This note outlines how internal reconstructions can be achieved by implementing schemes of arrangement that transfer the assets and liabilities of one group company to another.
Introduction: Internal reconstruction by a scheme of arrangement under section 413 of the Corporations Act (a s413 scheme of arrangement)
For corporate groups considering an internal reconstruction, a s413 scheme of arrangement provides a flexible alternative to more orthodox approaches commonly adopted.
As is well known, the Corporations Act enables a corporation to enter into a scheme of arrangement with its creditors or members (or any class of them). Schemes of arrangement are commonly used to implement agreed mergers, as an alternative to the comparatively rigid mechanism of a takeover bid.
However, as is less well known, schemes of arrangement can also be used to implement reconstructions. Under a s413 scheme of arrangement, it is possible to transfer some or all of the assets and liabilities of the scheme company to another company, followed (where all, rather than some, of the assets and liabilities of the scheme company are transferred) by deregistration of the scheme company.
Despite the real advantages of implementing a reconstruction by scheme of arrangement, this approach is rarely adopted. Based on our research, it appears that in the past 10 years there have been only around 20 reported examples. We have acted on two of these schemes over the last couple of years, with a successful outcome and a satisfied client on each occasion.
This scarcity is somewhat surprising. After the predecessor to the current reconstruction legislation was introduced in England in 1928, Lord Atkin described it (in the 1940 Nokes Case) as a “revolution in the law”. Unfortunately, it seems fair to say that it has become a forgotten revolution.
This briefing note will outline the effect of a s413 scheme of arrangement, examine the process involved and look at some of the advantages of proceeding this way. A s413 scheme of arrangement may also be used for arms’ length reconstructions, as well as amalgamations, but this note will focus on their use in internal reconstructions.
What is the effect of a s413 scheme of arrangement?
Section 413 of the Corporations Act gives the Court wide powers to make orders where the whole or any part of the undertaking or of the property of one company (Transferor) is to be transferred to another company (Transferee) under a scheme of arrangement which proposes an amalgamation or reconstruction. These orders may include orders approving the transfer to the Transferee of the whole or a part of the undertaking and of the ‘property’ or ‘liabilities’ of the Transferor, the continuation by or against the Transferee of any legal proceedings pending by or against the Transferor, the deregistration by ASIC (without winding up) of the Transferor, and other matters.
The terms ‘property’ and ‘liabilities’ have broad definitions. For example, liabilities can be “duties of any description” and property “includes rights and powers of any description” and may be of a personal character.
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The effect of a s413 scheme of arrangement will depend on the terms of the scheme. In our experience, a typical scheme is structured as a members’ scheme (that is, a scheme between the scheme company and its members), under which:
- Assets: all assets of the Transferor are transferred to and vest in the Transferee, without the need for any further act or deed;
- Liabilities: all liabilities of the Transferor are transferred to and become liabilities of the Transferee, without the need for any further act or deed;
- Legal Proceedings: any legal proceedings pending by or against the Transferor are continued by or against the Transferee, without the need for any further act or deed (other than an amendment of the record of the relevant court or tribunal); and
- Deregistration: the Transferor is deregistered by ASIC without winding up.
Once the scheme is approved by the members (typically just one member) and the Court, the assets and the liabilities of the Transferor simply vest in the Transferee by operation of the Court order. In particular:
- Contracts: contracts are transferred, even (depending on their terms) if they contain restrictions on assignment, such as an absolute prohibition on assignment or a prohibition on assignment without consent;
- Employees: employees and their benefits are transferred, although the Court expects evidence that there has been a consultation process undertaken with affected employees and applicable unions;
- Real property: no conveyancing documents are required, but there are rules about lodging the court orders to register the transfer; and
- Liabilities: all liabilities, whether present, unascertained, future or contingent, are transferred, even if they have not yet crystallised or been quantified. There is even precedent for transferring liabilities for potential personal injury claims, such as asbestos claims.
What is the procedure for a s413 scheme of arrangement?
Broadly, the procedure to implement an internal reconstruction by scheme of arrangement is as follows:
- the Transferor undertakes detailed due diligence to investigate all assets and liabilities that are to be transferred, and any potential issues in doing so – for example, potential stamp duty exposure and relief, other revenue implications, required third party approvals (eg, regulatory approvals), or where implementing a scheme may have unintended consequences (eg, by giving a contract counterparty a right to terminate following an event of default). This is perhaps the most critical step of the entire process;
- an explanatory statement is prepared satisfying applicable disclosure requirements. The explanatory statement is a far less complex document than is required for takeover schemes;
- the explanatory statement is lodged with ASIC for review. ASIC must be given a reasonable opportunity to review the explanatory statement before the first court hearing. ASIC must also be given at least 14 days’ notice of the first court hearing;
- the Transferor applies to the Court for an order convening a meeting of the members of the Transferor. This is known as the ‘first court hearing’;
- the explanatory statement is registered with ASIC. This means that the explanatory statement becomes a public document;
- the scheme meeting is convened and held, with the scheme being approved by the members with the requisite statutory majorities (majority by number present and voting and 75% of the votes cast). In the case of an internal group restructure, there is typically only a single member, which makes it a simple matter to hold the meeting on short notice;
- the second court hearing is advertised in a national daily newspaper;
- the Transferor applies to the Court for orders approving the scheme, transferring the assets and liabilities of the Transferor to the Transferee and deregistering the Transferor. This is known as the ‘second court hearing’;
- the court orders are lodged with ASIC, at which point the scheme becomes legally effective. However, the scheme is usually implemented at a later date, typically at a calendar month end after allowing time to do anything that needs to be done before the Transferor is deregistered, such as updating the PPSR; and
- the transfer of any registered assets (such as real property, intellectual property and shares) is registered.
When preparing the explanatory statement, it is possible to apply to ASIC for relief from specific disclosure requirements, where giving relief falls within existing ASIC policy or there are other compelling reasons. Ultimately, it is within ASIC’s discretion whether or not to give relief. In the context of intra-group reconstructions, it is typical to seek relief from the requirement to commission an expert to prepare a report. However, even if the explanatory statement does not contain an expert’s report, it will still need to contain disclosure about the affect of the scheme on creditors (including employees).
What are the advantages of a s413 scheme of arrangement?
Some of the advantages of implementing a reconstruction by a s413 scheme of arrangement include:
- because a s413 scheme or arrangement is a members’ scheme, creditors are not parties to the scheme and do not vote on the scheme. This means it is not possible for creditors, or a class of creditors, to veto the scheme. However, in approving the scheme, the Court will consider the interests of creditors and hence will require evidence about the affect of the scheme on creditors. Creditors may also seek leave to appear at either court hearing (although they are more likely to do so at the second court hearing, after it has been advertised) and express any concerns they may have about the treatment of creditors. However, this rarely happens, particularly if potential issues are identified in advance and appropriately addressed;
- it is not necessary to mechanically transfer all of the assets and liabilities of the Transferor to the Transferee. In particular it is not necessary to assign or novate each contract, avoiding the usually considerable effort and expense in doing so and avoiding the risk of the counterparty (or counterparties) seeking to re-negotiate or terminate the contract where their consent is required. This risk and the delays experienced in dealing with uncooperative counterparties should not be underestimated;
- the transfer does not ‘drag-on’ – it is finished on the implementation date. However, the cost and effort of implementing a s413 scheme of arrangement (including preparing an explanatory statement and obtaining ASIC, member and Court approvals) needs to be balanced against the cost and effort of undertaking the reconstruction by more conventional means;
- there is certainty of outcome – all assets and liabilities, whatever they might be (so long as they are otherwise capable of being transferred), are transferred, without the need to individually list or describe them. However, it is usual to identify the assets and liabilities to the greatest extent possible through due diligence so that any issues (eg, registration issues) in transferring them can be identified in advance and appropriately addressed;
- they are very flexible – for example, it is possible to transfer all or some of the assets and liabilities of a transferor company to one or more transferee companies. It is also possible to implement multiple concurrent schemes for complex group restructures;
- it is possible to transfer contracts of personal service – ie, employment contracts – which is an exception to the general rule;
- at the end of the process the scheme company is, if this is incorporated as a term of the scheme, deregistered by ASIC without winding up. This means that a separate process to wind-up or deregister the scheme company is not necessary; and
- the powers of the court are broad and orders may expressly cover “such incidental, consequential and supplemental matters as are necessary to ensure that the reconstruction or amalgamation is fully and effectively carried out”.
Conclusion: Situations where a s413 scheme of arrangement may be appropriate
A corporate group wanting to move assets and liabilities from one group company to another may choose to do so by mechanically transferring each asset and liability. However, there may be so many assets and liabilities that doing so would involve a long and drawn out process that may be dependent on third party co-operation. This may not be desirable where there are valuable material contracts.
Accordingly, where a group is considering an internal reconstruction it may be worth investigating whether it should be implemented using a s413 scheme of arrangement. This scheme route provides the ability to ‘clean house’ and easily transfer assets and liabilities from one company to another.
As this approach becomes better known, it is likely it will be used more often, given the flexibility it affords. It may be that in coming years these schemes will no longer be tarnished with the label of the “forgotten revolution".