Corporate structuring to enable restructuring

Asset protection in a corporate structure sense involves distancing a business’ valuable assets and / or imposing barriers to limit financial damage. That this type of planning pays dividends by protecting assets is obvious. However, what may not be self-evident are the further rewards obtainable in the context of a restructure.

Before examining these further rewards, let’s consider two types of corporate structuring strategies. The first one involves isolating valuable assets such as intellectual property (IP), land and licences. They are protected by placing them in separate entities (eg. one for IP, one for land and one for licences) and leased to the trading entity. As the trading entity carries on the business’ activity, it also contains most of the liabilities. Should the business fall on hard times, creditor recourse will be limited to the trading entity’s assets. The valuable assets, being in separate entities, will generally be out of reach.

The second strategy relates to a business that operates in a number of locations. In that situation, another layer of protection can be gained by operating each location in a separate legal entity. This strategy gives the owner the choice of funding a struggling location’s losses or limiting its infection to the rest of the business by putting that entity in external administration (liquidation, administration or small business restructuring).[1]

The reward yielded for this corporate planning in a restructure works like this: suppose a retail business is structured so that its intangible assets (website, business name, trade marks and social media profiles) are held in one entity and trading activity is conducted in another entity. Financial distress occurs and, as planned, the damage is suffered solely by the trading entity.

The director wishes to restructure the trading entity and continue trading. Assume also that the business is not eligible for small business restructuring. The director places the trading entity in voluntary administration and prepares a restructuring proposal for the trading entity’s creditors. The entity containing the intangible assets is not touched and remains out of external administration.

The Administrator’s duties include considering whether to recommend the director’s restructuring proposal to creditors. In evaluating the proposal, the Administrator may wish to compare its return to creditors to what could be obtained by offering the business for sale. This ‘testing the market’ strategy occurs frequently and is considered prudent in terms of demonstrating all options to save the business have been explored. The important thing to note is that, due to intangible assets being held elsewhere, it is unlikely that there is a business to be sold and hence little value in ‘testing the market’. Through their corporate restructuring strategy, the director has succeeded in avoiding attention otherwise drawn to the business’ condition (because of advertising) and in removing an action that might have caused the business to be sold (and therefore lost).

The same practical limitations apply to the ‘one location per entity’ corporate structure, assuming intangible assets are similarly quarantined.

Corporate structuring to protect assets becomes less feasible during financial trouble. There are often bigger issues to worry about and, more to the point, such measures will likely be reversed if circumstances decline to the point that a liquidator is appointed. Nonetheless, our remarks here show that there are solid benefits to be obtained by giving thought to a business enterprise’s corporate structure earlier on.

If your company is in financial difficulty and you are considering options, one of your actions should include a conversation with us. There is no charge and the discussion will help you frame the problem, the constraints in solving it, and the legal and commercial strategies to mitigate loss. Contact us to arrange a discussion. Our goal is to develop a path out of the sea of negative you may find yourself in.

[1] A downside of this structure is that it requires diligence in terms of ensuring each location’s debts are in that location’s name – the value of severing the limb is nominal if the location’s creditors are contracted with the parent company. Compliance requirements in terms of numerous legal entities may also be an issue.