Beyond COVID-19: Crisis response or road to recovery?
Crisis response or road to recovery?
The pandemic has created significant financial and operating challenges for all Australian businesses. While interim government fiscal support measures, and temporary changes to the insolvency regime such as the six month suspension of insolvent trading liability for directors, have helped to calm the storm and delay mass new insolvency filings, the fiscal cliff is fast approaching and the final quarter of 2020 will see an influx of insolvencies that will last well into 2021.
In this landscape, it is important for financiers to assess the insolvency risk across their loan and investment portfolios and consider their enforcement options and liability implications to ensure they are prepared for what lies ahead.
We therefore felt it was timely to write an insolvency law ‘refresher’, setting out the key issues and risks for financiers to consider and looking ahead to what new insolvency processes may be introduced in 2020-2021 as the Commonwealth Government commences its process of legal and economic reform.
There are four primary formal insolvency processes in Australia:
These processes are summarised in the table below.
|Liquidation||Voluntary administration||Receivership||Creditors' scheme of arrangement|
|When it Begins||
Creditors’ voluntary liquidation
Liquidator can be appointed by special resolution of shareholders (if directors believe company is insolvent) and liquidator must then convene meeting of creditors within 10 business days. Otherwise, creditors can appoint a liquidator at second meeting of creditors during voluntary administration.
Compulsory liquidationA creditor can apply to wind up a company on the basis it is insolvent. There is a presumption of insolvency if the company has not complied with a statutory demand.
|Voluntary administrator can be appointed by a resolution of directors (if company is insolvent or likely to become insolvent), a liquidator/provisional liquidator or a creditor with a security interest over the whole or substantially the whole of a company’s property.||
Receiver is most frequently appointed by a creditor with a security interest over the whole or substantially the whole of a company’s property, but right to appoint needs to be included in the security documents.Appointment can occur during voluntary administration or liquidation.
Initiated by negotiations between directors and creditors and requires at least two court applications.Used only in larger restructurings.
|Creditors’ Rights||Unsecured creditors are prevented from enforcing their rights, but secured creditors can exercise rights under a PPSR registered security interest.||Most creditors, owners and landlords are prevented from enforcing their rights. However, a creditor with a security interest over the whole or substantially the whole of a company’s property has 15 business days to exercise its rights (typically the appointment of a receiver) – if this is done, the secured creditor can stay outside the voluntary administration process.||Junior creditors can enforce their rights but subject to the security interest of the appointing creditor.||Creditors can continue to enforce their rights while a scheme is negotiated but are bound by the scheme if the approval thresholds are met (see below).|
|Directors’ Powers||Remain in office but powers are suspended.||Remain in office but powers are suspended.||Remain in office but powers over assets subject to the security are suspended.||Remain in office throughout the negotiation and implementation of the scheme, subject to any terms to the contrary in the scheme documents.|
Liquidator collects the company’s property and proceeds to sell assets.Liquidator will also investigate any voidable transactions and breach of officers’ duties and commence enforcement proceedings if appropriate.
Voluntary administrator must convene and hold a first meeting of creditors within eight business days of appointment.
Second meeting of creditors is held within 25 business days of being appointed. Here, the administrator must issue recommendations to creditors and creditors resolve whether to approve a DOCA, proceed to a winding up or return the company to its directors.
A DOCA can cover a wide range of matters, including debt for equity swaps and compromise of creditors’ claims.A DOCA is binding on secured creditors, as well as certain owners and lessors of property, if they either voted in favour of the DOCA or the court expressly orders.
The primary duty of a receiver is to realise the assets subject to the appointing creditor’s security interest and distribute the assets to the appointor. There is an express statutory duty for a receiver to take reasonable care to obtain market value or the best price possible.Receivership ends when property is sold and proceeds are distributed to the secured creditor, with residual balance going to any liquidator or administrator appointed.
There are two court applications, one convening a meeting of creditors to vote on the proposed scheme and another seeking approval of the scheme if agreed to by creditors.
In voting on a proposed scheme, creditors may need to be divided into separate classes.To be approved by creditors, a resolution must be passed, for each class of creditors, by a majority of creditors in fact present and voting and 75 per cent of the value of total debts owed to those creditors.
|Priority of Payment||
Realised funds are applied to meet the claims of secured creditors, expenses of the liquidation, employee entitlements, unsecured creditors’ claims and shareholders’ claims.For creditors with a security interest over circulating assets such as inventory, funds realised from sale of the assets must first be applied to meet certain employee entitlements.
If creditors resolve for the company to execute a DOCA, assets realised must be applied in the same manner as in a liquidation unless otherwise provided by the terms of the DOCA.Any purported variation to the liquidation order of payments may cause the court to terminate or invalidate the DOCA.
To the extent the appointing creditor’s security interest covers circulating assets, realised assets must first be applied to meet certain priority amounts, including employee entitlements.
Creditors will be paid in the manner set out in the scheme.Any differential treatment between creditors risks the scheme not being approved by either the required majority of creditors or the court at the second court hearing.
|Duration||Depends on scope of company’s property and complexity of sale process – typically at least 12 to 18 months.||Limited to 25-30 business day period, following which there will be a transition to a DOCA or liquidation or a return of the company to directors (depending on what is decided by creditors).||Depends on scope of company’s property and complexity of sale process – typically six months to a year.||At least three months.|
Since September 2017, directors have been able to take advantage of a safe harbour from insolvent trading liability under section 588GA of the Corporations Act 2001 (Cth) (Corporations Act), which protects them from personal responsibility for a company’s debts in circumstances where they develop and implement a dedicated informal restructuring plan acting on the advice of an appointed specialist restructuring expert.
The safe harbour is designed to encourage informal rescue attempts for viable companies which, despite current financial difficulties, have a reasonable prospect of being able to return to profitable trade in the longer-term.
By providing directors with immunity from insolvent trading liability where the conditions in section 588GA of the Corporations Act are met, the safe harbour acts as a key incentive for directors to pursue an informal rescue attempt (if the company is viable) rather than immediately appointing a voluntary administrator in an effort to invoke the defence to insolvent trading in section 588H(6).
However, the safe harbour is largely untested in the courts, and many directors do not see it as a ‘safe bet’, particularly amidst the economic and financial uncertainty of the pandemic.
In any event, there is not currently any enforcement moratorium that applies during the negotiation of an informal restructuring attempt, so major financiers and other creditors remain free to exercise their enforcement rights. When this is done, and the assets subject to a security interest comprise the bulk of a company’s primary undertaking, liquidation is usually the realistic end point for the company.
Apart from the duty to prevent insolvency trading under section 588G of the Corporations Act, directors in Australia owe the company core duties to act:
These duties are owed not just by appointed directors but also shadow directors, being persons, whether individuals or companies, whose instructions or wishes are followed by appointed directors as a matter of course. A shadow directorship most typically arises in the context of a corporate group, with both a parent entity and its individual officers capable of being shadow directors, a point recently emphasised by the High Court in March 2020 in ASIC v King  HCA 4.
Financiers should be careful about the risk of being found to be a shadow director, especially in the peak insolvency period ahead in circumstances where financiers elect to support an informal restructuring and their terms and conditions shape the course of the negotiations. That said, simple insistence on enforcement rights, leaving directors to exercise their own independent judgment about what is in the best interests of the company and what course the company will adopt, will not give rise to shadow director liability, as affirmed in Buzzle Operations Pty Ltd (in liq) v Apple Computer Australia Pty Ltd  NSWCA 109.
Shadow directorship aside, it is important for financiers to note that the Australian courts have held that the interests of ‘the company’ in assessing the best interests duty owed by directors correlates to the interests of creditors during a period of doubtful solvency. The Bell Group litigation reflects that financiers need to be careful in negotiating new security and payment terms in a corporate group setting which benefit one group entity but sacrifice the interests of related entities. In that case, appointed directors of the related entities may breach the best interests duty, and a court may make an order invalidating the new security terms and payments received by the financier.
Until 25 September 2020, the Coronavirus Economic Response Package Omnibus Act 2020 (Cth):
The Commonwealth Government is currently considering an extension to these interim measures, and also the potential for a six month prohibition on liquidators recovering unfair preference payments.
The Government is also considering deeper insolvency law structural reforms, including the possible adoption in Australia of features of the United States Chapter 11 ‘debtor in possession’ process. There is also a strong industry push for the adoption of a super priority financing regime, more extensive enforcement restrictions during a period of informal restructuring and during voluntary administration (for both secured and unsecured creditors) and greater scope for secured creditors to be ‘crammed down’ so that they are bound to a formal restructuring plan even if they do not vote in favour of it.
Reforms of this kind will directly impact on the security position and enforcement rights of financiers, and this will need to be factored into existing and future loan decisions and risk frameworks.
The law reform process in Australia will be shaped by recent measures adopted in the United Kingdom. Notably, the Corporate Insolvency and Governance Act 2020 (UK) came into force on 26 June 2020 and provides for a new ‘restructuring plan’ alternative. It is essentially like a creditors’ scheme of arrangement in Australia, but permits the court to approve the restructuring plan where one or more classes of creditors does not approve it by a 75% in value threshold. This could see dissenting secured creditors bound to a restructuring plan where that is in the best interests of creditors – and the public interest more generally in critical industries – as a whole.
The United Kingdom reforms also provide for an enforcement moratorium, binding on both secured and unsecured creditors, during the negotiation of an informal restructure. This applies for an initial 20 business day period (this can be extended) when an independent monitor forms the view that the moratorium is reasonably likely to lead to a successful restructure.
It is also important for financiers to be mindful of Australia’s cross-border insolvency regime.
Australia formally adopted the UNCITRAL Model Law on Cross-Border Insolvency (Model Law) through its enactment of the Cross-Border Insolvency Act 2008 (Cth) (CBIA).
The CBIA, and comparative legislation in other jurisdictions that have adopted the Model Law – including the United States, the United Kingdom, Canada, Japan and New Zealand – provides a streamlined process for a liquidator of a company in a Model Law jurisdiction to take control of assets of the company located overseas, as well as pursue investigations and institute recovery proceedings overseas (for example, to have voidable transactions set aside).
Essentially, this involves the liquidator (referred to under the Model Law as a ‘foreign representative’) applying to an overseas court to obtain recognition of the liquidation and a formal order permitting the liquidator to take control of foreign assets and pursue investigations and recovery proceedings in accordance with the provisions of the overseas insolvency law. In making an order, the court must be satisfied that the interests of local creditors are ‘adequately protected’.
Alternatively, section 581 of the Corporations Act sets out a mandatory obligation for Australian courts to provide assistance ‘in all external administration matters’ if they receive a letter of request from an overseas court in a ‘prescribed’ country (currently Jersey, Canada, PNG, Malaysia, New Zealand, Singapore, Switzerland, the United Kingdom and the United States). An Australian liquidator can also apply to the court to issue a letter of request to an overseas court under section 581.
Apart from the recognition provisions, the CBIA (and comparative legislation in jurisdictions that have adopted the Model Law) gives overseas creditors the same rights as local creditors to participate in insolvency proceedings by lodging a proof of debt and voting.
While the cross-border regime may expand the asset pool available for Australian financiers to enforce their claims in overseas jurisdictions, correspondingly the enforcement of claims by foreign creditors over Australian assets may impact on the security position of Australian financiers. This is a key risk issue that Australian financiers need to plan for in their enforcement strategies in coming months, with the number and scope of cross-border insolvencies likely to rise in light of the global economic and financial repercussions of the pandemic.
As a result of recent events in Ukraine, and the economic sanctions imposed on Russia, there are a number of potential issues facing financial institutions.
© Norton Rose Fulbright LLP 2021