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Spotlight on an industry aging (dis)gracefully – Rescuing residential aged care
By Alistair Fleming and Melissa Ferreira
Consolidation and rationalisation is expected to increase, with reliance on insolvency regimes such as voluntary administration to help facilitate restructures and business sales.
Chapter image Aged Care

Residential aged care has recently been in the news for all the wrong reasons, with headlines due to the particularly heavy impact of COVID-19 on this sector, the interim findings of the Royal Commission into Aged Care Quality and Safety and the alarming declaration by Leading Age Services Australia that a pre-COVID-19 accounting review indicating that almost 200 nursing homes housing some 50,000 people were operating at an unacceptably high risk of insolvency – a finding supported by the recently released report by the Aged Care Financing Authority (ACFA) which found “nearly all residential providers consulted said that their financial results had deteriorated in 2019-20”.

Australia’s aged care industry operates within a strict and complex legislative scheme under the Aged Care Act 1997 (Cth). It’s an industry that makes an impact – providing services to over 1.3 million Australians and generating annual revenues totalling over $24.4 billion (about 1% of GDP). The industry is heavily reliant on taxpayer funding, receiving $19.9 billion in Commonwealth funding in 2018-19, an increase of 10% from 2017-18. Almost 66% of total funding ($13.0 billion) was for residential care. A national benchmarking review conducted in March 2020 indicated that 60% of the aged care homes recorded an operating loss with 34% recording an Earnings Before Interest, Tax and Depreciation (EBITDA) loss.

It’s also an industry that can see the writing on the wall – recent research conducted by ACFA illustrates that the industry expects an ongoing process of rationalisation and consolidation within the sector. This process is highly unlikely to occur through takeovers or acquisitions due to the low margins and significant liabilities taken on by an incoming provider. Instead, we expect to see the industry rely on highly skilled insolvency practitioners to utilise insolvency regimes (in particular the voluntary administration process) in combination with close engagement with the relevant Commonwealth departments to effect consolidation within the industry – a process which can be used to obtain a great effect as seen in our recent role in the successful sale of the luxury residential aged care facility previously operated by the Berrington Care Group (BCG) to Bethanie.

Residential aged care – a shaky balancing act

The financial position of the industry was finely balanced before COVID-19, and while additional Commonwealth funding has been rolled out to assist the industry, it is more likely than not that the industry will see a “very significant financial impact”.

Further financial pressure will be exerted by the scrutiny and uncertainty, and eventual major reform, arising from the ongoing Royal Commission.

The average EBITDA per resident for residential care providers fell by 24% in 2017-18 and decreased slightly by a further 2.5% in 2018-19. The number of residential providers reporting a loss in 2018-19 was 42%.

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The 2018-19 financial results of residential care providers were supported by the Government’s one-off $320 million increase in the Aged Care Financing Instrument (ACFI) in the final quarter of that year. In the absence of this one-off funding increase, the overall financial performance of residential care providers would have deteriorated more significantly in 2018-19 to an EBITDA of about $7,000, or a 20% decrease from 2017-18.

Average EBITDA rates

A small decline in occupancy rates can have a significant impact on the financial results of providers, especially smaller facilities. A number of providers consulted said they were experiencing further declines in occupancy; they attributed the decline to the increase in home care packages and the concerns raised during the Royal Commission over the quality of care. Some also said there was an excess supply of residential beds in some areas. Older facilities were experiencing the biggest falls in occupancy, demonstrating that they have less appeal to consumers when compared with newer or refurbished facilities. Adding to this is the major risk facing residential aged care providers of the spread of COVID-19 in a facility, which may lead to a sizeable decline in occupancy if departures are not matched by new admissions. This could have a major impact on the financial performance of the facility and provider liquidity.

Funding of a low margin industry – an age old problem

Funding of residential aged care is complex and unusual, involving a mix of user-pays, secured financing, unsecured interest free loans from residents (Residential Accommodation Deposit (RADs), capital investment support through grants from the Commonwealth, capital endowments and Commonwealth subsidisation and allowances.

The most significant form of funding for capital investment for most residential aged care providers is from the RAD system – effectively upon entry to a facility, residents pay an interest-free loan to the provider which is returned to the resident (or their estate) upon their exit. As at 30 June 2019, $30.2 billion of accommodation deposits are held by providers with an average value of $318,000 per resident.

RADs are unsecured loans backed by a Commonwealth guarantee scheme in favour of the resident. Providers are entitled to, and do, use the funds derived from RADs paid in to pay down bridging loans and to fund building and improvements among other expenses. As a result, RADs are often a balance sheet liability, due to be refunded (minus certain fees and charges) upon the exit of a resident. With the average provider holding RADs of between 33-62% of their total balance sheet position, the existence of the Guarantee Scheme and understanding how it may be structured into a transaction, is imperative.

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The prognosis – deteriorating condition

Before COVID-19, the outlook for 60% of providers in the residential aged care sector looked dire. It can only be assumed that this position will worsen due to the pandemic and consolidation and rationalisation of this sector is expected to increase with providers relying on insolvency regimes such as voluntary administration to help facilitate restructures and business sales.

CASE STUDY
Rescuing the Berrington residential aged care facilities
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In late 2019 a West Australian high-end aged care service provider Berrington Care Group (BCG) entered voluntary administration after ongoing negotiations with a secured creditor became untenable.

The directors sought to utilise the protections offered by the voluntary administration process while effecting a restructure of the business through a sale of the two aged care facilities operated by BCG and winding down of the relevant companies. Key stakeholders in that process included the residents, the Commonwealth, the purchaser Bethanie and the creditors of BCG.

Legal complexities of a restructure

At the heart of any residential aged care business is not the bricks and mortar facility, but the concept of a “place”, a commodity allocated and controlled by the relevant Commonwealth departments and ultimately the largest determining factor of value of the business of any aged care provider. The Berrington sale transaction was complicated by the fact that BCG had significant RAD liabilities and limited cash when the administrators were appointed, combined with the fact that under the Aged Care Act liabilities (most importantly, RAD liabilities) are tied to a “place” even where it is transferred to another provider.

Without significant stakeholder engagement and negotiation, BCG’s significant RAD liabilities would have prevented any transaction being viable – after all, the Guarantee Scheme remains dormant in a voluntary administration or a deed of company arrangement process. Also, although RADs are unsecured debts held by residents, practically speaking they are not debts of a type that are capable of being compromised. Without a successful sale of the business, the outcome for the residents and employees of BCG looked dire – BCG would have been wound up, elderly residents of each of the two residential facilities operated by BCG would have been forced to move to alternative accommodation and facilities and employees would have lost their jobs. Another stakeholder that would lose if there were no sale was the Commonwealth (which would have had to pay out a significant amount of money under the Guarantee Scheme) and the broader industry (which under the Guarantee Scheme may have been required to pay a levy in order to assist in repaying any amount paid out by the Commonwealth).

The path to a successful transaction

By creating a mechanism which carefully balanced the powers and limitations of each stakeholder arising through the insolvency regime, the Aged Care Act, the Principles as well as the Guarantee Scheme, we were able to negotiate and effect a partial trigger of the Guarantee Scheme. This carefully crafted mechanism made a transaction viable by reducing the overall liabilities taken on by Bethanie by providing working capital. This in turn protected the residents' RADs and most importantly ensured that residents were able to remain in place.

Clayton Utz was uniquely qualified to advise on and facilitate the creation of the above mechanism and assist in ensuring successful completion of the Berrington transaction due to its close working relationship within each of the insolvency practitioner and government sector spaces, combined with the technical expertise of specialist restructuring and insolvency partner Alistair Fleming and specialist public sector partner Cain Sibley.

Both aged care and insolvency are heavily legislated areas with technical and complex requirements on the relevant stakeholders – our team's deep experience, relationships and technical nous helped navigate the stakeholders of the Berrington transaction through the complex legislative regimes and requirements to a successful and novel restructure.