious liquidity problems. It has defaulted on its last three loan repayments with MacBank, and the bank has indicated that it intends to appoint a receiver. The directors of the Board of Playco are concerned about Playco’s position and the possibility that it may be involved in insolvent trading and are considering placing the company in voluntary administration.
Explain the process of voluntary administration and its advantages and disadvantages in this situation for (i) Playco, (ii) its directors, and (iii) its secured and unsecured creditors.
Issue: The issue relates to the pros and cons of voluntary administration for Playco based on the specifications of the case study and the implications on its directors, secured and unsecured creditors.
Rule: Section 436A of the Corporations Act 2001 discusses the prospect of voluntary administration and how it triggers a moratorium on the actions of the company or the business. Section 588G of the act speaks about insolvent trading.
Application: Voluntary administration is a process where a company that is deemed to be insolvent is placed within the supervision of an independent individual or the voluntary administrator to investigate the affairs. One of the most prominent benefits of the process of voluntary administration for the company is that it could avoid potential liquidation and sustain its prospects in the long run. It typically involves the putting out of a proposal to the creditors in order to preserve the structure and the business of the company. Furthermore, in the event of voluntary administration, the claims of the company’s creditors are frozen, which allows for a breathing space to assess the situation. It also allows for a mechanism to negotiate with the creditors and compromise debts. The process in this case would require the administrator for Playco to call convene a meeting of all the creditors of the company within eight business days to from the committee of creditors or to appoint a different administrator. A second meeting would have to be convened within 20 business days, where a report would be presented to the creditors outlining the investigation. The meeting would require the creditors to either vole for winding up the company accept the Deed of Company Arrangement or return control of the company back to the directors. The DOCA would require 50% of the both the majority in number as well as value of the creditors for it to be applicable.
Based on the specification of the case study, the voluntary administration process would be advantageous for Playco since it could continue to trade while tis financial future and stability is being assessed. However, the directors would lose all control and essentially have to operate under the administrator. The secured creditors, as defined under Section 12 of Personal Property Securities Act 2009, refer to creditors who have a security interest of the company’s assets. They are prioritised over the unsecured creditors when a company fails to make repayments. The unsecured creditors would be paid only after the secured creditors and the priority creditors. Unsecured creditors are paid on a pro rata basis based on the funds left over, which means that any categories that follow them won’t be paid anything.
Conclusion: In conclusion, the advantages of voluntary administration for Playco would be to be able to continue trade while the disadvantage would be skepticism from investors. The directors would lose all control, but if no insolvent trading was carried out, the process of voluntary administration could involve them getting back control. The secured creditors are paid prior to the unsecured creditors, which makes the process of voluntary administration highly advantageous to them.
SpeedyWay Pty Ltd (‘SpeedyWay’) is a small hire-car company. On 1stFebruary2019, one of SpeedyWay’s creditors filed an application for a compulsory winding up in insolvency. The application was granted and the court made the relevant orders to wind up SpeedyWay on 20thMay2019. A liquidator (Lexy) was appointed and, following an investigation of the affairs of SpeedyWay, Lexy estimated that SpeedyWay’s assets (plant and equipment and cash at bank) were worth about $50,000 and that SpeedyWay’s creditors (not including Pablo – see below) were owed $200,000. Lexy is not completely confident that this estimate is accurate since the company does not seem to have kept proper financial records.
Lexy’s research has also uncovered a number of company transactions that she would like to investigate further. For example, Julia (the managing director and majority shareholder of SpeedyWay) caused SpeedyWay to sell a car to her good friend Fred for $10,000 on 21stNovember 2017. This was less than half the car’s appraised value. At the time, Fred had no knowledge of SpeedyWay’s financial position.
On 1st November2018, Julia gave $20,000 from the company funds to her daughter Hannah as an 18th birthday present. Hannah purchased a car with the money.
Several years ago, SpeedyWay took out an unsecured loan for $50,000 from MacBank. In December 2018, SpeedyWay negotiated to make ‘interest only’ payments on the loan for the following 12 months (up until then the payment schedule had required ‘principal and interest’ payments). As part of that agreement, SpeedyWay granted MacBank a circulating security interest over its fleet of cars as security for the existing loan, and MacBank immediately registered that security interest.
On 18th January2019, Julia told her friend Pablo (who was owed $20,000 by SpeedyWay) that SpeedyWay was ‘hopelessly insolvent’ and that it would not be able to repay the full amount. Pablo agreed to accept a payment of $10,000 in full and final satisfaction of the debt.
In relation to each of the four (4) transactions described in the preceding four (4) paragraphs, explain if any money might be recoverable by the liquidator for distribution to unsecured creditors and, if so, on what grounds? What other sources of funds might also be available for distribution to unsecured creditors?
Issue: The issue within the case study relates to whether any money might be recoverable by the liquidator for the distribution to the unsecured creditors of SpeedyWay and their grounds along with any other possible fund sources.
Rule: Section 53 of the Corporations Act 2001 speaks about examinable affairs of a company, where s53 (d) (iv) refers to the company as a body being wound up.
Application: Based on the specifications of the case study, the first transaction involved Julia, the managing director and majority shareholder of SpeedyWay causing the company to sell a car to her good friend Fred for $10,000, which was lower than half the appraised value of the vehicle. Fred had no knowledge of the financial position that SpeedyWay was in. Irrespective, the liquidator would not be able to recover any money in this transaction since a valid sale was completed and Fred had no information regarding the company’s position. The asset was transferred and SpedyWay was paid the sum as a consideration.
The second transaction involves Julia giving $20,000 to her daughter Hannah from the company funds as a birthday present, which Hannah used to purchase a car. Considering that the funds belonged to the company and Julia used it for personal purposes, the vehicle that was purchased with the funds could be considered as proceeds of the company. It could be sold off by the liquidator at its current market value to repay the creditors of SpeedyWay.
Considering the next transaction, SpeedyWay took out an unsecured loan of $50,000 from MacBank, which agreed to offer interest only payments for 12 months for a security interest over SpeedyWay’s fleet of cars. Naturally, it would position MacBank as a secured creditor and their security interests could not be used by the liquidator to repay the unsecured creditors.
Lastly, the debt owed by Pablo was based on a verbal agreement, where Pablo agreed to accept a payment of $10,000 in full satisfaction of the debt. He would in essence be considered as an unsecured creditor and would only be paid on a pro rata basis once the priority and the secured creditors are paid. In terms of the other sources of funds that the liquidator could make use of to repay the unsecured creditors, the $50,000 that the company had in the form of plant and equipment and cash at bank could be used. The cash at bank could be distributed while the plant and equipment could be rented out. Apart from these, the liquidator could also look into any licensing or manufacturing deals that SpeedyWay had, if any, and they too could be utilised to repay the debts of the unsecured creditors.
Conclusion: In conclusion, only the $20,000 out of the company funds that that Julia gave to her daughter for personal uses could be utilised to repay the unsecured creditors’ debts along with the $50,000 in plant and equipment and cash at bank.
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