Throughout 2016 a series of judgments were delivered that gave conflicting guidance to practitioners about what they should consider when accepting a voluntary administration appointment. In particular, the decisions in Condor Blanco Mines[1] and Planet Platinum[2] were extensively commented on, but left practitioners unsure whether they were obliged to inquire into the motives behind their appointment.[3]

When issues have arisen, practitioners have also had mixed results when approaching courts to validate their appointment. However, cases like the recent decision in Maria’s Farm Veggies[4] emphasise that hope is not necessarily lost. In that case, the New South Wales Supreme Court was prepared to validate the administrators’ appointment even though the secured creditor appointor was not entitled to enforce its security and appoint administrators. The question therefore arises as to whether practitioners can rely on the courts to validate their appointment if there are issues around validity of appointment.

Moving into 2017, it is hoped that the proposed safe harbour reforms, including the potential introduction of the ‘registered restructuring advisor’, will be progressed. Those reforms have been applauded as encouraging business revival, but may also encourage greater use of pre-pack (or pre-positioned) sales. Practitioner independence and phoenix activity remain a focus for ASIC[5] and Australia’s tough stance on pre-positioned sales remains. Will these reforms help or hinder administrators?

A quick refresher

Section 436A of the Corporations Act (Act) provides that a company may appoint an administrator when the board has resolved that in the opinion of the directors voting for the resolution, the company is insolvent, or is likely to become insolvent at some future time and an administrator should be appointed. This seemingly simple requirement becomes complicated when the directors may have other motives for the appointment.

In Planet Platinum, the Supreme Court of Victoria found that the administrator’s appointment was invalid, as the directors did not form the opinion that the company was insolvent and that the dominant purpose for the appointment was to deal with issues other than insolvency. Relevantly, the court stated that:

  1. Practitioners must be satisfied that the statutory pre-conditions in s 436A of the Act are met prior to accepting an appointment.
  2. There was insufficient information before the administrator to satisfy himself about the company’s solvency. In particular, the administrator made no enquiries of the company’s secured creditor, did not review any accounts and did not correct a statement made by the director at the first meeting of creditors that the company was not insolvent.
  3. The court’s curative powers under s 447A of the Act (discussed below) should only be exercised where the power is consistent with the objectives of part 5.3A of the Act.

Ultimately, in Planet Platinum it was held that the administrator had acted unreasonably, and should therefore pay the other parties’ costs and be precluded from recourse to the company’s assets for his own costs.

Subsequently, in Condor Blanco Mines the New South Wales Supreme Court disapproved of any suggestion in Planet Platinum that an administrator must delve into the directors’ motives for the appointment.

In that case, the Court found that the administrator’s appointment was invalid because at the time of the resolution one of the directors did not hold a genuine opinion that the company was, or would become, insolvent. The administrator was ordered to pay half of the company’s costs and his own costs of the proceedings challenging his appointment.

Importantly, this decision made clear that administrators are not required to undertake an independent verification of the factual basis on which the directors made the appointment. However, administrators must be attentive to any matter that may call into question whether the directors genuinely believed that the company was or would become insolvent and could validly pass a resolution pursuant to s 436A of the Act.

The Court found that administrators must consider:

  1. whether the resolution appointing them is, on its face, valid (to the extent it is possible on the available materials), and
  2. whether the directors appear to hold the opinion that the company is, or may become, insolvent at the time of voting.

Administrators should make some inquiry when approached so as to gain some insight into the company’s financial position and from this give the directors’ opinion a ‘rough check’. Publicly available information should also be examined to confirm the directors’ identity, that they are not disqualified from acting as a director and the administrator must also see that the board has adopted due process to pass an appropriate resolution.

Except in very exceptional circumstances, nothing further is required. In particular, generally administrators have no responsibility to delve into the directors’ motives in making that appointment, beyond the use of administration in response to actual or impending insolvency.

If it were ‘as plain as a pikestaff’ without any form of enquiry that the directors were using administration for extraneous purpose the practitioner would not discharge their relevant responsibility by accepting the appointment. However, beyond blatantly obvious cases, there is no expectation that at the time of appointment administrators must consider possibilities of improper purpose.

Where does this leave practitioners?

Until the inconsistency is resolved by a higher court, the position remains unclear. Some assistance can be found in judgments in the United Kingdom which are more consistent with the Condor Blanco Mines decision and state that administrators are not obliged to consider the directors’ motivations for the appointment, and rather should look ahead at what may happen during the administration if they are appointed.[6]

It is suggested that the Condor Blanco Mines decision presents a more practical approach and strikes a balance between the objects of Part 5.3A of the Act and the practical realities for prospective administrators.

As noted in that decision, practitioners cannot necessarily obtain all relevant facts and documents when contemplating acceptance of an appointment. However, administrators clearly cannot close their eyes to the obvious, and need to be mindful at all times of any matters suggesting that the directors do not genuinely believe that the company is or will become insolvent.

While this potential inconsistency in authorities remains, practitioners need to carefully consider whether steps need to be taken to validate their appointments.

Courts’ approach to validating appointments

The Condor Blanco Mines decision confirmed that administrators are not expected to resign in circumstances where they consider that the appointment is valid. Administrators are also not obliged to seek court orders validating their appointment, particularly when they are without funds. However, failing to seek appropriate orders may leave administrators with unresolved threats and an inability to practically progress the administration.

Potentially, administrators may seek assistance from courts in reliance on:

  1. s 447A, which gives courts broad powers to alter the operation of Part 5.3A of the Act so long as those powers are exercised consistently with the objects of Part 5.3A
  2. s 447C, which empowers courts to declare that administrators’ appointments are valid
  3. s 447D, which allows administrators to seek directions about matters arising in the course of their appointment (although this is usually only realistic where uncontested facts can be put before the court), and/or
  4. s 1322(4), which gives the court broad powers to validate procedural defects arising from breaches of the Act or a company’s constitution. However, s 1322(4) may not be used to cure defects in administrators’ appointments where the statutory preconditions are not satisfied.[7]

In both Planet Platinum and Condor Blanco Mines, the administrators unsuccessfully sought to invoke combinations of the above sections. In those cases, the administrators were unable to demonstrate that they had been validly appointed as solvency was not the directors’ primary consideration.

When confronted with allegations in relation to the validity of their appointment administrators need to carefully consider the relief to be sought. For example, an order declaring the validity of administrators’ appointments under s 447C may be refused, but that invalidity could be cured by an order under s 447A.

In Maria’s Farm Veggies,[8] the administrators were unsuccessful in obtaining a declaration under s 447C that their appointment was valid. In that case the administrators’ appointer was not entitled to enforce its security interest for the purposes of s 436C[9] at the relevant time, which meant that the appointment was invalid.

The administrators subsequently sought an order under s 447A varying the operation of Part 5.3A and s 436C with the effect that their appointment was valid. They also sought relief under s 1322 to validate their acts as administrators.

Orders were made modifying Part 5.3A to treat the administrator’s appointment as valid. The court clarified that, even though the secured creditor was not entitled to enforce its security as it did not satisfy the requirements of s 436C, this did not mean that the court could not modify the operation of Part 5.3A. The main factors that persuaded the court to validate the administrators’ appointment included:

  1. The company was clearly insolvent, and if control returned to the directors it was likely to return to external administration soon after.
  2. There was potentially significant disruption to the company’s affairs if the administration was ended and the steps taken by the administrators were challenged.
  3. The plaintiff creditor delayed taking steps to challenge the appointment for four months. This was particularly relevant in circumstances where the administration had progressed significantly.
  4. The administrators had obtained further funding from the company’s secured creditor and obtained orders limiting their personal liability for the additional funds.[10] That funding would not have been provided while the directors remained in control and if the administrators’ appointment was not validated they may lose their right of indemnity from company assets.
  5. The potential benefit of retaining an earlier relation-back period.

The question of costs was reserved, but obtaining orders to validate their appointment was nevertheless a good outcome for the administrators.

The Maria’s Farm Veggies decision also confirms that the court can determine an application pursuant to s 447A of the Act where factual matters are in dispute. This is particularly important where, as is often the case, commercial urgencies mean that the issue must be resolved quickly.

On a practical level, the overriding consideration is generally whether continuing the administration is consistent with the objects of Part 5.3A. For example, in Granger[11] the administrators’ appointment was found to be valid notwithstanding that the appointment resolution was passed by only one of the company’s two directors. The administrators were aware at the time of their appointment that it was invalid, but proceeded with the administration.

The court acknowledged that it was presented with a difficult issue, but there was no practical alternative to finding that the appointment was valid, as the second meeting of creditors was needed to finalise the administration of the clearly insolvent company.

However, the Court confirmed that administrators have a duty to ensure their appointment is valid, and as there was no inherent urgency it was incumbent on the administrators to make further enquiries before they accepted the appointment. The administrators were denied their costs of the application because they knew or ought to have known at the time of their appointment that the appointment was invalid.

It is also important to bear in mind that, when confronted with attacks on the validity of their appointment, administrators must act neutrally, and not take an adversarial position. If an administrator does become too involved in the dispute, they risk the adverse costs consequences suffered by the administrators in Condor Blanco Mines.

Prevention is usually the best cure, and it is suggested that this starts at the very beginning with the pre-appointment discussions.

Starting at the beginning: pre-appointment discussions

The starting point in ensuring an appointment is valid is the discussions and documents that the proposed administrator receives prior to the appointment. For example, in Planet Platinum the court was critical of the administrator’s pre-appointment discussions with the director and his advisors, in particular the failure to address solvency and the focus on other issues like the concern held by the director of ‘ASIC breathing down our necks’.

The ARITA Code clarifies that advice or information given by a practitioner at pre-appointment meetings should be limited to:

  1. the financial situation of the insolvent
  2. the solvency of the insolvent
  3. consequences of insolvency
  4. alternative courses of action available to the insolvent in the case of insolvency.[12]

Discussions can extend beyond this to matters such as the terms of a potential deed of company arrangement (DOCA) and administrators can form some preliminary views on any potential DOCA.[13] However, by focusing on these points the critical issue (solvency) cannot be overlooked and must be discussed even if other issues are raised.

There are other sections of the ARITA Code that need to be considered:

First, clause 20.2 of the Code requires an insolvency practitioner to make reasonable enquiries to satisfy themselves of the identity of directors prior to accepting an appointment. The Code clarifies that reasonable enquiries means using professional judgement to determine what is appropriate in the circumstances.

It is suggested that, consistent with the comments in Condor Blanco Mines, when verifying the director’s identity it would be prudent to consider documents such as ASIC searches and the company constitution to confirm that the appointment resolution appears valid on its face.

Second, practitioners must make enquiries and actively seek to identify any risks to independence before accepting an appointment.[14] Threats to independence can of course include referral relationships such as those that were criticised in ASIC v Franklin.[15] Any relationship a potential administrator may have with the restructuring advisor may come under the spotlight.

Third, practitioners must have appropriate checklists for all types of administrations.[16] As a minimum, practitioners must document and implement policies and processes to address independence.[17]

Transition from ‘safe harbour’ to administration

Legislation implementing safe harbour reforms is expected to be introduced in the first half of 2017.[18] The form of that legislation is not presently clear, but both safe harbour models in the Government’s Improving bankruptcy and insolvency laws – Proposals Paper contemplate some role for restructuring advisors.

Model A proposes the introduction of a defence for directors to insolvent trading claims if they have an expectation, based on advice from an appropriately qualified restructuring adviser, that the company can be returned to solvency within a reasonable timeframe and the director is taking steps to ensure the company does so.

Model B contemplates a carve out of the insolvent trading provisions where, relevantly, directors have taken ‘reasonable steps to maintain or return a company to solvency within a reasonable period of time’. The Proposals Paper indicates that the appointment of a restructuring advisor will be a relevant factor in assessing whether a director has taken reasonable steps.

If adopted, the safe harbour reforms may on some levels assist administrators in ensuring that their appointments are not open to criticism.

First, the Proposals Paper includes a precondition to the appointment of a restructuring adviser that the company maintain adequate, up-to-date financial records which explain the company’s financial position. This should avoid situations like that in ASIC v Sino,[19] where ASIC challenged the appointment of administrators on grounds including that the directors could not form the requisite opinion on solvency as they did not have up-to-date financials and that appointment was for other purposes.

In that case the appointment was valid as the board’s resolution was not based on ignorance or uncertainty about Sino’s financial position, notwithstanding that the precise information before the board was not identified. However, it is clearly safer to proceed with an appointment in circumstances where up-to-date financial information is available.

Second, the Proposals Paper states that a restructuring adviser’s opinion that the company can avoid liquidation and be returned to solvency must be properly informed. In those circumstances if administration proves necessary there should clearly be a proper basis to conclude that the company is or may become insolvent.

The Productivity Commission’s recommendations driving at minimising illegal phoenix activity and bringing greater transparency to pre-positioned sales were not adopted in the Proposals Paper. However, as the Productivity Commission acknowledged, the proposed safe harbour and restructuring advisor reforms may also lead to an increase in pre-positioned transactions.

Pre-positioned transactions are likely to remain potentially dangerous territory for administrators, particularly with their inevitable close association with phoenix activity. Phoenix activity clearly remains a focus for ASIC, and as matters presently stand administrators face potential independence issues and suggestions that they have breached their duties on sale of a company’s assets.

Administrators may seek to minimise those risks by ensuring that there is transparency around a proposed sale,[20] that an appropriate marketing campaign has been undertaken and the best possible price obtained. However, until reforms are made administrators enter into pre-positioned transactions at their own risk.

The final form of the safe harbour reforms remain to be seen. For the time being, proposed administrators need to bear in mind the tension between the different courts’ approaches to what is required of them. Questionable appointments clearly remain a focus for ASIC, and practitioners need to be alive to any suggestion that their appointment is anything other than insolvency-focused.