Administrators call for Smiles to be wound up as practice sales recoup $9.2m

Deloitte's administrators of fallen dental roll-up Smiles Inclusive (SI) and its branded practice chain Totally Smiles (TS) have urged creditors to vote in favour of liquidating both companies at a meeting to be held on 30 June.

A report prepared by the administrators Luci Palaghia and Timothy Heenan estimates gross proceeds of $9.2 million from practice sales, including 16 to Genesis Capital and 21 to individual purchasers.

This leaves 12 Totally Smiles practices that remain closed due to a lack of interest. Since the administration process began 169 of the company's 235 employees have either lost their jobs or resigned. More employees were subsequently hired though with expectations 92 staff members have been or will be transferred to Genesis.

Of the more than $9 million recovered, around a third is going to the administrators, $1.8 million are for lenders Macquarie Equipment Rentals Pty Ltd and Henry Schein Regional Trust trustee HSH, and after other costs the total available for secured creditor National Australia Bank (ASX: NAB) is just under $2.94 million.

This means NAB will likely receive 15 to 16 cents for every dollar from its loans to the embattled Gold Coast-based company. However, this is still more than the unsecured creditors are anticipated to receive, which is nothing. 

The administrators' investigations indicate formerly ASX-listed Smiles Inclusive and Totally Smiles "may have traded whilst insolvent from 31 December 2019, if not earlier".

"Based on preliminary investigations, including our review of the group's operations and discussions with the directors, our view is that the financial difficulties of the group was ultimately the legacy of the failed integration of the practices subsequent to the acquisition of the practices in 2018," the administrators wrote.

The report notes this failed integration led to sustained losses of $5 million in FY18, $31 million in FY19 and $13.6 million in the first half of FY20, thus "eroding the group's capital" to a point from which it ultimately never recovered.

"These losses were primarily driven by underperformance at the practice level which was systemic across the vast majority of practices," the administrators concluded.

"Although the group made attempts to remedy the integration issues and may have made some progress, it was unable to return to sustained profitability quickly enough to repair the balance sheet and to maintain the support of its key stakeholders.

"The confidence and continued support of key stakeholders, notably investors and financiers, was also likely to have been impacted by the series of requisitions for EGMs [extraordinary general meetings] by dissatisfied shareholders."

How Smiles Inclusive was turned upside down: A timeline of decay

At the creditors' meeting later this month two other options will also be on the table: 

• A Deed of Company Arrangement (DOCA) proposal which administrators received for Smiles Inclusive shortly prior to issuing their report, which they note requires further analysis and a canvassing of shareholder views; and
• An end to the administration itself.

The administrators are firmly against the second option.

"Based on our analysis, the group is presently insolvent and unable to pay its debts as and when they fall due," they wrote.

"Ending the voluntary administrations would not be in the best interests of creditors and would expose the Directors to the possibility of liability for breaches of director duties."

They explained their investigations had not identified any breaches of directors' duties, although some shortcomings were identified.

"We have identified potentially voidable transactions which may be recoverable by a liquidator, however further investigations would need to be undertaken should a liquidator be appointed," the administrators wrote.

"We estimate the potential recoveries to be up to $303k for SI, and $392k for TS. These constitute, primarily, unfair preference payments in the six months leading up to our appointment.

"In order for a liquidator to recover amounts in respect of these transactions, it would first be necessary to establish that a company was in fact insolvent at the time of the transaction or became insolvent as a result of entry into the transaction."

Palaghia and Heenan explained that if a director were found to have contravened their duties to prevent insolvent trading, they would be able to raise a number of possible defences. In addition, the directors may have been in Safe Harbour since 3 September 2019 for Smiles Inclusive and 19 September 2019 for TS.

"Furthermore, on 25 March 2020, the Coronavirus Economic Response Package Omnibus Bill 2020 received Royal Assent, which inserted section 588GAAA into the Act. Section 588GAAA provides relief for directors from potential insolvent trading. The temporary protections were extended until 31 December 2020," the administrators wrote.

"On balance, given the statutory defences available, and due to the impact of section 588GAAA of the Act, we consider it unlikely that there would be commercially recoverable actions available to creditors from the Directors for insolvent trading.

The administrators have also investigated numerous allegations made by certain third parties against past and present joint venture partners (JVPs), including the theft of practice equipment, unauthorised access and use of patient and other data, the unauthorised use of practice consumables and equipment, the diversion of patient receipts to the personal names of current and former JVPs, and the breach of restraint of trade by former JVPs.

"The information made available to us does not indicate that the above matters are widespread or systemic within the Group's business," the administrators noted, adding causes of action do exist but a likely recovery would be outweighed by the costs of recovery.

"Detailed forensic analysis and evidence gathering is required to substantiate and/or quantify certain claims. The costs of such further investigation may outweigh any benefit to creditors," they wrote.

"Should TS be liquidated, we will continue to investigate the above matters where it is in the interests of creditors to do so, however at this stage we do not foresee a material benefit for creditors."