When a company hits financial turbulence, the instinct often is to stabilise the business by accessing more funds is understandable. Yet, when the company is heading toward insolvency, that instinct can cause issues with directors’ duties, exposing directors to personal risk, potential claims, and extended financial fallout.
This article explores the tricks and traps of refinancing under pressure, and the alternatives available to companies through restructuring options that may provide a safer outcome.
The Issues
When a business is deteriorating financially, directors must tread carefully. Insolvency risks heighten the standard of scrutiny placed on every decision. Refinancing or restructuring that adds further debt, increases personal guarantees, or introduces harsher enforcement terms can expose directors to the risk of:
- breaching the duty to act with care and diligence
- incurring debts while insolvent
- failing to act in the best interests of creditors when insolvency is a possibility
Refinancing or restructuring is not inherently problematic. Rather, directors need to understand that choosing the wrong kind of refinancing, or choosing it for the wrong reasons, can deepen the insolvency spiral and broaden personal exposure.
Refinancing
When mainstream banks decline to lend due to deteriorating financials, directors may turn to non-traditional or private lenders. These lenders serve a clear market need, offering fast access to capital, flexible terms, and solutions where banks cannot assist.
However, directors should pause before signing on the dotted line.
Refinancing under distress can:
- Increase debt levels at a time when the company is already struggling
- Elevate interest and fee burdens that worsen cashflow
- Introduce short-term facilities requiring rapid repayment
- Require personal guarantees, exposing directors and their assets
- Embed aggressive enforcement rights that accelerate insolvency rather than prevent it
None of this is about criticising alternative lenders as they provide legitimate, often essential financing options. But directors must ensure refinancing is:
- Commercially justified,
- Supported by cashflow forecasts,
- Objectively reasonable, and
- Not prolonging inevitable insolvency.
Independent legal and financial advice, proper board deliberations, and maintaining written records of decision-making are crucial in mitigating later claims.
What about restructuring?
Restructuring can preserve company value, protect creditors’ interests, and reduce directors’ personal risk.
How a company restructures will always depend on its specific circumstances. The nature and composition of its debts, the profile and priorities of its creditors, its industry dynamics, and any regulatory or licensing requirements all shape the restructuring pathway. These factors influence not only what options are available, but which approach is most likely to deliver a sustainable outcome for the business and its stakeholders.
Companies generally face three potential restructuring pathways:
1. Deed of Company Arrangement (DOCA)
If a company’s directors have determined that a company is insolvent or is likely to become insolvent, the directors may make a resolution in writing to appoint a voluntary administrator. Voluntary Administration is a formal process designed to provide distressed companies with breathing space while an independent administrator assesses their position. During this period, creditor actions are paused and the administrator investigates the business to determine the best path forward.
One potential outcome of the voluntary administration process is the implementation of a DOCA. A DOCA is a binding arrangement voted on by creditors after the company enters voluntary administration. It allows the business to continue trading while compromising or rescheduling debts.
Key features of a DOCA are:
- Provides a controlled environment under administration
- Stops most enforcement actions
- Allows unsecured creditors to vote and determine the company’s path
- Can preserve business operations and employee entitlements
- Often delivers a better outcome for creditors than liquidation
2. Small Business Restructuring (SBR) Plan
The SBR framework is a streamlined option for financially distressed small businesses (under $1 million in liabilities). It allows directors to remain in control of the company while working quickly and efficiently with a restructuring practitioner to propose a plan to creditors.
Key features:
- Directors stay in control (unlike voluntary administration)
- Offers a moratorium on certain creditor actions
- Enables a compromise of debts while continuing normal trading
The SBR model is particularly effective where the business is still viable but burdened by legacy debt often making it a more attractive option than high-interest refinancing.
To be eligible for SBR, a company must meet all of the following criteria on the day the restructuring practitioner is appointed:
- total liabilities must not exceed $1 million, including all secured and unsecured debts;
- none of the company directors, current or within the past 12 months, has been a director of another company that entered restructuring or simplified liquidation within the past seven years, unless an exemption applies; and
- the company itself must not have undergone restructuring or simplified liquidation within the previous seven years.
Eligible companies that proceed with SBR must continue to meet their compliance obligations. This includes remaining up to date with tax lodgements, paying all employee entitlements (superannuation included), and dealing with any related-party liabilities.
As the ATO is typically the largest creditor of companies using SBR, it effectively has the final say on whether an SBR plan is approved. The ATO is unlikely to support a restructuring plan where there is a history of poor compliance, and it expects clear, well-supported proposals demonstrating genuine future viability.
3. Creditors’ Voluntary Liquidation (CVL)
When the business is no longer viable, a CVL may be the most responsible and safest option. A creditors’ voluntary liquidation occurs when shareholders decide the company can no longer pay its debts and is insolvent or approaching insolvency. A majority of the shareholders resolve to place the company into liquidation, after which an independent liquidator is appointed to take control, realise the company’s assets, and manage the process in accordance with the law.
Although liquidation is often perceived as a last resort, it can protect directors from far greater consequences.
Why directors should seriously consider a CVL:
- Stops the accrual of further debts
- Prevents potential future insolvent trading liability
- Allows an orderly winding-up under creditor control
- Enables investigation of company affairs by a liquidator
- Provides closure, rather than ongoing risk exposure
A poorly timed refinancing that simply delays an inevitable collapse can significantly worsen returns to creditors and personal exposure for directors. A CVL, by contrast, may demonstrate that directors acted promptly and responsibly when insolvency was apparent.
When should you chose a DOCA over a SBR plan?
SBR was introduced to give eligible small businesses a quick and efficient restructuring option while allowing directors to remain in control. However, as discussed above, SBR comes with a strict eligibility criteria and ongoing compliance obligations that are not always ideal in certain scenarios. A company may not meet the eligibility criteria or it may be that the key creditors do not support the SBR plan. Even when a company proceeds with an SBR plan, the ongoing compliance burden can make the process more costly than a DOCA.
A DOCA generally provides significantly greater flexibility in situations where there has been poor compliance, including not making payments to the ATO in the last six months, overdue lodgements, or debit director loan accounts and other director-related transactions that are likely to be scrutinised by the ATO. A DOCA allows a more adaptable option to negotiate with creditors, accommodate complex creditor structures, and address historical compliance issues without the rigid constraints of an SBR. As a result, directors may find that a DOCA offers a more predictable outcome.
Conclusion
Directors must weigh refinancing against the broader duties owed to creditors, the company, and themselves. They must also consider the timing of the refinancing and how long it will take to pay creditors.
Refinancing can be the right option, but only when carefully assessed, commercially justified, and supported by viability analysis.
Restructuring, whether through DOCA, SBR, or CVL, often provides safer, more strategic alternatives, preserving value while reducing risk.
In difficult times, the smartest move is rarely the fastest. Directors who methodically assess their options, document their reasoning, and seek professional advice place themselves and their companies in the strongest possible position.
