I INSOLVENCY LAW, POLICY AND PROCEDURE
i Statutory framework and substantive law
The Corporations Act 2001 (Cth) (the Corporations Act) is the primary legislative reference for, among other things, the registration, insolvency and reorganisation of companies incorporated in Australia. In the context of insolvency, the Corporations Act prescribes the manner in which an Australian company can enter into a formal insolvency process and how its assets are ultimately distributed to creditors.
The legislative framework for personal insolvency is set out in the Bankruptcy Act 1966 (Cth) (the Bankruptcy Act), which prescribes the manner in which an individual may enter into a personal insolvency agreement or a formal bankruptcy process. Unlike some other jurisdictions, bankruptcy in the Australian context refers to the insolvency of an individual only.
Despite the regulation and rules governing corporate and personal insolvency being contained in two separate and distinct pieces of legislation, the Australian government has introduced legislative reform by way of the Insolvency Law Reform Act 2016 (Cth), intended to align, to the extent possible, the Bankruptcy Act and the Corporations Act and create common rules for both corporate and personal insolvency processes (where possible).
For the purpose of this chapter, however, we have focused on the statutory framework and substantive law for corporate insolvency processes only.
The broad aim of insolvency law is to balance the interests of the primary stakeholders in an insolvent estate, these being debtors and creditors. A number of formal procedures are available under the Corporations Act in the event of insolvency. These include receivership (private and court-ordered), voluntary administration, deeds of company arrangement, provisional liquidation, liquidation (voluntary and involuntary, and solvent and insolvent), and schemes of arrangement (court-sanctioned).
The Australian test for solvency is set out in Section 95A of the Corporations Act, which provides that: 'A person is solvent if, and only if, the person is able to pay all the person's debts, as and when they become due and payable. A person who is not solvent is insolvent.'
The courts have not applied Section 95A as a rigid rule but rather as a factual question to be determined as a matter of commercial reality and in light of all the surrounding circumstances. The Section has been applied in a wide and varied manner. Despite its broad reading, courts have highlighted certain key issues that must be considered when faced with the question of assessing a company's solvency at a particular point in time. These key issues relate to the cash flow test and prospective considerations.
The position in Australia is that the key test of solvency is the 'cash flow' test, rather than the 'balance sheet' test (and this is clear from the wording of the legislation). That is to say, a company must have sufficient cash flow available to it to meet its debts as and when they fall due. The balance sheet analysis is not immaterial, however, as courts have held that it is often relevant in providing background and context for the proper application of the cash flow test.2
Safe harbour and ipso facto reforms
There has been a historical view, propounded by some, that Australia's insolvency regime is focused more on punitive measures than on the rehabilitation of debtor companies. This is in contrast to other jurisdictions3 whose insolvency laws, many consider, better promote restructuring, innovative reorganisations and value preservation. To seek to address some of these perceived issues, on 18 September 2017, the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill (the TLA Act) received royal assent. The TLA Act brought into operation two fundamental changes to Australia's insolvency laws:
- a new safe harbour from civil liability for insolvent trading for directors seeking to restructure financially distressed or insolvent companies (i.e., a safe harbour); and
- a legislative stay on the enforcement of certain ipso facto rights (i.e., an automatic stay on the enforcement of ipso facto rights).
The safe harbour provisions introduced Section 588GA into the Corporations Act. Under this Section, a director will not be 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'.4 The relevant director bears the evidential burden if he or she seeks to rely on this defence.
Importantly, the safe harbour provisions are not intended to protect directors against more general breach of duty claims. A director cannot rely on the new safe harbour provisions if, at the time the debt is incurred, the company has failed to pay employee entitlements or comply with certain reporting or taxation requirements.
The second recent development, the introduction into the Corporations Act of an automatic stay on the enforcement of ipso facto provisions, came into effect from 1 July 2018. Broadly, the automatic stay operates to preclude a party from enforcing certain rights (including terminating a contract or accelerating a debt) simply because the company has entered into certain formal insolvency processes.
However, the automatic stay will not apply to:
- receiver or controller appointments that are not over the whole or substantially the whole of the company's assets;
- entry by a company into a deed of company arrangement (DOCA);
- liquidations, other than those immediately following a voluntary administration or where the company is fully wound up in connection with a scheme of arrangement;
- rights or self-executing provisions arising under contracts entered into prior to 1 July 2018; and
- certain contract types and rights prescribed in the Regulations and Ministerial Declaration as being exempt from the automatic stay.
Pursuant to the new Sections 415E, 434K and 451F of the Corporations Act, a court may lift the automatic stay if the court is satisfied that it is in the interests of justice to do so or where a relevant scheme of arrangement is found not to be for the purpose of avoiding being wound up in insolvency.
Strengthening protections for employee entitlements
On 5 April 2019, the Corporations Amendment (Strengthening Protections for Employee Entitlements) Bill 2018 (Cth) (the SPE Act) received royal assent. The SPE Act introduced, among other things, three significant changes to the Corporations Act:
- an extension of the existing criminal offence provision to capture a person recklessly entering into transactions to avoid the recovery of employee entitlements;
- enhanced personal liability consequences by introducing a new civil penalty for such action with an objective reasonable person test; and
- the ability for a liquidator, in certain circumstances, to seek compensation for loss or damage suffered because of a contravention of the civil penalty provision, among other things.
The SPE Act introduced a new Section 596AB into the Corporations Act that sets a lower bar for contraventions; a person will contravene the offence provision if they enter into a relevant agreement or a transaction with the intention of preventing the recovery, or significantly reducing the amount, of employee entitlements and they are reckless as to whether such an agreement or transaction will avoid or prevent the recovery of the entitlements of employees, or significantly reduce the amount of the entitlements of employees that can be recovered.
Under the new Section 596AC of the Corporations Act, the SPE Act also introduced civil liability for persons who enter into a relevant agreement or a transaction and the person knows, or 'a reasonable person in the position of the person would know, that the relevant agreement or the transaction is likely to' avoid or prevent the recovery of employee entitlements or significantly reduce the amount of the entitlements of employees of a company that can be recovered. Section 596ACA provides that a person is liable to pay compensation for any loss or damage suffered by employees resulting from a contravention of Section 596AC while the company is in liquidation, and that a liquidator may recover from the person, as a debt to the company, the amount of loss or damage.
The SPE Act further introduced a Division 8 to Part 5.7B of the Corporations Act dealing with contribution orders for employee entitlements. Section 588ZA(1) provides that a court may make an employee entitlements contribution order in relation to an entity when it is satisfied that a company is being wound up; an amount of the entitlements of one or more employees of the insolvent company that are protected under Part 5.8A has not been paid; the contributing entity is a member of the same group; the contributing entity has benefited directly or indirectly from work done by those employees; that benefit exceeds the benefit that would be reasonable if the insolvent company and contributing entity were dealing at arm's length; and it is just and equitable to make the order. Section 588ZA(2) of the Corporations Act provides that the court may make an order for a contributing entity to pay the liquidator an amount equal to the benefit received by the contributing entity that exceeds the 'reasonable benefit' that might be expected if the contributing entity and the insolvent company were dealing at arm's length.
Given the already limited judicial interpretation of the former Section 596AC, it may take some time before the reforms are properly considered by the courts. Despite this, it will be interesting to see if liquidators pursue debts from persons engaging in employee-creditor defeating behaviour going forward under the new Section 596ACA.
Combating illegal phoenixing
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).
The Insolvency Practice Rules (Corporations) Amendment (Restricting Related Creditor Voting Rights) Rules 2018 (Cth) (the Rules) took effect on 7 December 2018 and amended the Insolvency Practice Rules (Corporations) 2016 (Cth) by, in effect, preventing phoenix operators from 'stacking' votes at creditors' meetings by assigning debts without consideration to related creditors who then vote to appoint, and keep in place, a 'friendly' liquidator or voluntary administrator (who will in turn fail to properly investigate the phoenix activity that has occurred). The Rules provide, in respect of debt assigned to a related creditor, that:
- the related creditor will only be allowed to vote up to the value it paid for the debt; and
- an external administrator must ask all related creditors who have been assigned a debt for written evidence of the assignment and the consideration paid for the assignment for voting purposes.
In addition, the Treasury Laws Amendment (Combating Illegal Phoenixing) Bill 2019 (the Bill) proposes a power for liquidators to recover property that is the subject of creditor-defeating dispositions (in line with their existing legislated ability to claw back voidable transactions).
Following the 2019 federal election, the Bill is currently on hold; however, if passed, the Bill will result in the introduction of a new Section 588FE(6B) of the Corporations Act, which will provide that creditor-defeating dispositions of company property are voidable if they are made while a company is insolvent or if they cause the company to become insolvent or enter external administration within 12 months of the disposition. The proposed new Section 588FDB of the Corporations Act defines a creditor-defeating disposition as 'a disposition of company property for less than its market value (or the best price reasonably obtainable) that has the effect of preventing, hindering or significantly delaying the property becoming available to meet the demands of the company's creditors in winding up'.
The Bill also proposes enhancing the personal liability consequences for illegal phoenix transactions by introducing both a civil penalty regime and criminal liability (with recklessness being the fault element) for creditor-defeating behaviour conducted by directors or facilitators (e.g., pre-insolvency advisers).
The Bill also seeks to introduce a new Section 203AA of the Corporations Act to prevent the backdating of director resignations when such resignations are reported to the Australian Securities and Investments Commission (ASIC) more than 28 days after their purported occurrence. It also provides that if a resignation would result in the company having no other directors, it will have no effect unless the company is being wound up.
These proposed laws seek to address illegal phoenix practices relating to backdating the effective date of director resignations to escape liability for a company's actions following the effective date.
iii Insolvency procedures
The formal insolvency procedures available under Australian law are:
- receivership (both private and court-appointed);
- voluntary administration;
- a DOCA;
- provisional liquidation;
- liquidation (both solvent (members' voluntary liquidation) and insolvent); and
- a court-sanctioned scheme of arrangement between creditors and the company.
For all insolvency processes, other than for a members' voluntary liquidation, the individual appointed must be a registered liquidator.
The main role of a receiver is to take control of the assets of a company (subject to the security pursuant to which the receiver is appointed) and realise those assets for the benefit of the secured creditor. 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 a receiver and a receiver and manager.5 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.
A receiver can be appointed to a debtor company pursuant to either (1) the relevant security document granted in favour of the secured creditor when a company has defaulted and the security has become enforceable, or (2) an application made to the court.6 The latter is far less common and, as such, this chapter focuses on privately appointed receivers.
The security document itself will set out the secured party's rights to appoint a receiver (usually effected by way of a deed of appointment, and the secured creditor will ordinarily indemnify the receiver by way of a deed of indemnity). Once appointed, the receiver will ordinarily (by way of contract) be the agent of the debtor company (not the appointee) and will have wide-ranging powers, including the ability to operate the business, sell assets or borrow against the secured assets. Those powers are set out in the underlying security document and are supplemented by the receiver's statutory powers set out in Section 420 of the Corporations Act.
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 the whole or substantially the whole of the assets of a company. Alternatively, and depending on the financial circumstances, a receiver may immediately engage in a sale process. When engaging in a sale process, a receiver has a statutory obligation under Section 420A of the Corporations Act to obtain market value or, in the absence of a market, the best price reasonably obtainable in the circumstances. It is this duty that has presented the most significant stumbling block to the adoption of pre-packaged restructuring processes through external administration7 that have been seen in, for example, the UK market (colloquially referred to as pre-packs). This is because of the inherent concern that a pre-pack involving a sale of any asset without testing the market could be seen as a breach of the duty under Section 420A.8
Having said that, pre-packs are becoming more common in circumstances where time and funding is short or the value of what is being sold is clearly below the value of the secured debt, or a sale process with integrity has been conducted prior to the receiver's appointment.
Once a receiver has realised the secured assets and distributed any net proceeds to the secured creditor (returning any surplus to the company or later-ranking security holders), he or she will retire in the ordinary course.
The concept of voluntary administration was introduced into Australian law in 1993. Voluntary administration, unlike receivership for example, is entirely a creature of statute. The purpose and practice is outlined in Part 5.3A of the Corporations Act. While voluntary administration has often been compared to the Chapter 11 process in the United States, it is not a debtor-friendly process like Chapter 11. In a voluntary administration, the administrator and creditors control the final outcome to the exclusion of management and members.
The object of Part 5.3A is to:
- maximise the chances of the company, or as much as possible of its business, to remain 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.9
There are three ways an administrator may be appointed under the Corporations Act:
- by resolution of the board of directors that, in their opinion, the company is, or is likely to become, insolvent;10
- 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;11 and
- a secured creditor that is entitled to enforce security over the whole or substantially the whole of a company's property may, in writing, appoint an administrator if the security interest is enforceable.12
An administrator (often called a voluntary administrator) has wide powers to 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 interests13 and in respect of litigation claims. This 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.
There are two meetings during the course of an administration that are critical to its outcome. Once appointed, an administrator must convene the first meeting of creditors within eight business days. At this first meeting, the identity of the voluntary administrator is confirmed, the initial 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 (this may be extended by application to the court). At the second creditors' meeting, the administrator must provide a report on the affairs of the company to the creditors and outline their view on the best option available to maximise returns to creditors. 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 administration14 (this is rare as it would only occur when the company is actually solvent).
The administration will terminate following the outcome of the second meeting (i.e., either by progressing to liquidation, entry into a DOCA or returning the business to the directors to operate as a going concern). When the administration terminates, a secured creditor that was previously estopped from enforcing a security interest because of the statutory moratorium becomes entitled to take steps to enforce that security interest unless the reason for the termination is the implementation of a DOCA approved by that secured creditor.
The automatic stay on ipso facto provisions (see Section I.ii, above) will not apply when the company enters into a DOCA. If the creditors of the company resolve at the second meeting that the company should be wound up, the automatic stay will apply.
A DOCA is effectively a contract or compromise between a 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 administration.
DOCAs are flexible. 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. They may also involve the issuance of shares (subject to certain conditions), 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.15
For a debtor company to enter into a DOCA, a bare majority of creditors, both by value and number, voting at the second creditors' meeting must vote in favour of the company executing a DOCA. If there is a voting deadlock, for example when there is a majority in number but not in value or vice versa, pursuant to Rule 75-115(3) of the Insolvency Practice Rules (Corporations) 2016 (Cth), the chairperson of the meeting (usually the administrator) may exercise a casting vote to pass, or not to pass, a resolution. The right to exercise a casting vote is not mandatory and cannot be used if the resolution relates to an administrator's remuneration.
Once executed, 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' meeting, and typically only those who voted in favour of the DOCA at the second creditors' meeting are bound by its terms.16 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, 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 or in accordance with its terms.
A provisional liquidator may be appointed by the court at any time after the filing of a winding-up application and before the making of a winding-up order in a number of circumstances.17 The most commonly used grounds include:
- when 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.
There must be a reasonable prospect of the company being wound up.
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.
The effect of the appointment is to give interim control of the company to a liquidator to the exclusion of the directors. A provisional liquidator will normally only be appointed by the court if there is a risk to the assets and affairs of a company prior to a company formally entering liquidation. As such, a provisional liquidator is normally only given very limited powers (i.e., 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, and 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.
The automatic stay on ipso facto provisions (see Section I.ii, above) does not apply to provisional liquidation and therefore provisional liquidation is likely to result in some form of damage to the business of the company.
Liquidation is the process whereby the affairs of a company are wound up and its business and assets are realised. A company may be wound up voluntarily by its members if solvent or, 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 the company's debts in the following 12 months). If not, or if the company is later found to be insolvent, the creditors take control of the process and it converts to a creditor's voluntary liquidation.
Creditors may also 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.
The most common ground for a winding-up application being made to the court is insolvency. This is usually indicated by the company's failure to comply with a statutory demand issued by a creditor 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 a compulsory winding up, the liquidator will have wide-ranging powers, including the ability to challenge voidable transactions and take control of the assets of the company. Most likely, a liquidator will not run the business as a going concern, unless that 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 a formal insolvency process; 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 (it requires court approval at two stages). 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 one another 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 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.18 Thus, the basis upon which parties have previously grouped creditors into classes is now a less certain benchmark for class composition moving forward.
The outcome of a scheme of arrangement is dependent on the terms of the arrangement or compromise agreed with the creditors but, most commonly, a company is returned to its normal state upon implementation as a going concern with the relevant compromises having taken effect.
The scheme of arrangement process does have a number of limiting factors associated with it, however, 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 the court is of the view that the scheme of arrangement is not equitable). These factors explain why schemes of arrangement tend to be undertaken only in large corporate restructures and in situations where timing is not fatal to a restructure.
iv Starting proceedings
The Federal Court of Australia and the Supreme Courts of each Australian state and territory have jurisdiction to hear matters relating to the insolvency of a corporation (both civil and criminal offences arising from insolvency proceedings).
Matters pertaining to debt recovery and monetary compensation can also be dealt with by other courts, such as district courts, county courts and magistrates' courts, within their jurisdictional limits. The judicial institutions have discretion to transfer matters between them if considered appropriate.
It is generally only the Federal Court and the Supreme Courts that have jurisdiction to wind up a company.
Interestingly, two of the more common forms of insolvency process – voluntary administration and receivership – often have no court involvement.
v Control of insolvency proceedings
For administrations and liquidations, the relevant insolvency practitioner has control of the company itself to the exclusion of the directors.
In an insolvent winding up, the members lose any right to management of the company. The liquidator is vested with wide powers of investigation and inquiry as well as the power to recover and gather in and secure the company's property. Liquidation does not interfere with the rights of a secured creditor who is able to retain and enforce the security and recover the full amount for the debt owed.
In a voluntary administration, the creditors control the final outcome to the exclusion of management and members, and ultimately decide on the outcome of the company.
Upon execution of a DOCA, the voluntary administration will terminate and the company will no longer enjoy the benefit of any automatic statutory stay or moratorium prescribed in the Corporations Act. Once the DOCA has been executed, a director's powers are no longer suspended, but they can only exercise their powers consistently with the provisions of the DOCA.
When the powers granted to a receiver are expressed broadly, as they usually are, the receiver will control the management of the company and its business to the exclusion of the directors.
Following the implementation of a scheme, often an administrator will be appointed (a scheme administrator) to implement the terms of the scheme, which role ceases once the scheme is implemented. This is not a requirement under the Corporations Act but is often used in large and complex creditors' schemes.
vi Special regimes
As noted in Section I.i, the Corporations Act is the primary legislative instrument for insolvency and restructuring in Australia and governs the insolvency proceedings of all companies incorporated in Australia and companies incorporated or possessing separate legal personality in foreign jurisdictions that carry on business in Australia, as well as building societies, credit unions and managed investment schemes.
The provisions of the Corporations Act do not govern the potential insolvency proceedings for:
- government agencies;
- state or federal corporate bodies; or
- entities created by statute that are not companies.
The individual statutes creating these bodies will normally provide for their dissolution or winding up.
As a general comment, there is no precedent in Australia for a government-owned enterprise becoming insolvent.
The Personal Property Securities Act 2009 (Cth) is the primary legislation that governs personal property security and is therefore an integral part of restructuring and insolvency law in Australia.
vii Cross-border issues
Australian courts cooperate with foreign courts and insolvency practitioners, and will recognise the jurisdiction of the relevant court in which the centre of main interest (often referred to as the COMI) is located. This approach follows the UNCITRAL Model Law on Cross-border Insolvency (the Model Law), which was codified into Australian law through the Cross-Border Insolvency Act 2008 (Cth) (the Cross-Border Act). The aim of the UNCITRAL Model Law on Recognition and Enforcement of lnsolvency-Related Judgments of 2018 (MLREIJ) is to complement and to clarify uncertainties arising from the Model Law. The MLREIJ has not yet been adopted in Australia.
Both the Corporations Act and the Cross-Border Act contain mechanisms to address cross-border insolvency matters.
Under Section 581 of the Corporations Act, Australian courts have a duty to render assistance when so requested by a foreign insolvency court. While in most cases Australian courts have provided assistance when requested to do so under Section 581, there have been exceptions. For example, in Yu v. STX Pan Ocean Co Ltd (South Korea),19 the Federal Court of Australia was reluctant to grant additional relief on the basis that it would adversely affect any rights that other Australian creditors may have otherwise had, whether under the Corporations Act or otherwise.
The Cross-Border Act (incorporating the Model Law) also allows for the recognition of foreign proceedings. The court's power to grant relief appears to extend also to the enforcement of foreign judgments. Notably, receivers do not have the benefit of taking action in foreign jurisdictions that other insolvency administrators have under the Cross-Border Act.20 This is because receiverships relate only to a debt owed to the appointer and, as such, cannot be said to be 'collective proceedings' in terms of the application of the Model Law.
Furthermore, the Foreign Judgments Act 1991 (Cth) creates a general system of registration of judgments obtained in foreign countries but will only apply to judgments pronounced by courts in countries where, in the opinion of the governor general, substantial reciprocity of treatment will be accorded by that country in respect of the enforcement in that country of judgments of Australian courts.
The determination of whether a foreign proceeding should be recognised in Australia as a 'foreign main proceeding' or a 'foreign non-main proceeding' depends on the location of the debtor's COMI. This distinction is important because recognition of a foreign proceeding as a foreign main proceeding will automatically stay actions of individual creditors against the debtor and of enforcement proceedings concerning the assets of the debtor in all non-main jurisdictions, suspend the debtor's right to dispose of its assets and allow clawback proceedings in respect of antecedent transactions to be commenced by the foreign representative21 (this is not necessarily the case for a foreign non-main proceeding). Under the Cross-Border Act, there is a rebuttable presumption that a debtor's COMI is its registered office, or in the case of a natural person, his or her habitual residence.
The Model Law provides no guidance on the standard required for COMI determination. It is noted in the explanatory memorandum for the Model Law that this silence was deliberate as the concept of a COMI has been developed through case law. To that end, Australian courts have applied the general test from Re Eurofood IFSC Ltd22 when considering whether this presumption has been rebutted, as follows: 'The “centre of main interests” should correspond to the place where the debtor conducts the administration of his interests on a regular basis and is therefore ascertainable by third parties.'
In addition, the Australian courts will aim to adopt similar reasoning when considering a COMI as comparable jurisdictions (such as the bankruptcy courts in the United States) and have, accordingly, equated the concept of COMI with the principal place of business. In considering where the COMI of a debtor or group of companies exists, the courts will consider a number of factors, including:
- the location of the debtor's headquarters;
- the location of those who actually manage the debtor;
- the location of the debtor's primary assets;
- the location of the majority of the debtor's creditors or a majority of creditors who would be affected by the case; and
- the jurisdiction whose law applies to most disputes.
II INSOLVENCY METRICS
With the handing down of the final report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (Royal Commission) in February 2019 (the Final Report), the Australian corporate and banking market has changed, perhaps indefinitely. A key driver of this transformation has been the effect of increased media attention (especially social media) on the behaviour of banks, which has resulted in reputational risk becoming a primary concern for management and general counsel. A key outcome of the Royal Commission was a renewed focus on regulation, with the Final Report recommending greater collaboration between ASIC and the Australian Prudential Regulatory Authority. Importantly, the Royal Commission has introduced a shift towards a 'why not litigate?' stance regarding ASIC's enforcement approach and has placed greater scrutiny on regulator performance. This is likely to embolden regulators and increase the level of public oversight.
Sectors that have suffered particular distress in recent times include retail, mining and mining services, property and construction. Increased restructuring activity is expected in each of these sectors in the foreseeable future.
A significant proportion of external administration appointments have continued to result from borrowers breaching financial covenants, not meeting amortisation payments or an inability to refinance at the end of facility terms. In these circumstances, when there are no other options available, directors will invariably opt to appoint a voluntary administrator. Often this will result in concurrent appointments, with the secured creditor appointing a receiver 'over the top' of a voluntary administrator. Even though receivership appointments have decreased in light of banks' revised approaches to distressed situations, these dual appointments still occur and are a feature of the Australian restructuring landscape.
Each quarter, ASIC publishes insolvency statistics outlining the total number of companies that entered into external administration (that is administration, liquidation or receivership) during that quarter and a comparative analysis of the previous quarter and a 12-month comparison.
For the quarter ending March 2019, ASIC reported a notional 10 per cent decrease in external administration appointments against the December 2018 quarter, with a total of 1,817 companies entering into external administration. The March 2019 quarterly total of 1,813 companies was similar to that of March 2018.
III PLENARY INSOLVENCY PROCEEDINGS
Significant proceedings in the Australian market include the following restructures:
- Toys R Us Australia (Toys), by way of a voluntary administration and subsequent liquidation of the Australian business. The winding up of Toys followed the collapse of its US parent (which filed for bankruptcy protection under Chapter 11 of the US Bankruptcy Code in 2017) and reflects the particular challenges faced by the retail industry;
- Slater and Gordon Limited (S&G) (arguably the highest-profile restructure for a publicly listed company in the Australian market in recent times) was achieved by way of two inter-conditional schemes of arrangement resulting in S&G's senior lenders taking control of the S&G Group via a debt-for-equity swap involving the exchange of 95 per cent of S&G's equity for a reduction of A$636.6 million in senior secured debt owed by S&G. Significantly, this transaction involved the resolution of shareholder class actions (both brought and threatened) against S&G and, unusually, using a scheme to achieve this outcome in a manner that ensured that there are no future adverse financial consequences for S&G or its directors;
- Paladin Energy Limited (Paladin) by way of a voluntary administration followed by a DOCA (approved by Paladin's creditors) involving an extinguishment of certain claims in exchange for the transfer of 98 per cent of the equity from existing shareholders by way of a court application under Section 444GA of the Corporations Act (and without the need for existing shareholder approval – note our comments regarding Section 444GA in footnote 15, above). The successful outcome demonstrates the flexibility of DOCAs to effect restructures and recapitalisations and should encourage creditors of listed companies to pursue value-preserving debt-for-equity transactions without the need for shareholder approval, or the need for the threshold of 75 per cent in value to be met for each class of creditors as required under a creditors' scheme; and
- Ten Network Holdings Limited (Ten Network) by way of a voluntary administration resulting in a contested bidding process with competing DOCA proposals put forward. A DOCA proposal involving the use of a creditors' trust mechanism (whereby the DOCA completes and converts into a creditors' trust enabling the company to come out of insolvency quickly and the creditors release their claims against the company in exchange for a claim as a beneficiary against the trust) and a court application for orders under Section 444GA of the Corporations Act were accepted by creditors.
The Paladin and Ten Network restructures demonstrate the flexibility of DOCAs and the ability of a deed administrator, under Section 444GA of the Corporations Act, to transfer shares in a company with leave of the court when this is opposed by the shareholders. The court will only grant orders under this Section if 'it is satisfied that the transfer would not unfairly prejudice the interests of members of the company'. These shareholders would not be prejudiced, based on the existing case law, if their shares have no 'economic value'. This provision ensures that existing shareholders are afforded a level of protection and consideration, through the court process, while allowing creditors, or others, to acquire the equity interests through a DOCA when it is fair to do so.
IV ANCILLARY INSOLVENCY PROCEEDINGS
There have been no significant ancillary insolvency proceedings in the past 12 months.
However, recent case law has foreshadowed the prospect that foreign representatives administering international formal processes in Australia (as part of applying for recognition under the Model Law) might be required to make a security payment into court as to ensure that local courts are kept better informed of any changes in the status of foreign processes.23
The Australian economy has experienced only limited growth during the past few years despite record low interest rates. It feels as if the country is still recovering from the aftermath of the global financial crisis.
Further, tightening capital adequacy requirements (through the Basel Accords) and prudential standards, and more conservative approaches to risk (particularly following the Royal Commission), have resulted in banks limiting their exposures to certain industries and allowing 'non-traditional' lenders (such as hedge funds, investment banks and alternative capital providers) to enter certain sectors.
The changing risk appetite of the banks and the general lending climate has limited opportunities in Australia's relatively new secondary debt market. Although there are proactive buyers present in the Australian secondary debt market, there are fewer opportunities to purchase debt. Despite this, in recent years, large and complex restructures (i.e., S&G and BIS Industries) saw lenders trading their debt to facilitate the transaction; the driver to sell the debt, in those cases, was the banks' general unwillingness to hold equity in the distressed entities. Considering the relative stability of the Australian banking sector and the robust regulatory framework governing it, secondary debt traders can look forward to greater participation in the Australian market that should become more active if economic conditions continue to decline. With the culmination of the Royal Commission and a very low interest rate environment prevailing (as noted above), the past 12 months have been a subdued period for Australian restructures. We expect this to continue for the remainder of this calendar year.
However, with more and increasingly diverse parties entering the lending market, new legislation having just come into effect and borrowers still vulnerable to interest rate rises and other shocks (such as decreases in commodity prices), the ensuing years could be very interesting in the restructuring and insolvency market in Australia.
1 Dominic Emmett and Peter Bowden are partners and Hannah Cooper is a lawyer at Gilbert + Tobin.
2 For further consideration of the cash flow test, see Bell Group Limited (in liq) v. Westpac Banking Corporation [No. 9]  WASC 239.
3 The best example of a liberal insolvency regime is found in Chapter 11 of the US Bankruptcy Code. The United Kingdom, Singapore, Germany and Canada have also reformed their insolvency regimes in an effort to promote financial recovery.
4 See Section 588GA of the Corporations Act 2001 (Cth) [Corporations Act].
5 Most security interests will allow for the appointment of either. We use these terms interchangeably in this chapter.
6 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.
7 A pre-pack is where a restructure is developed by the secured lenders prior to the appointment of a receiver, and is implemented immediately, or very shortly after, the appointment is made.
8 The regulation of pre-packs in Australia was flagged in the Productivity Commission's Report on Business Set-up, Transfer and Closure that was released to the public on 7 December 2015, although no further steps have been taken to date.
9 Corporations Act, Section 435A.
10 ibid., Section 436A.
11 ibid., Section 436B.
12 ibid., Section 436C.
13 However, there is an exception to the moratorium on the exercise of rights under security interests in the case of a secured creditor that has security over the whole or substantially the whole of the assets of the company and such rights are exercised within the 'decision period' (being 13 business days after the appointment of the administrator).
14 Corporations Act, Section 439C.
15 ibid., Section 444GA. The mechanism under Section 444GA was to effect various 'high-profile' debt for equity restructures, such as Mirabela, Nexus Energy, Ten Network and Paladin.
16 There have been two cases in the past few years challenging the validity of the widely held view that secured creditors are not 'bound' by a deed of company arrangement [DOCA] unless they vote in favour of it. In Australian Gypsum Industries Pty Ltd v. Dalesun Holdings Pty Ltd  WASCA 95 and Re Bluenergy Group Limited  NSWSC 977, it was held that a DOCA can (if so expressed) have the effect of extinguishing the debt of a secured creditor that did not vote in favour of the DOCA pursuant to Section 444D(1) of the Corporations Act. However, this extinguishment is subject to the preservation of the secured creditor's ability (by virtue of Section 444D(2)) to realise or deal with its security in respect of its proprietary interest in the secured property and to the extent that its debt was provable, and secured assets were available at the date that debt would otherwise be released under the DOCA, without requiring that the debt be preserved into the future or for other purposes.
17 Corporations Act, Section 472(2).
18 See First Pacific Advisors LLC v. Boart Longyear Ltd  NSWCA 116.
19 Yu v. STX Pan Ocean Co Ltd (South Korea), in the matter of STX Pan Ocean Co Ltd (receivers appointed in South Korea)  FCA 680.
20 Cross-Border Insolvency Act 2008 (Cth), Section 8.
21 In King (Trustee), In the matter of Zetta Jet Pte Ltd v. Linkage Access Limited  FCA 1979, the Federal Court of Australia held that the purpose of the Cross-Border Act is to give foreign representatives standing to commence proceedings in Australia. Foreign representatives seeking to rely on the voidable transactions provisions in the Corporations Act would still need to comply with the terms of those provisions (including, as was the case here, satisfying the requirement that the foreign entity be a 'company' within the meaning of Section 9 of the Corporations Act).
22  Ch 508.
23 See Board of Directors of Rizzo-Bottiglieri-De Carlini Armatori SpA v. Rizzo-Bottiglieri-De Carlini Armatori SpA  FCA 153.