Australia’s restructuring landscape has changed significantly in recent weeks on two fronts. One of the changes arises from the safe harbour and ipso facto reforms to Australia’s insolvency laws receiving royal assent on 18 September 2017. The second event arose rather more unexpectedly from the Federal Court decision of Re Korda, in the matter of Ten Network Holdings Pty Ltd (Administrators Appointed)(Receivers and Managers Appointed)  FCA 914 (Ten Decision).
We discussed the detail of the proposed law reforms in our article ‘Any Port in a Storm? Analysing Safe Harbour and Ipso Facto Insolvency Reforms’. Following royal assent, Australian insolvency law now has:
a ‘safe harbour’ for directors who are seeking to develop or implement a restructuring of a company which shields them from personal liability for insolvent trading under section 588G of the Corporations Act 2001; and
a stay on enforcement of ‘ipso facto’ clauses in a contract entered into after 1 July 2018 that are triggered when a company enters formal insolvency proceedings.
The ‘safe harbour’ reform takes immediate effect from 18 September 2017 and the ‘ipso facto’ reform will take effect from 1 July 2018 (or earlier by proclamation).
The safe harbour reform clears the way for a company or board operating in the twilight zone of insolvency to take steps for early intervention and to seek out the advice of restructuring professionals to put in place a restructuring plan. There is now no excuse for a board to sit on their hands and wait for a third party to determine their fate. Central to any restructuring plan is engaging appropriately qualified advisors who can assist in putting together a plan. These advisors can also do contingency planning which involves analysis of the impact of a free fall insolvency and the possible advantages of using a light touch insolvency process to implement the restructuring. In its submissions to the court in the Ten Decision, the Australian Securities and Investments Commission (ASIC) noted that “directors contemplating potential insolvency should be encouraged to do the very thing that the Ten Group did, namely engage with qualified professionals early, to develop a restructuring plan that will increase the chances of rescue or maximise the amount that can be salvaged for the benefit of creditors and, if at all possible, members.”
By engaging early and preparing for the worse, a company has a greater chance of rescue but up until now, Australian insolvency law and practice has stymied directors from engaging early and largely prevented insolvency and restructuring professionals from being engaged early. The insolvency law reforms and the Ten Decision pave the way for a change in this approach.
When considered together with the insolvency law reforms, the Ten Decision is important for a number of reasons. First, it tips on its head the industry’s traditional (and at times conservative) approach to conflicts of interest and independence of insolvency practitioners. Secondly, it reminds us of the court’s ability to appoint a special purpose administrator in appropriate circumstances under section 447A of the Corporations Act 2001 where there may be a perceived or actual conflict of interest. Finally, the decision may lead to an increase in the use of “planned” insolvencies as a restructuring tool in Australia (as opposed to traditional pre-packs).
Conflict and Independence
It is central to the operation of Australia’s insolvency laws that administrators and liquidators act independently and impartially. They should take all necessary steps to avoid or appropriately manage conflicts of interest and circumstances which may give rise to a reasonable apprehension of bias. In this pursuit of independence and impartiality, insolvency practitioners in Australia have typically been reluctant to accept administration appointments in circumstances where he or she has had prior, substantial involvement with the company.
What constitutes substantial involvement has typically involved a case-by-case self-assessment by the practitioner prior to any need for intervention by the court and has largely been centred on a consideration of the time spent working with the company, the work performed and the fees charged during the pre-appointment period.
It wouldn’t be controversial to suggest that a pre-appointment engagement of over three months involving approximately 50 meetings with management, directors, financiers, guarantors and advisors which resulted in the payment of over $1,000,000 in remuneration is likely to constitute “substantial involvement”. However, it is clear from the reasoning in the Ten Decision that:
the starting point for making an assessment does not have to be that prior, substantial involvement of itself causes a reasonable apprehension of bias;
it is now open to the practitioner to consider the benefits to the company, its creditors (and possibly members) of this prior, substantial involvement; and
provided certain safeguards are in place to protect against any apprehension of bias or conflict of interest, a practitioner should not automatically rule themselves out from taking a subsequent appointment solely on the basis of their prior involvement with the company even if that engagement involved a significant amount of work at a substantial cost to the organisation.
In addition to the use of special purpose administrators (discussed below), one of the other safeguards raised in the judgment centred on the disclosures contained in the administrator’s Declaration of Independence, Relevant Relationships and Indemnities (DIRRI) required under section 436DA of the Corporations Act (Act). ASIC submitted, and the Court agreed, that had KordaMentha fully disclosed the extensive nature and detail of the pre-administration work with the Ten Group in its DIRRI that the angst around their appointment as administrators in light of this pre-appointment involvement may have largely been avoided.
Previously, administrators may have been reluctant to disclose too much detail on prospective administration planning in the DIRRI for fear of placing directors of that company in the direct firing line under Australia’s insolvent trading laws or exposing their own firm to a potential voidable transaction claim. It is likely that these concerns are largely addressed if a company is operating in a safe harbour.
Special Purpose Administrators
The Ten Decision is also a timely reminder that the courts have the power under section 447A of the Corporations Act to appoint a special purpose administrator in circumstances where there may be a perceived or actual conflict of interest but where there is an ultimate benefit to creditors from a time and cost perspective to leave the incumbent administrator in place.
As the court noted in the decision of Hughes v Westgem Investments Pty Ltd (Receivers and Managers Appointed) (No 3)  WASC 360:
the decision to appoint a special purpose administrator must be made on a case by case basis;
special purpose administrators can be appointed to deal with perceived conflicts of interest and if necessary to cure actual conflicts; and
an administrator’s prior involvement with a company will not of itself create a conflict of interest if that administrator is then appointed to the company. However, substantial involvement with the company may give rise to a conflict of interest.
Although appointments of this nature have been rare in Australia, with the introduction of the safe harbour reform, it is more likely that insolvency practitioners will have a greater involvement for a longer lead time in companies trading in the twilight zone which may give rise to perceived or actual conflicts which could be proactively managed by the limited appointment by the court of a special purpose administrator.
The Ten Decision is a good example of where the court has used these powers to cure, what was considered to be, a reasonable apprehension of bias arising from the payments made to KordaMentha during the pre-appointment period.
Insolvency practitioners are urged to get on the front foot and seek judicial direction early if there is any doubt.
Pre-packed Transactions and Planned Insolvencies
There is a distinction to be drawn between a typical pre-pack transaction and a planned insolvency where the parties use a formal insolvency method to implement a broader restructuring in circumstances where a fully consensual restructuring is unable to be achieved. The formal insolvency process is used to cram down dissenting creditors to deliver the restructuring. This technique is commonly used in the United Kingdom (along with traditional pre-packs) where achieving a fully consensual restructuring is not possible. In these circumstances, the pre-insolvency planning is critical to working up any non-consensual Plan B strategy.
In our view, the Ten Decision opens the door to an increased use of the planned insolvency process. The pre-appointment planning undertaken by the Ten Group with the assistance of KordaMentha, their consequent appointment as voluntary administrators and the acquisition by CBS of the Ten Group by way of a deed of company arrangement is a classic example of how a planned insolvency can work successfully in the Australian market to maximise value and create certainty.
In contrast, a pre-pack is considered to be a sale of all or some of a company’s assets which is arranged prior to, and completed shortly after, a formal insolvency appointment. In most instances, it is completed without any approval or involvement of the creditors and the counter-party to the pre-pack transaction is known at the time of the formal insolvency. Historically, the use of pre-pack transactions in Australia has been limited. Most commentators agree that the key impediments to their use in Australia have been largely due to:
Restrictions on insolvency practitioners regarding independence, conflicts of interest and involvement with the company pre-appointment;
Australia’s draconian insolvent trading laws;
The prevalence of ipso facto clauses which enable counterparties to terminate key contracts on the appointment of an administrator.
Although the insolvency law reforms are likely to address issues around insolvent trading and ipso facto clauses, the restrictions on insolvency practitioners regarding independence and conflicts of interest are likely to remain. Whether we see an increase in pre-pack transactions in Australia where an alternate insolvency practitioner is used to take the appointment (as opposed to the pre-appointment advisor taking the ultimate appointment) remains to be seen.
There is a lengthy discussion in the Ten Decision about pre-packs, however there is nothing in the judgment which would appear to support the lifting of the restrictions on insolvency practitioners regarding independence, conflicts of interest and involvement with the company pre-appointment to facilitate an increased use of traditional pre-packs in Australia. In fact, His Honour Justice O’Callaghan was quick to draw this distinction in his judgment in the Ten Decision. He noted that it would be difficult to imagine a situation in which the taking of a pre-pack administration appointment in circumstances where the practitioner has had detailed involvement and assistance with the pre-pack proposal would ever be countenanced.
The insolvency law reforms and the practical approach adopted by the court in the Ten Decision to independence and conflicts of interest are a step in the right direction and hopefully, a significant move towards companies in Australia being more comfortable with exploring informal, consensual restructuring options with the help of experienced advisors.