An overview of Australian insolvency and restructuring, by energy and resources partner Robert Milbourne and restructuring and insolvency partner Jason Opperman.
The commodities sector remains in distress, which will have consequences for all participants in the sector – owners, boards, counterparties, contractors, lenders.
What happens when a company can no longer cover its liabilities? We set out below a primer to understand the various options and their consequences to counterparties.
DIRECTOR’S LIABILITY
Perhaps one of the most important functions of a company’s directors is to monitor the fiscal health of the company and to intervene immediately if there is any risk that the company may not be able to meet its obligations as they come due. If directors allow trading to continue when a company is technically insolvent, they may be personally exposed to the liabilities of the company. If your company is insolvent, do not allow it to incur further debt. Insolvent trading can have serious consequences for directors.
There are various penalties associated with insolvent trading, including civil penalties, compensation proceedings and criminal charges. Unless it is possible to promptly restructure, refinance or obtain equity funding to recapitalise the company, generally, your options are to appoint a voluntary administrator or a liquidator. The three most common insolvency procedures are voluntary administration, liquidation and receivership.
VOLUNTARY ADMINISTRATION
An administration is essentially a process in which the board of directors appoints a professional restructuring advisory firm to administer the company with the aim of entering an arrangement with the company’s creditors to effect some form of compromise or restructure. The company will continue to operate under the voluntary administration process. If the administrator is unable to restructure the company to maintain its viability as a going concern then the company will most likely end up in liquidation. An administrator can be appointed by the board of the company, resolving that the company is insolvent or likely to be insolvent and that a named administrator should be appointed.
Alternatively, a secured creditor who is entitled to enforce its security, where that security is over the whole or substantially all of the property and undertaking of the company, can also appoint an administrator. Once a person is named as administrator, and consents to the appointment, then he or she takes control of the company. The powers of the directors are essentially suspended during the administration. During the administration, there is a moratorium in which steps cannot be taken to wind up the company.
Without administrator or court consent, secured creditors cannot enforce their security unless they had commenced doing so before the administrator’s appointment. In addition, court proceedings against the company are stayed absent administrator or court consent. The administrator must convene a meeting of creditors within eight business days of the administrator’s appointment. At this meeting the creditors can determine whether to replace the current administrator with one of their own choosing, and they can appoint a committee of creditors. The administrator will begin an investigation into the business and the circumstances which led to the administrators appointment.
The administrator will prepare a report to creditors on these matters with a view to recommending one of three outcomes: (i) that the company and its creditors resolve to enter into a deed of company arrangement (DOCA), which is a means by which a compromise of existing debt or a restructure can be achieved, (ii) the company be wound up, or (iii) the company be returned to the control of its directors – which is unlikely if the company is insolvent.
The creditors will decide on one of these options about one month after the administrator was appointed (but this can be extended by court application).
DEED OF COMPANY ARRANGEMENT
The DOCA is a deed of agreement under which a compromise or restructure is effected in an administration. A DOCA can be proposed by any person and there may be competing proposals that the creditors might have to consider. Once approved, the company has 15 business days to execute the deed. If this is not done, the company automatically enters into liquidation, with the administrator becoming the company’s liquidator.
The DOCA binds all unsecured creditors, even if the creditor voted against the deed. Once the terms of the deed are effected, then the deed ends and the company continues on with its balance sheet “cleaned up”. While a DOCA is in effect, the ability of the company to operate under normal circumstances is constrained.
SCHEME OF ARRANGEMENT
A scheme of arrangement is the path many mining and resources companies are most likely to take to achieve a restructure. A scheme of arrangement is a means by which a company can enter into an arrangement with its members/and or creditors or a class of members and/or creditors to effect a compromise or restructure.
The proposal needs the approval of not only the members and/or creditors sought to be bound by the scheme but also approval from the court. Typically, the company will formulate the proposal for a scheme, which will specify who will be the administrator during the scheme and what their duties will be, the duration of the scheme, the extent of the compromise or restructuring, which creditors will be paid, and the consequences of a breach of the scheme, among other matters. A scheme can benefit stakeholders if it allows resource company operations to continue and key supply contracts to be preserved (albeit perhaps at renegotiated rates).
A board may consider appointing a voluntary administrator while formulating a scheme of arrangement or, alternatively, put forward a proposal for a DOCA. Once a proposal is formulated, an explanatory statement is required to be prepared. This sets out the operation and effect of the proposed scheme. Included in the statement is a report as to the affairs of the company, the financial position of the company, and related financial information. An application is then made to the court for approval to distribute the explanatory statement and to permit the convening of meetings of the affected creditors.
ASIC must be given 14 days notice of the application and it might seek to appear at the hearing. At the meeting, creditors vote on the scheme proposal. To be effective and binding, creditors must approve the scheme by greater than 50 per cent in number of those present and voting and greater than 75 per cent in terms of value. If the creditors approve the scheme, then a second application to the court is required – and the court must itself approve the scheme.
Once approved, the scheme becomes binding. Generally during a scheme, creditors may face a reduction on their quantum or terms, and certain contracts may be renegotiated. One key benefit of a scheme over, say, a DOCA, is its flexibility. A scheme can overcome the general requirement of pari passu distribution that would apply in a liquidation (and is generally required to be adhered to in a DOCA as well).
LIQUIDATION
A liquidation is the orderly winding up of a company’s affairs. It involves selling or disposing of the company’s assets, cessation or sale of its operations, distributing any proceeds realised during the winding up among its creditors and distributing any surplus among its shareholders. There are three types of liquidation: (i) court, (ii) creditors’ voluntary, and (iii) members’ voluntary.
A creditors’ voluntary liquidation is a liquidation initiated by the company. A court liquidation starts as a result of a court order, made after an application to the court, usually by a creditor of the company. When a company is being wound up in insolvency, the liquidator has a duty to all the company’s creditors. The liquidator’s role is to collect, protect and realise the company’s assets, investigate and report to creditors about the company’s affairs, including any unfair preferences which may be recoverable, any uncommercial transactions which may be set aside, any possible claims against the company’s officers, enquire into the failure of the company and possible offences by people involved with the company, and report to ASIC after payment of the costs of the liquidation.
Subject to the rights of any secured creditor, the liquidator will distribute the proceeds of the winding up – first to priority creditors, including employees, and then to unsecured creditors. The liquidator must then apply for deregistration of the company on completion of the liquidation. Except for lodging documents and reports required under the Corporations Act, a liquidator is not required to do any work unless there are enough assets to pay their costs. If the company is without sufficient assets, one or more creditors may agree to reimburse a liquidator’s costs and expenses of taking action to recover further assets for the benefit of creditors. In this case, if additional assets are recovered, the liquidator or particular creditor can apply to the court for the creditor to be compensated for the risk involved in funding the liquidator’s recovery action.
RECEIVERSHIP
A company most commonly goes into receivership when a receiver is appointed by a secured creditor over some or all of the company’s assets. The receiver’s primary role is to collect and sell sufficient of the company’s secured assets to repay the debt owing to the secured creditor. A director who is also a secured creditor should seek advice before appointing a receiver.
KEY CONSIDERATIONS
Contractors, creditors, lenders and other stakeholders may have conflicting interests in the restructuring and administration of any insolvent resources company. It is therefore essential to understand how other stakeholders’ rights can impact on your rights. Early strategic planning in the event of a restructuring is essential and can have significant benefits to participants to secure their rights and achieve a satisfactory outcome.
Options that may be available could include (i) working with management to formulate a plan to avoid the company becoming insolvent, (ii) working with bondholders or other creditors with the aim of putting in place arrangements which would encourage the continued operation of the company in the event that a receiver is appointed, or (iii) taking a passive approach to the situation to wait until formal steps are taken by the company or its lenders.
The extent to which participants wish to become involved, if at all, in planning for a restructuring or working with management will obviously depend on a range of commercial considerations including the impact of the company ceasing operations, the importance of the company as a long term strategic customer, reputational issues, and the extent of financial exposure and willingness or ability to withstand delay in restructuring.
Restructuring does not require an appointment of an administrator or the execution of a DOCA, and in many cases, participants interests may be served by pre-empting such outcomes. At a minimum it is essential to be well prepared with respect to any potential outcome.
“Early strategic planning in the event of a restructuring is essential and can have significant benefits to participants…”
AUTHOR PROFILES
JASON OPPERMAN
Jason Opperman is head of K&L Gates Restructuring and Insolvency practice in Australia.
ROBERT MILBOURNE
Robert Milbourne is a mining and resources partner based in Brisbane and adjunct professor of law at the University of Queensland School of Law.
Add Comment