An extract from The Restructuring Review, 13th Edition
General introduction to the restructuring and insolvency legal frameworki Formal procedures
The formal procedures available under Australian law are:
- receivership (both private and court-appointed);
- voluntary administration;
- deeds of company arrangement (DOCA);
- provisional liquidation;
- liquidation (both solvent (members' voluntary liquidation) and insolvent); and
- court-sanctioned schemes of arrangement between creditors and the company.
For receivership, voluntary administration, DOCA and liquidation, the individual appointed must be an independent registered liquidator, except in the case of a members' voluntary liquidation.Receivership
The main role of a receiver is to take control of the relevant assets subject to the security pursuant to which they are appointed and realise those assets for the benefit of the secured creditors. One or more individuals may be appointed as a receiver or a receiver and manager of the assets. Despite some historical differences, in practice, it is difficult to distinguish between the two roles and most security interests will allow for the appointment of either. Receivers are not under an active obligation to unsecured creditors on appointment, although they do have a range of duties under statute and common law. Despite being appointed by the secured creditors, a receiver is not obliged to act on the instructions of the secured creditors. A receiver must, however, act in their best interests, and this will invariably lead a receiver to seek the views of secured creditors on issues that are material to the receivership (particularly given that a receiver cannot effectively undertake a transaction involving the secured property without a release by, or the consent of, the secured creditor).
There are two ways in which a receiver may be appointed to a debtor company. The most common manner is pursuant to the relevant security document granted in favour of the secured creditor when a company has defaulted and the security has become enforceable. Far less common in practice is the appointment of a receiver pursuant to an application made to the court. Court appointments normally take place to preserve the assets of the company in circumstances where it may not be possible to otherwise trigger a formal insolvency process. Given the infrequency of court-appointed receivers, however, this chapter focuses on privately appointed receivers.
For a privately appointed receiver, the security document itself will entitle a secured party to appoint a receiver, and will also outline the powers available (supplemented by the statutory powers set out in Section 420 of the Act). Generally, a receiver has wide-ranging powers, including the ability to operate the business and to borrow against or sell the secured assets. The appointment is normally effected contractually through a deed of appointment and indemnity. By way of the underlying security document, the receiver will be the agent of the debtor company, not the appointing secured party (although this agency relationship will change if a liquidator is appointed to the debtor company, whereby the receiver will become the agent of the secured party).
On appointment, a receiver will immediately take possession of the assets subject to the security. Once in control of the assets, the receiver may elect to run the business (if relevant) if he or she is appointed to oversee all or substantially all of the assets of a company. Alternatively, and depending on financial circumstances, a receiver may engage in a sale process immediately. While engaging in a sale process, a receiver is under a statutory obligation to obtain market value or, in the absence of a market, the best price reasonably obtainable in the circumstances. This obligation is enshrined in Section 420A of the Act. It is this duty that has posed the most significant stumbling block to the adoption of pre-packaged restructuring processes through external administration that have been seen in, for example, the UK market. This is because of the inherent concern that a pre-packaged restructure that involves a sale of any asset without testing against the market could be seen as a breach of the duty under Section 420A. Once a receiver has realised the secured assets and distributed any net proceeds to the secured creditors (returning any surplus to the company or later ranking security holders), he or she will retire in the ordinary course.Voluntary administration
The concept of voluntary administration was introduced into Australian law in 1993. Voluntary administration, unlike receivership, is entirely a creature of statute, and its purpose and practice are outlined in Part 5.3A of the Act. Voluntary administration has often been compared with the Chapter 11 process in the United States, but unlike Chapter 11, voluntary administration is not a debtor-friendly process. In a voluntary administration, the creditors control the final outcome to the exclusion of management and members. The creditors ultimately decide on the outcome of the company, and it rarely involves returning management responsibilities to the former directors.
The purpose of Part 5.3A is to either:
- maximise the chances of the company, or as much as possible of its business, to continue in existence; or
- if the first option is not possible, achieve a better return for the company's creditors and members than would result from an immediate winding up of the company.
There are three ways an administrator may be appointed under the Act:
- by resolution of the board of directors that, in their opinion, the company is, or is likely to become, insolvent;
- a liquidator or provisional liquidator of a company may, in writing, appoint an administrator of the company if he or she is of the opinion that the company is, or is likely to become, insolvent; and
- a secured creditor who is entitled to enforce security over the whole or substantially whole of a company's property may, in writing, appoint an administrator if the security interest is over the property and is enforceable.
An administrator has wide powers and will manage the company to the exclusion of the existing board of directors. Once an administrator is appointed, a statutory moratorium is activated, which restricts the exercise of rights by third parties under leases and security interests, and in respect of litigation claims, the moratorium is designed to give the administrator the opportunity to investigate the affairs of the company, and either implement change or be in a position to realise value, with protection from certain claims against the company. With respect to leases, in addition to the moratorium on enforcement, an administrator can apply to court to extend the rent-free period prescribed in the Act, ranging from a week to a month, with the effect of the administrator further limiting any personal liability for rent for the relevant period. Further, while the Act does not permit an administrator to dispose of property that is subject to a security interest or is owned by another party; an administrator may make such a disposition after obtaining a court order to that effect.
There are two meetings over the course of an administration that are critical to the outcome of the administration. Once appointed, an administrator must convene the first meeting of creditors within eight business days. At this meeting, the identity of the voluntary administrator is confirmed, the remuneration of the administrator is approved and a committee of creditors may be established. The second creditors' meeting is normally convened 20 business days after the commencement of the administration (referred to as the convening period). The convening period may be extended by application to the court. At the second creditors' meeting, the administrator provides a report on the affairs of the company to the creditors and outlines the administrator's views as to the best option available to maximise returns. There are three possible outcomes that can be put to the meeting: entry into a DOCA with creditors (discussed further below); winding up the company; or terminating the administration.
The administration will terminate according to the outcome of the second meeting (i.e., by progressing to liquidation, entry into a DOCA or returning the business to the directors to operate as a going concern (although this is rare)). When the voluntary administration terminates, a secured creditor that was estopped from enforcing a security interest due to the statutory moratorium becomes entitled to commence steps to enforce that security interest unless the termination is due to the implementation of a DOCA approved by that secured creditor.Deed of company arrangement
A DOCA is effectively a contract or compromise between the company and its creditors. Although closely related to voluntary administration, it should, in fact, be viewed as a distinct regime, as the rights and obligations of the creditors and company will differ from those under a voluntary administration.
The terms of a DOCA may provide for, inter alia, a moratorium of debt repayments, a reduction in outstanding debt and the forgiveness of all or a portion of the outstanding debt. It may also involve the issuance of shares, and can be used as a way to achieve a debt-for-equity swap through the transfer of shares either by consent or with leave of the court (as noted above). This mechanism has been utilised numerous times to effect debt-for-equity restructures, including, for example, in Mirabela, Nexus Energy, Channel Ten and Paladin.
Entering into a DOCA requires the approval of a bare majority of creditors both by value and by number voting at the second creditors' meeting. In order to resolve a voting deadlock, for example, where there is a majority in number but not in value or vice versa, under Rule 75-115(3) of the Insolvency Practice Rules (Corporations) 2016 (Cth) an administrator may exercise a casting vote to pass, or not pass, a resolution. The right to exercise a casting vote is not mandatory. A DOCA will bind the company, its shareholders, directors and unsecured creditors. Secured creditors can, but do not need to, vote at the second creditors' meetings, and typically only those who voted in favour of the DOCA at the second creditors' meeting are bound by its terms. Unlike a scheme of arrangement, court approval is not required for a DOCA to be implemented provided it is approved by the requisite majority of creditors.
Upon execution of a DOCA, the voluntary administration terminates. The outcome of a DOCA is generally dictated by the terms of the DOCA itself. Typically, however, once a DOCA has achieved its stated aims it will terminate. If a DOCA does not achieve its objectives, or is challenged by creditors, it may be terminated by the court.
A DOCA may also be utilised where the convening period has not been extended and the administrators require more time to sell the business or its assets than provided for in the legislation; for example, an administrator may wish to postpone a sale until market conditions improve, so as to generate a better return for creditors, and might use a DOCA to push out the timeline. Such arrangements are known as holding DOCAs and do not generally contain any specific provisions as to the future of the company or, on their face, any benefit for creditors. Their primary purpose is to provide more time for forming and agreeing a restructuring proposal. Holding DOCAs also confer other benefits, including an extension of the moratorium on all creditors bound by the DOCA, time and cost savings on applying for an extension of the convening period and greater flexibility for the administrator. While the use of holding DOCAs has at times been controversial, the court has generally supported their use as a means of facilitating a better result for creditors.Provisional liquidation
A provisional liquidator may be appointed by the court in a number of circumstances. The most commonly used grounds include:
- where an irreconcilable dispute at a board or shareholder level has arisen that affects the management of the company; or
- if the court is of the opinion that it is just and equitable to do so.
A creditor, a shareholder or the company itself has standing to apply for the appointment of a provisional liquidator, although in most cases a creditor will be the applicant. A provisional liquidator will normally only be appointed by the court if there is a risk to the assets of a company prior to a company formally entering liquidation. As such, a provisional liquidator is normally only given very limited powers (e.g., the power to take possession of the assets), and the main role of the provisional liquidator is to preserve the status quo.
A court determines the outcome of a provisional liquidation. It may order either that the company move to a winding up, with the appointment of a liquidator, or that the appointment of the provisional liquidator is terminated.Liquidation
Liquidation is the process whereby the affairs of a company are wound up and its business and assets are realised for value. A company may be wound up voluntarily by its members if solvent or, alternatively, if it is insolvent, by its creditors or compulsorily by order of the court.Voluntary liquidation (members and creditors)
The members of a solvent company may resolve that a company be wound up if the board of directors is able to give a 12-month forecast of solvency (i.e., an ability to meet all its debts within the following 12 months). If not, or if the company is later found to be insolvent, the creditors take control of the process. Creditors may resolve at a meeting of creditors to wind up the company and appoint a liquidator. This may take place at the second meeting of creditors during an administration. If the requisite approvals are obtained in either a members' voluntary winding up or a creditors' voluntary winding up, a liquidator is appointed.Compulsory liquidation
The most common ground for a winding-up application made to the court is insolvency, usually indicated by the company's failure to comply with a statutory demand for payment of a debt. Following a successful application by a creditor, a court will order the appointment of a liquidator.
In both a voluntary and compulsory winding up, the liquidator will have wide-ranging powers, including the ability to challenge voidable transactions and take control of assets. Generally, a liquidator will not run the business as a going concern, unless it will ultimately result in a greater return to stakeholders. During the course of the winding up, the liquidator will realise the assets of the company for the benefit of its creditors and, to the extent of any surplus, its members. At the end of a winding up, the company will be deregistered and cease to exist as a corporate entity.Scheme of arrangement
A scheme of arrangement is a restructuring tool that sits outside formal insolvency; that is, the company may become subject to a scheme of arrangement whether it is solvent or insolvent.
A scheme of arrangement is a proposal put forward (with input from management, the company or its creditors) to restructure the company in a manner that includes a compromise of rights by any or all stakeholders. The process is overseen by the courts and requires approval by all classes of creditors. In recent times, schemes of arrangement have become more common, in particular for complex restructurings involving debt-for-equity swaps, in circumstances where the number of creditors within creditor stakeholder groups may make a contractual and consensual restructure difficult.
A scheme of arrangement must be approved by at least 50 per cent in number and 75 per cent in value of creditors in each class of creditors. It must also be approved by the court to become effective. The test for identifying classes of creditors for the purposes of a scheme is that a class should include those persons whose rights are not so dissimilar as to make it impossible for them to consult together with a view to a common interest. Despite this long-standing proposition, recent case law has suggested that courts may be willing to stretch the boundaries of what would ordinarily be considered to be the composition of a class and, in doing so, may agree to put creditors in classes even where such creditors within the class appear to have objectively distinct interests. Thus, the basis upon which parties have previously grouped creditors into classes is now a less certain benchmark for class composition in the future.
The outcome of a scheme of arrangement is dependent on the terms of the arrangement or compromise agreed with the creditors. Most commonly, a company is returned to its normal state upon implementation as a going concern but with the relevant compromises having taken effect.
The scheme of arrangement process does, however, have a number of limiting factors associated with it, including cost, complexity of arrangements, uncertainty of implementation, timing issues (because it must be approved by the court it is subject to the court timetable and cannot be expedited) and the overriding issue of court approval (a court may exercise its discretion to not approve a scheme of arrangement, despite a successful vote, if it is of the view that the scheme of arrangement is not equitable). These factors explain why schemes of arrangement tend only to be undertaken in large corporate restructurings and in scenarios where timing is not fatal to a restructuring.ii Rights of enforcement
Secured creditors may enforce their rights in every form of external administration. During a voluntary administration, a secured creditor with security over the whole or substantially the whole of the company's property may enforce its security, provided it does so within 13 business days of receiving notice of appointment of the voluntary administration, or with leave of the court or consent of the administrator. In addition, if a secured creditor takes steps to enforce its security before the voluntary administration commences, it may continue to enforce its security in the ordinary course of business.
Where a company pursues a DOCA, a secured creditor who did not vote in favour of such a proposal will have the ability to enforce its security interests once the DOCA becomes effective. If a voluntary administration otherwise terminates, a secured creditor may also commence steps to enforce its security interest upon termination.iii Directors' duties in distressed situations
Case law in Australia, particularly Westpac Banking Corporation v. Bell Group Ltd (in liq) (No 3) (Bell), has reaffirmed the position that a director must be increasingly mindful of the interests of creditors as a company approaches insolvency. A director's duty to creditors arises by operation of the well-established fiduciary duty owed by a director to the company more generally. When a company is solvent, the interests of the shareholders are paramount, and conversely, when a company is near insolvency or of doubtful solvency, the interests of the creditors become increasingly relevant. It is important to emphasise that the duty to take into account creditors' interests is owed to the company, not to the creditors per se.
The extent of this duty continues to be an evolving area of the law. It is, however, now well established under Australian law that directors must at the very least have regard to the interests of creditors when a company is in financial distress or insolvent. As noted by Lee AJA in Bell:
At the point of insolvency, or the pending manifestation of insolvency, the duty to act in the best interests of each company was of central importance for the companies to comply with statutory obligations and the obligation of the companies not [to] prejudice the interests of creditors.
Further, it has been suggested that when the solvency of a company is doubtful or marginal, it would be a misfeasance to enter into a transaction that the directors ought to know is likely to lessen the company's value if to do so will cause a loss to creditors. Directors should not, for instance, allow the company to enter into commitments that it clearly will not be in a position to meet or that may prejudice the interests of creditors generally.iv Clawback
Under Australian law, transactions will only be vulnerable to challenge when a company enters liquidation. Only a liquidator has the ability to bring an application to the court to declare certain transactions void. In the report to creditors at the second creditors' meeting, a voluntary administrator may identify potentially voidable transactions, but he or she is not empowered to pursue a claim in respect of such a transaction. Any such claim must be brought by a subsequently appointed liquidator.
There are several types of transactions that can be found to be voidable including:
- unreasonable director-related transactions;
- unfair preferences;
- uncommercial transactions;
- transactions entered into to defeat, delay or interfere with the rights of any or all creditors on a winding up; and
- unfair loans.
Transactions in categories (b), (c) and (d) will only be voidable where they are also found to be insolvent transactions, that is, transactions that occurred while the company was cash-flow insolvent, or contributed to the company becoming cash-flow insolvent. Each type of voidable transaction has a different criterion and must have occurred during certain time periods in the lead up to administration or liquidation. The relevant time period is generally longer if the transaction involves a related party.
Upon the finding of a voidable transaction, a court may make a number of orders, including directions that the offending person pay an amount equal to some or all of the impugned transaction; directions that a person transfer the property back to the company; or directions that an individual pay an amount equal to the benefit received.
As part of the 2018–2019 Federal Budget, the Australian government announced a series of reforms to combat illegal phoenix activity (i.e., transactions taking place at a time when a company is nearing insolvency that are intended to defeat creditors). As part of the wider reforms, The Treasury Laws Amendment (Combating Illegal Phoenixing) Act 2020 (Cth) has extended the power for liquidators to recover property that is the subject of creditor-defeating dispositions (in line with their existing ability to clawback voidable transactions). It also imposes civil and criminal liability for directors and advisors engaging in creditor-defeating dispositions of company property.v Insolvent trading
Directors may be held liable for new debts incurred by a company trading while cash-flow insolvent. This potential liability does not extend to debts incurred prior to the date a company became cash-flow insolvent, or recurring payments that become due after that date under the terms of pre-existing arrangements such as rent or interest (i.e., when the liability to pay such amounts already existed at the time of insolvency).
In terms of a director's personal liability, a court may make an order requiring the director to compensate the company for loss arising out of the insolvent trading, prevent a director from managing a corporation for a period of time and, in rare circumstances where the failure to prevent insolvent trading is ruled as a result of dishonesty, a fine of A$200,000 may be levied against the offending director.
The appointment of a voluntary administrator or a liquidator by the directors protects a director from any claim that he or she allowed the company to trade while insolvent in respect of any debts incurred after the date of such appointment.
With effect from September 2017, the new Section 588GA of the Act, provides that a director is not liable for debts incurred by a company while it is insolvent if, 'at a particular time after the director starts to suspect the company may become or be insolvent, the director starts developing one or more courses of action that are reasonably likely to lead to a better outcome for the company' than the 'immediate appointment of an administrator or liquidator to the company'. A director that seeks to rely upon Section 588GA(1) of the Act bears the evidential burden in relation to that matter. That is, providing evidence that suggests a reasonable possibility that the matter exists or does not. This safe harbour protection does not apply in certain circumstances, including where, at the time the debt is incurred, the company has failed to pay employee entitlements or comply with certain reporting or taxation requirements.
In order to assist directors in seeking to ensure they obtain the benefit of the safe harbour protection, the Act lists some indicia for a director to regard when determining whether a course of action is reasonably likely to lead to a better outcome for the company. This includes whether the relevant director is:
- properly informing himself or herself of the company's financial position;
- taking appropriate steps to:
- prevent any misconduct by officers or employees of the company that could adversely affect the company's ability to pay all its debts; or
- ensure that the company is keeping appropriate financial records consistent with the size and nature of the company;
- obtaining advice from an appropriately qualified entity who was given sufficient information to give appropriate advice; or
- developing or implementing a plan for restructuring the company to improve its financial position.
To date, there has been no case law providing judicial interpretation of Section 588GA as a defence to insolvent trading, including guidance as to how some of the important concepts and terminology associated with the safe harbour provisions should be applied.