Insolvency Law Reform Bill: Voluntary administration - how it works in practice
Insolvency Law Reform Bill
Voluntary administration - how it works in practice.
1
The Insolvency Law Reform Bill was tabled before Parliament on 21
December 2005. The Select Committee have reported on the Bill and
current indications are that it will become law, in substantially its
current form, in early 2007. The bill will introduce the
Australian-based Voluntary Administration regime.
2
Insolvency practitioners will need to understand how this new procedure
works, and what immediate practical issues arise on appointment. This
paper will explain the key features of this procedure, and discuss:
• important timeframes;
• what effect the appointment has on creditors;
• potential pitfalls for administrators;
• the second meeting;
• examples where Deeds of Company Arrangement (“DOCA”) have been successful; and
• what happens when a DOCA terminates.
3 Objective
3.1 The stated objective of Voluntary Administration (under the
proposed part 15A of the Companies Act) is to provide for the affairs
of an insolvent company, or one that may become insolvent, to be
administered in a way that:
a. Maximises the chances of the company, or as much as possible of its business, continuing in existence; or
b. If it is not possible for the company to continue in existence,
results in a better return for the company’s creditors than would
result from an immediate liquidation.
4 Commencement of VA
4.1 Voluntary administration commences when an administrator is
appointed. The appointment of an administrator may be initiated by the
company if its directors resolve that the company is insolvent, or
likely to become insolvent. The appointment needs to be in writing.
4.2 Voluntary administration may also be instigated by a secured
creditor who has an enforceable security interest on the whole or
substantially the whole of the company’s properties. If a company is in
liquidation, or interim liquidation, the liquidator may also initiate
an administration.
5 First Meeting
5.1 Within five working days after the administration begins, the
voluntary administrator must issue notices to “as many creditors as
reasonably practicable” convening a meeting which is to be held within
eight working days. Notice calling the meeting is to be sent 5 working
days before the meeting. The meeting must also be advertised.
5.2 At this meeting creditors have the opportunity to replace the
administrator and to appoint a committee of creditors. The provisions
of schedule 5 of the Companies Act apply as if the administrator was a
liquidator, therefore the conduct of the meeting is essentially the
same as for a meeting of creditors in a liquidation. The key difference
is that in order for a resolution to be passed, a majority in number
and a 75% majority in value of the creditors must vote in favour of the
resolution.
Ansett administration
5.3 Before the first meeting of the Ansett administration, to be held 5
days after appointment, representative employees obtained an order
permitting union representatives to vote on behalf of employees that
were union members but not represented by proxy or in person. There
were many employees (16,000) widely dispersed. From that moment, the
union representing a majority of creditors in number and in value ($686
million, principally contingent redundancy claims) controlled the
voting and significantly influenced the administration.
6 Effect of Appointment
6.1 The administrator assumes control of the company, and its property
and affairs. To give the company breathing space, a moratorium comes
into effect. There are also personal liability issues which
administrators need to be aware of.
Moratorium
6.2 A moratorium (with certain exceptions) is imposed upon creditors of
the company, on those who own property used by the company, and on any
party who holds a guarantee from a director of the company. The
moratorium is intended to preserve the company’s position until the
watershed meeting, which is to be held with 25 days of appointment.
6.3 This prevents creditors from taking action against the company
without the administrator’s written consent or leave of the court.
Owners of leased goods therefore cannot take action to recover goods
during the administration period without consent. The administrator
cannot sell the property except:
a. with the consent of the owner; or
b. in the ordinary course of business; or
c. with the leave of the court.
Ansett – extended moratorium
6.4 In the Ansett administration, the period between the first and
second meetings was extended for a total of just over six months. At
the reconvened second meeting the creditors passed a resolution that
the company execute a DOCA. The time within which the DOCA was to be
executed was then extended by a further two months. This meant that
secured creditors, such as lessors of aircraft, were bound by the
moratorium which continued right throughout that eight month period.
Exceptions to the moratorium
6.5 The main exception to the moratorium is that it is not binding on
substantial secured creditors i.e., charge holders with a charge over
the whole, or substantially the whole, of the assets of the company.
This allows substantial secured creditors to appoint a receiver. This
option must be exercised within 10 working days of receiving notice of
the appointment of the administrator.
6.6 Other people not bound by the moratorium include:
a. a secured creditor who holds a charge other than a charge over the
whole, or substantially the whole, of the property of the company, and
has begun to enforce the charge prior to commencement of the
administration;
b. a secured creditor who holds a charge over
perishable property, irrespective of whether the charge is enforced
before or after the appointment;
c. owners or lessors of property
used or in the possession of the company who have enforced a right to
take possession prior to appointment; and
d. owners or lessors of perishable property.
6.7 Secured creditors and owners or lessors of property (as described
in a and c above) must have actually commenced enforcement of the
charge or recovery of property to fall within the exception. Mere
service of a demand for repayment will not suffice.
Court orders restricting rights of secured creditors and owners of property
6.8 The court can make orders restricting the enforcement rights of the
people in a to d above. It may only do so if what the administrator
proposes to do will adequately protect that person’s interest. This can
be a useful power to an administrator wishing to keep the assets of the
business together for sale as a going concern.
6.9 Debis
Financial Services (Aust) Pty Ltd v Allied Bellambi Collieries Pty Ltd
(1999) 17 ACLC 1636 is an example of the use of this power. Debis had a
charge over a large item of mining equipment, located underground in a
mine. Prior to the administrator’s appointment, a receiver had been
appointed to that piece of equipment by Debis. The administrator put
forward a DOCA proposal under which the mine would be sold to a
purchaser, that would also purchase the mining equipment, and pay out
the secured creditor. The administrator filed proceedings and sought an
order preventing the receiver from gaining access to the machine during
the administration. The receiver opposed on the basis that if the sale
went ahead but did not include the equipment, then it would have
difficulty recovering it because the mine would need to be shut down
for it to be retrieved. The administrator gave an undertaking that any
sale agreement would contain a clause that allowed Debis to remove the
machine on reasonable notice if it was not included in the sale
agreement. This was held to be “adequate protection”. Hamilton J said
that “the protection to which the Court is required to be satisfied is
not protection which is absolute or perfect in all circumstances, but
protection which is adequate or suitable considering the circumstances
which actually prevail.”
6.10 Other factors the court will
consider are the length of the remaining duration of the
administration, the adequacy of the protection to the secured creditor,
the fact that the value of the equipment on the open market was lower
than its value as part of a going concern, and the general policy of
the Act to permit companies to return to viability.
7 Personal Liability of Administrator
7.1 The Administrator is personally liable for general debts incurred
during the administration period, but is entitled to an indemnity out
of company assets. There is no personal liability for debts that fall
due during the administration period under agreements entered into by
the company pre-administration. Liability for unliquidated damages
incurred during the administration period (e.g. liability for failure
to comply with a covenant in a lease) will not be a debt for this
purpose.
Employees
7.2 The Administrator
is also liable for wages that accrue during the administration of the
company, unless the administrator has lawfully given notice of the
termination of the employment contract within 14 days of appointment.
The court may, on the administrator’s application, extend the period of
14 days.
Rent and other payments
7.3 The Administrator is personally liable for rent and other payments
accruing by the company during the administration period under rental
agreements made before the administration began.
7.4
However there is a seven day “no liability period” following from the
day that the administration begins. The Administrator may issue a
non-use notice in relation to leases or rented property within seven
days after the administration begins. The owner of the property may
then exercise its rights in relation to the property. Non-use notices
must specify the property to which it relates, and state that the
company does not propose to use the property.
7.5 There is
power for the court to excuse an administrator from liability, even
though a non-use notice was not issued. This might be exercised where
the books of the company are so disorganised that it was impossible to
ascertain within 7 days what third party assets the company possessed.
7.6 If, on appointment, the company has limited assets, the
administrator will usually have no option other than to cease trading
the business in the absence of any external funding. Otherwise the
administrator risks personal liability in relation to wages, rent and
other payments.
8 Event of Default Clauses
8.1 There is no statutory right for a voluntary administrator to void
clauses in company contracts that entitle the other party to terminate
the contract by the mere fact of an appointment of a voluntary
administrator, regardless of whether or not the company is able to
perform. The moratorium does not extend that far.
8.2 In
the One.Tel voluntary administration, the company’s supplier Optus
immediately ceased to allow One.Tel to its network to continue to
resell mobile telephony. As reselling access to a mobile phone network
was One.Tel’s core business, any chance of a business restructure using
a DOCA was shattered, and the company went into liquidation at the
second meeting. In that case there was probably little that could have
been done, however the message is for administrators to immediately
talk to suppliers if they wish supply to continue.
9 Second or “Watershed” Meeting
9.1 Within 25 working days of appointment, the voluntary administrator
must hold a second meeting at which the creditors of the company will
decide the company’s fate, unless the convening period for the second
meeting is extended by the court. This meeting is referred to as the
“watershed” meeting.
9.2 The notice for the meeting must be sent out 5 days before the meeting and must contain:
a. a report as to the affairs of the company,
b. a copy of any proposal for a deed of company arrangement, and
c. a statement of the administrator’s opinion on the three possible alternatives for the company:
i. returning the company to its directors;
ii. appointing a liquidator; or
iii. executing a rescue or compromise proposal in the form of a DOCA.
The second meeting can be adjourned for up to sixty days (unless a further extension is ordered by the court).
9.3 As discussed above, the provisions of schedule 5 of the Companies
Act apply as if the administrator was a liquidator, therefore the
conduct of the second meeting is essentially the same as for a meeting
of creditors in a liquidation. The key difference is that in order for
a resolution to be passed, a majority in number and a 75% majority in
value of the creditors must vote in favour of the resolution.
Extension of time for second meeting
9.4 The administrator may also apply to the court to extend the
convening period between the first and second meetings. Reasons to make
such an application for an extension may include:
a. to enable the administrator to finish the report;
b. to enable preparation of a DOCA;
c. to continue negotiations regarding a sale of the business; and
d. to discuss the draft with the creditor’s committee, so as to increase the chances of acceptance.
This is a power that has been used frequently in Australia. The
judgment of Young J in Mann v Abruzzi Sports Club (1994) 12 ACLC 137
gives an insight into the court’s approach:
“The
administrator is, on the evidence, doing the best he can to deal
speedily with negotiations to enable the company to go back into
survival mode and it would seem that there is no prejudice to creditors
or to members in extending the time. Furthermore, if a meeting of
creditors was convened now the administrator would not have sufficient
material to be able to give a meaningful account of his administration
to the creditors.
Accordingly it seems to me that
this is a case where I should extend the time. I am a little reluctant
to do so because I do not wish to invite a spate of these applications
whenever administrators find that they run out of time to comply with
the Act. On the other hand I do not want it thought that administrators
can only apply where they have special grounds. In all cases one must
keep in mind the object of the [Act]”
9.5 It seems
that the bill will allow an application for an extension after the end
of the convening period. However, a prudent administrator should apply
before the end of the convening period, if at all possible. The court
will want to see evidence in relation to:
a. the wishes of the
secured creditors and owners and lessors of property, because they are
primarily the parties affected by the extension of the moratorium;
b. the work done to date by the administrator.
9.6 Applications for extensions of time, and in fact all applications
for orders under this new part of the Companies Act, should be brought
promptly and on affidavit evidence, in a similar manner to which a
receiver’s application for directions is currently sought.
Alternatively, the application may be brought as an interlocutory
application using the same procedure as when seeking an injunction.
10 Why would a substantial secured creditor support administration?
10.1 The question is often asked as to why a substantial secured
creditor would support an administration and not appoint a receiver
within the 10 day period. There are a number of circumstances when a
secured creditor might prefer to support administration:
a. When
there is doubt as to whether enforcement would realise a sufficient
amount to repay the secured debt. Putting together a DOCA with the
co-operation of directors and other creditors may result in a better
outcome.
b. Although a receiver appointed by a secured creditor
with a charge over the whole, or substantially the whole, of the
company’s assets will usually be entitled to run the business and sell
it as a going concern, the receiver will have to deal with claims by
lessors of equipment, suppliers collecting stock under reservation of
title, and landlords threatening to repossess premises. Under voluntary
administration, the moratorium (subject to the above mentioned
exceptions) will mean those persons will not be able to frustrate the
administrator’s ability to operate the business and hold it together
while a DOCA is formulated.
c. Transactions between the company
and a secured creditor may be subject to the voidable transactions
provisions of the Companies Act. Administrators do not have the ability
to challenge voidable transactions, only liquidators. In that case, the
secured creditor may prefer to keep the company out of liquidation.
d. If the secured creditor is comfortable with the capability and
integrity of the administrator, it may be happy to let the
administration proceed.
10.2 It is important to remember
that a secured creditor is only bound by a DOCA to the extent that its
terms restrict enforcement of security rights, or if it votes in favour
of it. A DOCA must therefore always cater specifically for, and appeal
to, secured creditors. Therefore it is open to secured creditors to
support an administration and wait to see if there is a satisfactory
deed proposal at the second meeting. If none emerges, the company will
go into liquidation and the secured creditor can enforce at that point.
Alternatively, if the DOCA proposal does not appeal, a substantial
secured creditor can elect not to vote for it, and enforce at that
point.
11 Use of casting vote
11.1 The
administrator must chair the meeting and has a casting vote. This means
that when there is a majority in number going one way on a resolution
to approve a DOCA, and a 75% majority in value going against the DOCA,
the administrator can decide.
11.2 There have been a
number of Australian cases regarding use of the casting vote, where a
DOCA has been terminated by order of the court due to inappropriate use
of the casting vote. What is required of administrators is a weighing
up of a number of factors. Administrators should consider:
a.
opposition to the proposal by the major creditor, especially when there
is a large disproportion between the major debt and the other debts;
b. support from directors where the DOCA will give advantage to them;
c. the overall objectives of the voluntary administration regime.
12 Deeds of Company Arrangement
12.1 DOCA’s are essentially the compromise or restructure between the
company and its creditors. They can vary from a mere moratorium to a
major reorganisation or compromise. The major disadvantage with deeds
of company arrangements is that in practice they do not work unless
they separately bind, or specially cater for creditors who are not
merely unsecured. Priority creditors need to be looked after otherwise
they will not vote in favour of the proposal.
12.2 A DOCA
proposal may be internal or external. An example of an internal
proposal may effectively be a compromise proposal from shareholders,
directors or management. An external proposal may come from an outside
party wishing to purchase the company’s business, and continue to carry
on business under the existing corporate structure.
12.3
Whatever the proposal, it must generally offer a better return to
unsecured creditors than what they would be likely to receive in a
liquidation. It must also appeal to secured creditors otherwise at the
end of the administration period, those creditors will not vote in
favour of the DOCA and be able to enforce.
12.4 There are a series of prescribed provisions which will apply in a DOCA unless expressly excluded. These terms include:
a. the identity of the deed administrator;
b. the property available to creditors (sometimes referred to as the Deed Fund);
c. to what extent the company will be released from its debts (i.e. the
extent to which available funds will be distributed to each class of
creditors);
d. the conditions, if any, for the deed to come into operation;
e. order of priority; and
f. circumstances in which the deed terminates.
The aim of the process is to allow the terms to be flexible.
Execution of DOCA
12.5 If a proposed DOCA approved by creditors is not executed within
the 15 day working period following the meeting without an extension,
the administrator must apply to the court for appointment of a
liquidator. A DOCA is usually executed by the company and its
administrators.
Unequal treatment of creditors
12.6
There is no obligation under a DOCA to treat classes of creditors
equally if there are general commercial reasons for not doing so.
Australian courts have said that a DOCA which forces certain classes of
unsecured creditors to wait longer than other classes, and to receive
less, is not unfairly prejudicial. In many cases there will be
commercial reasons for discriminating in favour of, for example,
subcontractors if it is vitally necessary for the company to retain the
loyalty of those people.
12.7 However, with the priority
to the IRD for GST and PAYE in a liquidation scenario remaining in
place, and the requirement for a resolution to be approved by a
majority in number and 75% in value, it may be difficult to achieve a
DOCA with unequal treatment of different classes of creditors. This is
because creditors should always compare their treatment under the DOCA
proposal with a liquidation.
Secured creditors not bound
12.8 A DOCA will bind all creditors of the company for claims arising
on or before the day specified in the deed. Secured creditors that do
not vote in favour of the DOCA are not bound. Entering into the DOCA
creates a separate regime that governs the rights between the parties.
Termination of a DOCA
12.9 A DOCA can be terminated:
a. by court order;
b. by creditor’s resolution at a meeting convened by the deed
administrator or requested by 10% or more of the creditors in value; or
c. automatically on an event specified in the DOCA.
When a
DOCA is terminated, technically the company reverts to its directors
and shareholders. However the court or creditors at a meeting
terminating the DOCA can vote to appoint a liquidator.
12.10 A DOCA releases the company from debt only to the extent provided
for in the DOCA and to the extent that the creditor concerned is bound
by the DOCA. Debts incurred under the DOCA period are not personal
debts of the deed administrator.
Suitable for large companies?
12.11 A DOCA can deal with companies of any size, however the size and
complexity of a company will mean that the convening period will often
have to be extended until such time as the administrator is able to
made a recommendation in relation to the future of the company. This is
what happened in Ansett, with a delay well beyond the 25 day moratorium
period initially contemplated in the Act. For a large public listed
company, it has been suggested that interim liquidation is more
appropriate. This was the step taken by the directors of HIH Insurance
Limited.
13 Deed of Company Arrangement – Case Studies
Pasminco - Zinifex
13.1 Pasminco Limited was a large ASX listed company which appointed a
voluntary administrator in September 2001. Pasminco continued to trade
and a restructure of the group was effected by a DOCA, achieved
principally by splitting the group into two parts and exchanging
existing debt for equity in the restructured entity, with the sale of
50% (approximately) of the equity in the market place.
13.2
The DOCA had sufficient flexibility to allow for the variations to the
structure for the proposed capital raising if the float was not to
proceed. Creditors accepted the DOCA and Pasminco, now renamed Zinifex,
successfully refloated in April 2004. The share price has risen
significantly since floating which indicates the market’s general
acceptance of the restructure.
W C Penfold – Stationary Group - June 2004
13.3 The key feature of the DOCA was the sale of the company’s business
to a consortium of investors including two directors, a corporate
recovery fund, and an office products marketing group. It was
effectively a management buy-out. Under the DOCA the buyer took
possession of the brand, stock, fixtures and fittings, and store
leases.
13.4 The unsecured creditors received a meagre
3.3c in the dollar of the $6.4 million in debt. However 21 of the 32
stores remained open, to come under a franchise arrangement. All
current and past employees received their entitlements. The alternative
was a liquidation and the business would not continue. A nil dividend
was forecast. Creditors were critical that the same directors ended up
in control with no exposure, however they had also lost their
investment.
13.5 The returns to unsecured creditors were
funded by the sale of the listed corporate shell. This occurred through
use of a Creditor’s Trust Deed, which was contemplated in the DOCA. If
the deed administrator deemed it appropriate, the DOCA allowed him to
establish a creditor’s trust.
13.6 The unsecured creditors
under the DOCA became beneficiaries of a trust, and the administrator
becomes the trustee. This enables the DOCA to be terminated and a
recapitalisation of the listed shell to occur. Creditor’s trusts are a
useful tool where the company is listed, as there is generally always
value in a listed shell.
14 Popularity of Voluntary Administration
14.1 Voluntary administration is the most popular form of insolvency
administration in Australia. In June 2004, the Australian Parliamentary
Joint Committee on Corporations and Financial Services reported on the
effectiveness of the VA regime after a decade of operation.
14.2 The submissions received commented positively on the procedure and
the general view was that the process is a useful and valuable
procedure. The committee concluded that the process strikes a balance
because it allows time and breathing space for a business to
reorganise, failing which the procedure permits a prompt transition to
a liquidation. The procedure is flexible and it gives insolvency
practitioners an effective tool to restructure businesses experiencing
financial difficulty.
