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.
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 key test of solvency in Australia 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, because courts have held that it is often relevant in providing background and context for the proper application of the cash flow test.2
The Australian government's response to the covid-19 pandemic
In response to the covid-19 pandemic, the Australian government enacted the Coronavirus Economic Response Package Omnibus Act 2020 (Cth), which came into effect on 25 March 2020. This legislation provides temporary economic and other relief to ensure continuity for Australian businesses and jobs during this period of uncertainty.
In the insolvency context, the temporary measures are intended to provide 'breathing space' and reduce the number of businesses entering into formal insolvency processes. The measures, which are intended to operate alongside the other recent reforms discussed below, include:
- relief for directors and holding companies from trading while insolvent where new debts are incurred in the ordinary course of business;
- increasing the threshold at which creditors can issue a statutory demand (from A$2,000 to A$20,000) and increasing the time companies have to respond to such demands (from 21 days to six months); and
- the ability for the Treasurer to provide targeted relief for classes of persons from provisions of the Act (by legislative instrument) to deal with unforeseen events and government actions resulting from the pandemic.
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 jurisdictions where insolvency laws, many consider, better promote restructuring, innovative reorganisations and value preservation.3 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, without commencing a formal insolvency process such as voluntary administration or liquidation,4 (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'. To assess this 'better outcome' test (noting the relevant director bears the evidential burden if he or she seeks to rely on this defence), Section 588GA(2) sets out the steps that a director could take, including developing and implementing a plan for restructuring to qualify for safe harbour. The Australian courts are yet to consider the operation of the safe harbour provision. Commentators have criticised the 'better outcome' test as onerous and complex, so the extent to which this safe harbour provision has encouraged directors to attempt to restructure is unclear.5
Further, the safe harbour provisions are not intended to protect directors against statutory and 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 if the stay relates to a relevant scheme of arrangement, that scheme 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 limited judicial interpretation of the former Section 596AC, it may take some time before the reforms are properly considered by the courts.6 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, being transactions that take place when a company is nearing insolvency and is 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) Act 2020 (the Illegal Phoenixing Act) provides 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).
The Illegal Phoenixing Act commenced on 18 February 2020 and resulted in the introduction of a new Section 588FE(6B) of the Corporations Act, which provides 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 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 Illegal Phoenixing Act enhances 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 Illegal Phoenixing Act also introduces 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. This seeks 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 (MVL)) and insolvent); and
- a court-sanctioned scheme of arrangement between creditors and the company.
For all insolvency processes, other than a MVL, 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.7 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.8 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 secured creditor) 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 and may 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. This duty has traditionally presented a significant stumbling block to the adoption of pre-packaged restructuring processes through external administration widely used in the UK market (colloquially referred to as pre-packs).9 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.10 Pre-packs are likely to become more common in circumstances where the value of assets held are demonstrably less than the secured debt. Australia's creditor-friendly insolvency regimes and strict independence requirements for insolvency practitioners have also hindered the use of pre-packs.
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.11
There are three ways an administrator (often called a voluntary 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;12
- 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;13 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.14
An 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 interests15 and the continuing of litigation claims. This moratorium is intended to give the administrator the opportunity to investigate the affairs of the company to either implement change or 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, but 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: enter into a DOCA with creditors (discussed further below), wind up the company, or terminate the administration by returning the business to directors as a going concern16 (this last outcome is rare as it would only occur when the company is actually solvent).
The administration will terminate following the outcome of the second meeting. When the administration terminates, a secured creditor that was previously estopped from enforcing a security interest because of the statutory moratorium discussed above 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 is a distinct regime, as the rights and obligations of the creditors and company 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.17 There has also been an increase in the use of 'holding DOCAs', which do not provide for a distribution of the company's property to creditors but rather allow the deed administrators more time to effect a restructuring of the company or a sale of its assets.18 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 in the administration 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 (1) if the resolution relates to an administrator's remuneration; or (2) to vote against the administrator's removal as administrator.
Once executed, a DOCA will bind the company, its shareholders, directors and unsecured creditors in respect of claims arising before the date specified in the DOCA. 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.19 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. Further, the court has the power to terminate a DOCA if it is oppressive to creditors or contrary to the interests of the creditors as a whole.20
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.21 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.
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.22 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. Creditors whose rights are affected are required to participate in the scheme. 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 involvement 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.23
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 key advantages of a scheme of arrangement are its flexibility and ability to bind secured and unsecured financial creditors and members, keep management in place and bind creditors' rights against third parties (provided there is a sufficient nexus between the scheme and the rights).24 The disadvantages of schemes include cost, complexity of arrangements, uncertainty of implementation, timing issues (because a scheme must be approved by the court and is subject to the court timetable, although the courts have demonstrated an increased willingness to move swiftly in recent times)25 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 fair or 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 (including 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. 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 a scheme administrator will be appointed to implement the terms of the scheme (who must be a registered liquidator), and this 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 corporate 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 will cooperate with foreign courts and insolvency practitioners in two principal ways.
First, under Section 581 of the Corporations Act, Australian courts have a duty to render assistance when requested by a foreign insolvency court and may also request a foreign court to provide assistance to an Australian liquidator in respect of an external administration matter (being the winding up of an Australian company, body corporate or Part 5.7 body (including a foreign company carrying on business in Australia)). Australian courts are obliged to assist the bankruptcy courts of prescribed countries, including the United Kingdom and United States. For all other countries, whether the Australian court will offer assistance is discretionary.
Insolvency practitioners may also seek assistance under the Cross-Border Insolvency Act 2008 (Cth) (the Cross-Border Act) which implements the UNCITRAL Model Law on Cross-border Insolvency (the Model Law). For those jurisdictions that have adopted it, the Model Law provides a process for creditors and their representatives to request and receive assistance from foreign courts in relation to foreign insolvency proceedings.
The Cross-Border Act allows for the recognition of foreign proceedings in Australia under Chapter 5 of the Corporations Act (with the exception of receiverships and solvent liquidations).26 Whether an Australian court is required to recognise a foreign proceeding depends on the location of the debtor's centre of main interest (COMI).
Recognition of a foreign proceeding as a 'foreign main proceeding' (being a proceeding taking place where the debtor's COMI is located) 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 representative.27 The scope of the stay that applies is the same as that which would apply under the analgous Australian procedure in Chapter 5 (other than Parts 5.2 and 5.4A) of the Corporations Act. For example, if the foreign proceeding is a 'debtor-in-possession' corporate rescue or restructuring proceeding involving a plan requiring creditor approval, the most analogous Australian procedure would be voluntary administration under Part 5.3A.28 If the Australian court recognises the foreign proceeding as a 'foreign non-main proceeding' (being a foreign proceeding taking place where the debtor has an 'establishment' rather than its COMI), then an automatic stay will not apply, however the court does have the discretion to grant appropriate relief.
Under the Cross-Border Act, there is a rebuttable presumption that a corporate debtor's COMI is its registered office. The Model Law provides no further guidance on the standard required for COMI determination and, to that end, Australian courts have applied the general test established in Re Eurofood IFSC Ltd29 that a debtor's COMI should be assessed by criteria that are both objective and ascertainable by third parties.30
In considering where the COMI of a debtor or group of companies exists, the court will consider a number of factors, including the location of debtor's headquarters, books and records, financial and operational centre, primary assets, the majority of the debtor's creditors or a majority of creditors who would be affected by the proceedings, administration, payroll, accounts payable or cash management activities, tax authority and the jurisdiction which applies to most disputes.31
In 2018, UNCITRAL published the final version of the UNCITRAL Model Law on Recognition and Enforcement of lnsolvency-Related Judgments (MLREIJ) which seeks to complement and clarify uncertainties arising from the Model Law by providing a framework for the domestic recognition and effectuation of 'insolvency related judgments' issued by the courts of a foreign jurisdiction and reducing the prospect of conflicting judicial decisions and auxiliary proceedings. The MLREIJ has not yet been adopted in Australia (or elsewhere).
Lastly, 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. Notably, due to a lack of reciprocity, judgments of US courts cannot be enforced under this legislation.
II INSOLVENCY METRICS
This past year has been particularly challenging for the Australian economy. The bushfire disaster in late 2019 and early 2020 (and incidence of flood and cyclones) resulted in widespread loss of life, wildlife and property with severe consequences for small business and the broader economy. The tourism and retail sectors were particularly hard hit, given the timing of the disaster over the busy Christmas and New Year holiday period. The covid-19 pandemic has now further exacerbated Australia's economic woes. While the government has implemented a raft of measures to provide economic and other temporary relief for Australian businesses during the pandemic (see Section I.ii above), the measures may prove too little too late for many businesses.
Sectors that have suffered particular distress include retail, mining and mining services, property and construction. Since the beginning of the year, Australia has seen a large number of household names enter into formal insolvency processes, including department store Harris Scarfe, clothing and accessories retailers Seafolly, Tigerlily, Jeanswest, Colette, Bardot and Kikki.K and aviation giant, Virgin Australia. Countless businesses across all sectors of the economy are exploring restructuring and turnaround options in an effort to manage this prolonged period of economic uncertainty. To that end, restructuring activity is expected to increase in the months to come, particularly once the government's covid-19 temporary relief is lifted.
Since 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), there has been 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.
Each quarter, ASIC publishes insolvency statistics outlining the total number of companies that have 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 2020, a total of 1,747 companies entering into external administration, which has been a decrease compared to the previous three quarters where the average was 2,169 companies. However, this number is expected to increase exponentially in the coming months once the government lifts its temporary relief and the effects of the covid-19 pandemic are made apparent.
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 20, 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.
- 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.
- Wollongong Coal (ASX: WLC) and Jindal Steel by way of joint creditors' schemes of arrangement to effect a US$347 million restructuring of the Australian mining businesses debt. Prior to implementation, the schemes terminated automatically by their terms as certain payments had not been made by the required date. The parties were successful in applying to court for an order to retrospectively amend the terms of the schemes to extend the due date for payment. The transaction is significant as it confirms that courts in Australia have the ability to retrospectively amend an approved scheme, rather than requiring parties to resort to the costly and lengthy process of implementing a second overriding scheme of arrangement.
- Sargon Group (Sargon) by way of a voluntary administration, which resulted in a sale of its business and assets to the Cloverhill Group. The sale was complicated by the state of the market during the covid-19 pandemic and various unsecured parties, at the eleventh hour, claiming ownership and security interests in the assets the subject of the sale. This required an urgent court application where the court sanctioned the disposition of those assets under Section 442C of the Corporations Act.32
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 that have been finalised 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.33
Figures released by the Australian Bureau of Statistics have confirmed that, during the first three months of 2020, Australia's economy shrank for the first time in nine years and the country has now formally entered recession. The bushfire disaster (and other natural disasters) in the past year, ongoing uncertainty around the covid-19 pandemic and drastically reduced government and household spending and imports stemming from these recent events foreshadow a very challenging period ahead for the Australian economy.
Tightening capital adequacy requirements (through the Basel Accords) and prudential standards, and more conservative approaches to risk (particularly following the Royal Commission and the covid-19 pandemic), have resulted in banks limiting their exposures across all sectors. This has paved the way for 'non-traditional' lenders (such as hedge and special situations funds, investment banks and alternative capital providers) to replace banks as alternative sources of capital.
It will be interesting to see whether the recession results in increased activity in the secondary debt market, which is still relatively new in Australia, and, in turn, increased restructuring activity. In recent years, large and complex restructures (i.e., S&G and BIS Industries and more recently Bluewaters) have seen lenders trading their debt to facilitate a restructuring transaction. The driver to sell the debt, in those cases, was the banks' general unwillingness to hold equity in the distressed entities.
With the government's focus squarely on stabilising the economy, it is not yet clear whether there will be any further changes to Australia's insolvency and restructuring legislation. However, many commentators have predicted that the covid-19 pandemic will provide a catalyst for substantive legislative reform.
The unprecedented situation facing Australia and indeed the world no doubt points to an interesting period ahead in the restructuring and insolvency market in Australia.
1 Dominic Emmett is a partner 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] (2008) 225 FLR 1.
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 Explanatory Memorandum, Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill (Cth), 3.
5 See Robert Baxt, 'Editorial' (2017) 45 Australian Business Law Review 195, 196; Craig Edwards, 'Australia's Safe Harbour Law - A better outcome for restructuring and entrepreneurship?' (2019) 27 Insolvency Law Journal 66, 77-80.
6 A contravention of Section 596AB has only been considered once since its implementation See Connelly v. Commonwealth of Australia, in the matter of Australian Road Express Pty Ltd (Receivers and Managers Appointed) (in liq)  FCA 1429. However, the alleged contraventions did not proceed to trial for substantive determination because the parties discontinued the proceedings.
7 Most security interests will allow for the appointment of either. We use these terms interchangeably in this chapter.
8 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.
9 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.
10 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.
11 Corporations Act, Section 435A.
12 ibid., Section 436A.
13 ibid., Section 436B.
14 ibid., Section 436C.
15 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). Whether a secured creditor's security extends to 'whole or substantially the whole' of a company's assets is a question of fact and in one example, Re Australian Property Custodian Holdings Ltd (Administrators Appointed) (Receivers and Managers Appointed)  VSC 492; 80 ACSR 114, the court found that a charge over 68 per cent of debtor company's assets was insufficient. To manage this risk, financiers often take out a 'featherweight' security over all assets of the debtor company which becomes enforceable once an administrator is appointed.
16 Corporations Act, Section 439C.
17 ibid., Section 444GA. The mechanism under Section 444GA, where non-consensual share transfers are sanctioned by the court, has effected various 'high-profile' debt for equity restructures, such as Mirabela, Nexus Energy, Ten Network and Paladin.
18 Mighty River International Ltd v Mineral Resources Ltd  WASCA 72.
19 There are two cases that have challenged the view that secured creditors are not 'bound' by a DOCA unless they vote in favour of it. In Australian Gypsum Industries Pty Ltd v. Dalesun Holdings Pty Ltd  WASCA 95; 297 FLR 1 and Re Bluenergy Group Limited  NSWSC 977; 300 FLR 155, the court distinguished between the personal right (the debt) and property right (the security) of creditors. It was held that a DOCA can (if so expressed) extinguish the debt of a secured creditor that did not vote in favour of the DOCA pursuant to Section 444D(1) of the Corporations Act but not the secured creditor's ability (under Section 444D(2)) to realise or deal with its security in the secured property, provided there was a right to enforce the security at the time the DOCA took effect.
20 Corporations Act, s 445D(1)(f). This provision was recently considered in Shafston Avenue Construction Pty Ltd v. McCann  FCAFC 85.
21 Corporations Act, Section 472(2).
22 During the covid-19 pandemic, the time companies have to respond to a statutory demand has been increased from 21 days to six months (see Section I.(ii) above).
23 See e.g. First Pacific Advisors LLC v. Boart Longyear Ltd  NSWCA 116; 320 FLR 78. In that case, the fact that some creditors had the right to appoint directors and receive a collateral benefit were not sufficient differences to warrant separate classes.
24 Fowler v. Lindholm  FCAFC 125; (2009) 178 FCR 563.
25 e.g., In the matter of Wollongong Coal Limited and Jindal Steel & Coal Australia Ltd  NSWSC 73; and Re Tiger Resources Ltd (No 2)  FCA 266.
26 Cross-Border Act, Section 8.
27 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).
28 Senvion GmbH, in the matter of Senvion GmbH (No 2)  FCA 1732.
29  Ch 508. This test has been applied by Australian courts: Ackers v. Saad Investments Company Ltd (in liq) (2010) 190 FCR 285; Young, Re Buccaneer Energy Ltd v. Buccaneer Energy Ltd  FCA 711.
30 See also Moore v Australian Equity Investors  FCA 1002.
31 Kapila, in the matter of Edelsten  FCA 1112; 320 ALR 506.
32 See McCallum, in the matter of Re Holdco Pty Ltd (Administrators Appointed)  FCA 666.
33 See Board of Directors of Rizzo-Bottiglieri-De Carlini Armatori SpA v. Rizzo-Bottiglieri-De Carlini Armatori SpA  FCA 153.