I OVERVIEW OF RESTRUCTURING AND INSOLVENCY ACTIVITY
The Australian economy is continuing to experience sluggish fiscal conditions, with the economic growth rate predicted to decrease from 2.8 per cent in 2018 to 2.1 per cent in 2019.2 While Australia has not had a technical recession since 1991, businesses appear to be highly vulnerable to economic shocks. Debt levels (especially household debt) have reduced and the property market has seen a sharp decline in what is generally considered to be, a market correction of inflated prices. While the five years leading up to late 2017 saw housing prices increase nationally by over 50 per cent, commentators and trend analysts are forecasting house prices in Australian capital cities will fall by around 7 per cent in 2019, attributing the decline to greater supply, tighter restrictions on lending and increasingly difficult conditions for foreign investors.3
Non-traditional lenders continue to make inroads into the corporate and institutional lending spaces, especially in the property and construction sectors. Tightened capital adequacy restrictions as a result of, among other things the Basel Accords, more restrictive prudential standards and internal risk directives have resulted in the partial retreat of banks from these industries. This has encouraged more investment activity from hedge funds, investment banks and alternative capital providers and increased the number of alternative financing arrangements in the leveraged transaction space. For example, financiers in the Australian market are now utilising unitranche facilities that have traditionally been more popular overseas. The adoption of such structures over the past few years has been an interesting development and may pose novel challenges to the Australian debt market in the coming years, should these deals become distressed.
Non-traditional lenders have also benefited from the effects of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (the Royal Commission). With the handing down of the final report of the Royal Commission in February 2019, the Australian corporate and banking market has changed, perhaps indefinitely. A key driver of this transformation has been the impact of an increased media spotlight (especially social media) on the behaviour of banks. Reputational risk is heightened and has come to be a primary concern for management and general counsel. A key outcome of the Royal Commission was a renewed focused on regulation, with the final report recommending greater collaboration between the Australian Securities Investment Commission (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.
Because of this increased degree of public and regulatory scrutiny, banks are generally less inclined to enforce security or make formal appointments. This has provided distressed borrowers with more leniency, giving them the opportunity to consult financiers and negotiate alternative measures to deleverage their positions through informal means. With formal insolvency appointments being an unattractive, 'last resort' option, the number of secured creditor-led enforcement outcomes (i.e., receiverships) has declined. Some have argued that this is creating a 'moral hazard' risk for the banks' customers. Banks are attempting to mitigate the effects of this shift by working within their customers rather than enforcing; behaviour which does not seem to be changing any time soon.
The changing risk appetite of the banks and the general lending climate has limited opportunities in Australia's relatively new secondary debt market. While there are proactive buyers present in the Australian secondary debt market, there are generally fewer opportunities to purchase debt. Despite this, in recent years large and complex restructures (i.e., Slater and Gordon 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 Australia banking sector and the robust regulatory framework governing it, secondary debt traders can look forward to comfortably participating in an Australian market that should become more active, if economic conditions continue to decline.
Schemes of arrangement continue to be a popular mechanism for effecting larger and more complex restructures, such as the restructuring of Slater and Gordon, BIS Industries, Quintis Group and Wiggins Island Coal Export Terminal (WICET). While formal appointments (i.e., of liquidators and administrators) may be less common, they are often used as leverage against debtors in restructuring negotiations. Voluntary administration and deeds of company arrangement continue to be frequently used in debt-for-equity swaps; particularly at the small to mid-market level. The main driver for restructures of this type is the power given to deed administrators to compulsorily transfer shares with court approval pursuant to Section 444GA of the Corporations Act 2001 (Cth) (the Act) (if the shares have no 'economic' value).
Recently, the mining and mining services, retail and construction sectors have experienced heightened levels of distress. It is expected that each of these sectors (particularly mid-market mining projects and mining services companies in Western Australia) will experience increased levels of restructuring activity.
Despite current trends, breaches of financial covenants, failures to meet amortisation payments or parties inability to refinance, continue to drive a significant proportion of external administration appointments. Where no informal arrangement can be reached between equity, management and lenders, directors will invariably opt to appoint a voluntary administrator over risking liability under Australia's draconian insolvent trading laws (notwithstanding recent legislative amendments aimed at alleviating such fears, i.e., the 'Safe Harbour'). This will often result in concurrent appointments where a secured creditor appoints a receiver 'over the top' of a voluntary administrator. Despite the shift in approach from Australian banks, such concurrent appointments still continue to feature in Australia's restructuring landscape.
While seemingly slower owing to several external factors, the insolvency and restructuring market continues to develop and provide opportunities. However, with a more diverse lending market, recent 'Safe Harbour' and ipso facto reforms, proposed legislation (i.e., anti-phoenixing legislation) and borrowers remaining susceptible to interest rate rises and other economic shocks, the ensuing years may bring new challenges and give rise to novel trends in the Australian market.
II GENERAL INTRODUCTION TO THE RESTRUCTURING AND INSOLVENCY LEGAL FRAMEWORK
i Formal procedures
The formal procedures available under Australian law are:
- receivership (both private and court-appointed);
- voluntary administration;
- deeds of company arrangement (DOCA);
- provisional liquidation;
- liquidation (both solvent (members' voluntary liquidation) and insolvent); and
- court-sanctioned schemes of arrangement between creditors and the company.
For receivership, voluntary administration, DOCA and liquidation, the individual appointed must be an independent registered liquidator, except in the case of a members' voluntary liquidation.
The main role of a receiver is to take control of the relevant assets subject to the security pursuant to which they are appointed and realise those assets for the benefit of the secured creditors. 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 the two roles and most security interests will allow for the appointment of either.4 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. Despite being appointed by the secured creditors, a receiver is not obliged to act on the instructions of the secured creditors. A receiver must, however, act in their best interests, and this will invariably lead a receiver to seek the views of secured creditors on issues that are material to the receivership (particularly given a receiver cannot effectively undertake a transaction involving the secured property without a release by, or the consent of, the secured creditor).
There are two ways in which a receiver may be appointed to a debtor company. The most common manner is pursuant to the relevant security document granted in favour of the secured creditor when a company has defaulted and the security has become enforceable. Far less common in practice is the appointment of a receiver pursuant to an application made to the court. 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. Given the infrequency of court-appointed receivers, however, this chapter focuses on privately appointed receivers.
For a privately appointed receiver, the security document itself will entitle a secured party to appoint a receiver, and will also outline the powers available (supplemented by the statutory powers set out in Section 420 of the Act). Generally, a receiver has wide-ranging powers, including the ability to operate the business, borrow against or sell the secured assets. The appointment is normally effected contractually through a deed of appointment and indemnity. By way of the underlying security document, the receiver will be the agent of the debtor company, not the appointing secured party (although this agency relationship will change if a liquidator is appointed to the debtor company, whereby the receiver will become the agent of the secured party).
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 all or substantially all of the assets of a company. Alternatively, and depending on financial circumstances, a receiver may engage in a sale process immediately. While engaging in a sale process, a receiver is under a statutory obligation to obtain market value or, in the absence of a market, the best price reasonably obtainable in the circumstances. This obligation is enshrined in Section 420A of the Act. It is this duty that has posed the most significant stumbling block to the adoption of pre-packaged restructuring processes through external administration5 that have been seen in, for example, the UK market. This is because of the inherent concern that a pre-packaged restructure that involves a sale of any asset without testing against the market could be seen as a breach of the duty under Section 420A.6 Once a receiver has realised the secured assets and distributed any net proceeds to the secured creditors (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, is entirely a creature of statute, and its purpose and practice is outlined in Part 5.3A of the Act. Voluntary administration has often been compared with the Chapter 11 process in the United States, but unlike Chapter 11, voluntary administration is not a debtor-friendly process. In a voluntary administration, the creditors control the final outcome to the exclusion of management and members. The creditors ultimately decide on the outcome of the company, and it rarely involves returning management responsibilities to the former directors.
The purpose of Part 5.3A is to either:
- maximise the chances of the company, or as much as possible of its business, to continue 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.7
There are three ways an administrator may be appointed under the Act:
- by resolution of the board of directors that, in their opinion, the company is, or is likely to become, insolvent;8
- 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 the company is, or is likely to become, insolvent;9 and
- a secured creditor who is entitled to enforce security over the whole or substantially whole of a company's property may, in writing, appoint an administrator if the security interest is over the property and is enforceable.10
An administrator has wide powers and will 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 interests,11 and in respect of litigation claims, the 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 over the course of an administration that are critical to the outcome of the administration. Once appointed, an administrator must convene the first meeting of creditors within eight business days (at such meeting, the identity of the voluntary administrator is confirmed, the 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 (referred to as the 'convening period'). The convening period may be extended by application to the court. At the second creditors' meeting, the administrator provides a report on the affairs of the company to the creditors and outlines the administrator's views as to the best option available to maximise returns. 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 administration.12
The administration will terminate according to 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 (although this is rare)). When the voluntary administration terminates, a secured creditor that was estopped from enforcing a security interest due to the statutory moratorium becomes entitled to commence steps to enforce that security interest unless the termination is due to the implementation of a DOCA approved by that secured creditor.
Deed of company arrangement
A DOCA is effectively a contract or compromise between the 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 a voluntary administration.
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. It may also involve the issuance of shares, 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 (as noted above).13 This mechanism has been utilised numerous times to effect debt-for-equity restructures including, for example, in Mirabela, Nexus Energy, Channel Ten and Paladin.
Entering into a DOCA requires the approval of a bare majority of creditors both by value and number voting at the second creditors' meeting. In order to resolve a voting deadlock, for example, where there is a majority in number but not in value or vice versa, under Rule 75-115(3) of the Insolvency Practice Rules (Corporations) 2016 (Cth) an administrator may exercise a casting vote in order to pass, or not pass, a resolution. The right to exercise a casting vote is not mandatory. 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' meetings, and typically only those who voted in favour of the DOCA at the second creditors' meeting are bound by its terms.14 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, however, 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.
A DOCA may also be utilised where the convening period has not been extended and the administrators require more time to sell the business or its assets than provided for in the legislation; for example, an administrator may wish to postpone a sale until market conditions improve, to generate a better return for creditors and might use a DOCA to push out the timeline. Such arrangements are known as 'holding DOCAs' and do not generally contain any specific provisions as to the future of the company or, on their face, any benefit for creditors. Their primary purpose is to provide more time for forming and agreeing a restructuring proposal. Holding DOCAs also confer other benefits, including an extension of the moratorium on all creditors bound by the DOCA, time and cost savings on applying for an extension of the convening period and greater flexibility for the administrator. While the use of holding DOCAs has at times been controversial, the court has generally supported their use as a means of facilitating a better result for creditors.
A provisional liquidator may be appointed by the court in a number of circumstances. The most commonly used grounds include:
- where 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.
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. A provisional liquidator will normally only be appointed by the court if there is a risk to the assets of a company prior to a company formally entering liquidation. As such, a provisional liquidator is normally only given very limited powers (i.e., the power 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. It 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.
Liquidation is the process whereby the affairs of a company are wound up and its business and assets are realised for value. A company may be wound up voluntarily by its members if solvent or, alternatively, 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 its debts within the following 12 months). If not, or if the company is later found to be insolvent, the creditors take control of the process. Creditors may 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 made to the court is insolvency, usually indicated by the company's failure to comply with a statutory demand 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 compulsory winding up, the liquidator will have wide-ranging powers, including the ability to challenge voidable transactions and take control of assets. Generally, a liquidator will not run the business as a going concern, unless it 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 formal insolvency; 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 in order to become effective. 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 together 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 to be 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.15 Thus, the basis upon which parties have previously grouped creditors into classes is now a less certain benchmark for class composition in the future.
The outcome of a scheme of arrangement is dependent on the terms of the arrangement or compromise agreed with the creditors. Most commonly, a company is returned to its normal state upon implementation as a going concern but with the relevant compromises having taken effect.
The scheme of arrangement process does, however, have a number of limiting factors associated with it, 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 it is of the view that the scheme of arrangement is not equitable). These factors explain why schemes of arrangement tend to only be undertaken in large corporate restructures and in scenarios where timing is not fatal to a restructure.
ii Rights of enforcement
Secured creditors may enforce their rights in every form of external administration. During a voluntary administration, a secured creditor with security over the whole or substantially the whole of the company's property may enforce its security, provided it does so within 13 business days of receiving notice of appointment of the voluntary administration, or with leave of the court or consent of the administrator. In addition, if a secured creditor takes steps to enforce its security before the voluntary administration commences, it may continue to enforce its security in the ordinary course of business.
Where a company pursues a DOCA, a secured creditor who did not vote in favour of such a proposal will have the ability to enforce its security interests once the DOCA becomes effective.16 If a voluntary administration otherwise terminates, a secured creditor may also commence steps to enforce its security interest upon termination.
iii Directors' duties in distressed situations
Case law in Australia, particularly the Westpac Banking Corporation v. Bell Group Ltd (in liq) case (Bell),17 has reaffirmed the position that a director must be increasingly mindful of the interests of creditors as a company approaches insolvency. A director's duty to creditors arises by operation of the well-established fiduciary duty owed by a director to the company more generally. When a company is solvent, the interests of the shareholders are paramount, and conversely, when a company is near insolvency or of doubtful solvency, the interests of the creditors become increasingly relevant. It is important to emphasise that the duty to take into account creditors' interests is owed to the company, not to the creditors per se.18
The extent of this duty continues to be an evolving area of the law. It is, however, now well established under Australian law that directors must at the very least have regard to the interests of creditors when a company is in financial distress or insolvent. As noted by Lee AJA in Bell:
At the point of insolvency, or the pending manifestation of insolvency, the duty to act in the best interests of each company was of central importance for the companies to comply with statutory obligations and the obligation of the companies not [to] prejudice the interests of creditors.19
Further, it has been suggested that when the solvency of a company is doubtful or marginal, it would be a misfeasance to enter into a transaction that the directors ought to know is likely to lessen the company's value if to do so will cause a loss to creditors. Directors should not, for instance, allow the company to enter into commitments that it clearly will not be in a position to meet or that may prejudice the interests of creditors generally.
Under Australian law, transactions will only be vulnerable to challenge when a company enters liquidation. Only a liquidator has the ability to bring an application to the court to declare certain transactions void. In the report to creditors at the second creditors' meeting, a voluntary administrator may identify potentially voidable transactions, but he or she is not empowered to pursue a claim in respect of such a transaction. Any such claim must be brought by a subsequently appointed liquidator.
There are several types of transactions that can be found to be voidable including:
- unreasonable director-related transactions;
- unfair preferences;
- uncommercial transactions;
- transactions entered into to defeat, delay or interfere with the rights of any or all creditors on a winding up; and
- unfair loans.
Transactions in categories (b), (c) and (d) will only be voidable where they are also found to be 'insolvent transactions', that is, transactions that occurred while the company was cash-flow insolvent, or contributed to the company becoming cash-flow insolvent. Each type of voidable transaction has a different criterion and must have occurred during certain time periods in the lead up to administration or liquidation. The relevant time period is generally longer if the transaction involves a related party.
Upon the finding of a voidable transaction, a court may make a number of orders, including directions that the offending person pay an amount equal to some or all of the impugned transaction; directions that a person transfer the property back to the company; or directions that an individual pay an amount equal to the benefit received.
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). As part of the wider reforms, which also proposed civil and criminal liability for directors and advisors engaging in creditor-defeating dispositions of company property, the Treasury Laws Amendment (Combating Illegal Phoenixing) Bill 2019 (the Bill) proposed legislating a power for liquidators to recover property that is the subject of creditor-defeating dispositions (in line with their existing ability to claw back voidable transactions).
v Insolvent trading
Directors may be held liable for new debts incurred by a company trading while cash-flow insolvent. This potential liability does not extend to debts incurred prior to the date a company became cash-flow insolvent, or recurring payments that become due after that date under the terms of pre-existing arrangements such as rent or interest (i.e., when the liability to pay such amounts already existed at the time of insolvency).
In terms of a director's personal liability, a court may make an order requiring the director to compensate the company for loss arising out of the insolvent trading, prevent a director from managing a corporation for a period of time and, in rare circumstances where the failure to prevent insolvent trading is ruled as a result of dishonesty, a fine of A$200,000 may be levied against the offending director.
The appointment of a voluntary administrator or a liquidator by the directors protects a director from any claim that he or she allowed the company to trade while insolvent in respect of any debts incurred after the date of such appointment.
With effect from September 2017, new Section 588GA of the Act, provides that a director is not 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'. A director that seeks to rely upon Section 588GA(1) of the Act bears the evidential burden in relation to that matter. That is, providing evidence that suggests a reasonable possibility that the matter exists or does not. The safe harbour protection does not apply in certain circumstances, including where, at the time the debt is incurred, the company has failed to pay employee entitlements or comply with certain reporting or taxation requirements.
In order to assist directors in seeking to ensure they obtain the benefit of the safe harbour protection, the Act lists some indicia for a director to regard when determining whether a course of action is reasonably likely to lead to a better outcome for the company. This includes whether the relevant director is:
- properly informing himself or herself of the company's financial position;
- taking appropriate steps to:
- prevent any misconduct by officers or employees of the company that could adversely affect the company's ability to pay all its debts; or
- ensure that the company is keeping appropriate financial records consistent with the size and nature of the company;
To date, there has been no case law providing judicial interpretation of Section 588GA as a defence to insolvent trading, including guidance as to how some of the important concepts and terminology associated with the safe harbour provisions should be applied.
III RECENT LEGAL DEVELOPMENTS
i 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 Act:
- an extension of the previous 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
- an ability for a liquidator, among others in certain circumstances, to seek compensation for loss or damage suffered because of a contravention of the civil penalty provision.
The SPE Act introduced a new Section 596AB to the Act, which provides for a lower bar for contravention; a person will contravene the offence provision if they enter into a relevant agreement or a transaction and they are reckless as to whether such agreement or transaction will avoid or prevent the recovery of the entitlements of employees of a company or significantly reduce the amount of the entitlements of employees of a company that can be recovered.
Under the new Section 596AC of the 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 the entitlements of employees of a company or significantly reduce the amount of the entitlements of employees of a company that can be recovered. The new Section 595ACA 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 of the 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 where 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 party is a member of the same group; 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 party were dealing at arm's length; and it is just and equitable to make the order. Section 588ZA(2) of the Act provides that the Court may make an order for a contributing party to pay the liquidator the amount equal to the benefit received by the contributing party that exceeds the 'reasonable benefit' that might be expected where the contributing party and the insolvent company were dealing at arm's length.
While these reforms have yet to be considered by the Courts and, considering the already limited judicial interpretation of the former Section 596AC, it may remain so for some time. It will be interesting to see whether liquidators pursue debts from persons engaging in employee-creditor defeating behaviour.
ii Combating illegal phoenixing
As discussed in Section II.iv above, the Bill was recently considered by the Australian parliament. The Bill seeks to introduce reforms aimed at combatting illegal phoenix activity; transactions that utilise the insolvency regime to shift assets and defeat creditors.
If passed, the Bill will see the introduction of a new Section 588FE(6B) of the Act, which will provide that creditor-defeating dispositions of company property are voidable where they are made while a company is insolvent or where they cause the company to become insolvent or enter external administration within the 12 months after the disposition. The proposed new Section 588FDB 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'.
Similar to the SPE Act, the Bill also proposes to enhance 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' (i.e., pre-insolvency advisors).
The Bill also seeks to introduce a new Section 203AA of the Act to prevent the backdating of director resignations where such resignations are reported to ASIC more than 28 days after their purported occurrence. It also provides that where 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 sections seek to address illegal phoenix practices related to backdating the effective date of director resignations to escape liability for the company's (supposedly) subsequent actions.
IV SIGNIFICANT TRANSACTIONS, KEY DEVELOPMENTS AND MOST ACTIVE INDUSTRIES
In July 2018, amendments to the Act came into operation, introducing an 'automatic stay' into the Act on the enforceability of ipso facto provisions that allow a contract to be terminated or altered owing to:
- a company entering into a scheme of arrangement;
- the appointment of a receiver or controller to all or substantially all of the company's assets;
- the appointment of an administrator to a company; or
- the appointment of a liquidator immediately following administration or a scheme.
The automatic stay does not apply retrospectively (i.e., for agreements entered into prior to the TLA Act coming into force). In addition, the automatic stay does not explicitly apply to: receiver or controller appointments that are not over all or substantially all of the company's assets; entry into a deed of company arrangement; or liquidations which do not immediately follow an administration or scheme.
Under the new Sections 415E and 451F of the Act, a court may lift the automatic stay in respect of certain ipso facto clauses if it is satisfied that doing so is in the interests of justice or where a relevant scheme of arrangement is found to not be for the purpose of avoiding winding up.
The operation of the automatic stay excludes certain rights prescribed in an accompanying ministerial declaration and certain contracts, agreements or arrangements separately set out in Regulations. We also note that the automatic stay does not apply to ipso facto rights attached to financial products that are necessary for their provision, in agreements made after the commencement of the formal restructure or to other types of contracts set out in regulation or declared by the minister.
By way of illustration, some of the contractual rights excluded from the operation of the automatic stay provisions include: (1) a right to terminate under a standstill or forbearance arrangement; (2) a right to change the priority in which amounts are to be paid under a contract, agreement or arrangement; and (3) a right of set-off, combination of accounts or a right to net balances or other amounts.
Similarly, among the agreement types excluded by the Regulations include: (1) contracts, agreements or arrangements that are a licence or permit issued by federal, state or local government; (2) contracts that are derivatives and contracts for the underwriting of an issue or sale of securities or financial products; and (3) contracts under which a party is or may be liable to subscribe for, or to procure subscribers for, securities or financial products.
As the automatic stay provisions have only been in operation for just one year, there has not been any judicial consideration as to the operation of these provisions, including the excluded rights and contract, agreements and arrangements.
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' is located. This approach follows the UNCITRAL Model Law on insolvency, which was codified into Australian law through the Cross-Border Insolvency Act 2008 (Cth).
There is also scope under different legislation such as the Act for Australian courts to recognise foreign judgments in Australia. Specifically, under Section 581 of the Act, Australian courts have a duty to render assistance when required by a foreign insolvency court. Further, the Act has extraterritorial application; for example, an Australian court has jurisdiction to wind up a foreign company.
VI FUTURE DEVELOPMENTS
What will be particularly interesting over the next few years will be the impact the ipso facto legislation has on restructurings. We also envisage further discussion around potential future reforms to our insolvency laws (which may, for example, seek to facilitate pre-packs); however, any further changes to the insolvency and restructuring legislation, beyond the proposed anti-phoenixing reforms, is unlikely in the 2019 calendar year.
While we are of the view that the safe harbour regime will impact voluntary administration appointments at the small to mid-market level, with some directors willing to seek to rely on the safe harbour and trade the company out of its difficulties, in an environment where there are only very few domestic bank-led receiverships, we anticipate that the number of voluntary administrations will remain constant.
With the number of new entrants entering the leveraged finance market and operating at the higher end of the risk curve, together with the numerous industries continuing to face structural difficulties (e.g., mining, mining services and retail), it would not take much for the needle to turn. We also expect to see a return to banks trading their debt in the near term, and we consider the various overseas participants that are actively present in Australia are here to stay.
1 Dominic Emmett and Peter Bowden are partners, and Anna Ryan is a senior lawyer at Gilbert + Tobin.
2 See J. Greber, 'Australia's growth rate slowing at twice the speed of peers, say IMF', Australian Financial Review, 9 April 2019, https://www.afr.com/news/economy/australia-s-growth-rate-slowing-at-twice-the-speed-of-peers-says-imf-20190409-p51c74 (accessed 11 June 2019).
3 See M. Janda, 'Housing prices set to fall another 10pc before 2020 rebound, Moody's Analytics says', ABC News, 9 April 2019, https://www.abc.net.au/news/2019-04-09/home-loans-rebound-but-moodys-predict-further-price-falls/10984590 (accessed 11 June 2019); and Core Logic, Housing Market Update - June 2019, https://www.corelogic.com.au/reports/housing-market-update (accessed 11 June 2019).
4 For the purposes of this chapter, the terms 'receiver' and 'receiver and manager' will be used interchangeably.
5 Often referred to as a 'pre-pack', this 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.
6 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.
7 Section 435A of the Act.
8 Section 436A of the Act.
9 Section 436B of the Act.
10 Section 436C of the Act.
11 There is, however, an exception to the moratorium on the exercise of rights under security interests in the case of a secured creditor that has security over all or predominantly 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).
12 Section 439C of the Act.
13 Section 444GA of the Act.
14 There have been two cases challenging the validity of the widely held 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 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 Act. However, this extinguishment is subject to the preservation of the secured creditor's ability (by virtue of Section 444D(2) of the Act) 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 that debt be preserved into the future or for other purposes.
15 See First Pacific Advisors LLC v. Boart Longyear Ltd  NSWCA 116.
17  WASC 157.
18 Spies v. the Queen  HCA 43.
19 Westpac Banking Corporation v. The Bell Group Limited (In Liq) [No. 3]  WASCA 157 at 920.