Everyone's a winner, baby? Pooling insolvent groups

By David Cowling.

Key Points:
A court will be able to approve a pooling arrangement if it believes that "it is just and equitable to do so".

A key plank of the Government's recently-announced insolvency law reforms is a proposal to allow pooling in insolvent corporate groups.

"Pooling" generally describes a process under which all of the group companies' individual assets and liabilities are rolled together. The group is then treated as if it were a single company. This, of course, means that creditors are treated as creditors of the group, rather than of individual companies.

The most common reason used to justify pooling is that the group companies' business affairs have become so intertwined and mixed up that it would be almost impossible (or unacceptably expensive) to unwind them.

Many creditors in this sort of situation will not have known - or cared - which individual company they were dealing with. As long as the cheque didn't bounce, they didn't care whether it came from XYZ Ltd, XYZ No 3 Ltd or XYZ Services Ltd.

However, that can change dramatically if the group becomes insolvent:

• XYZ Ltd may have enough money to pay its creditors 10 cents in the dollar
• XYZ No 3 Ltd may only be able to rustle up one cent in the dollar
• XYZ Services Ltd may not be able to pay its creditors anything.

If the assets and liabilities of the group are pooled, creditors may get two cents in the dollar. That may be good news for the creditors of XYZ No 3 and XYZ Services, but it won't have the creditors of XYZ jumping for joy.

That's the problem with pooling: in most cases, it will result in some creditors receiving less than their legal entitlement. And that's a large part of the reason why Australian courts have tended to be wary of giving the green light to pooling arrangements. The courts' reluctance is reinforced by the fact that the Corporations Act currently contains no provisions actually authorising pooling: the pooling arrangements submitted to the courts to date have tended to be based on creative uses of various bits and pieces of the Act.

Now the Federal Government is proposing to amend the Act by inserting a set of rules specifically designed to allow pooling.

The process in outline

It's proposed that pooling will be allowed in voluntary administration and winding up. The broad framework is the same for both: an administrator or liquidator will be able impose a pooling arrangement but, if creditors object to it, the pooling arrangement will require the approval of a court.

For technical reasons, statutory pooling would not legally involve the creation of a central pool of assets and liabilities, but the effect is largely the same. Under statutory pooling, every company in the group would be liable for the unsecured debts of every other company in the group. This would mean that creditors of a company with no assets would be able to claim against another group company that did have assets. At the same time of course, a creditor of a company with assets would find that the pool of creditors able to claim against that company had expanded to cover every creditor of every other company in the group.

How would a pooling arrangement come into effect? There are some differences in this respect between voluntary administrations and liquidations.

In a voluntary administration, the administrator would be able to declare a pooling arrangement, and it would then be up to individual creditors to object. If there was an objection, the pooling arrangement could not come into effect unless the administrator got court approval for the pooling.

Similarly, in a winding up, the liquidator could implement a pooling arrangement if no creditors objected. However, the liquidator could also sidestep the creditor objection process and go straight to the court for approval.

The court's powers

It is obvious that, unless creditors are on tranquilisers, many pooling proposals are going to end up in court.

This means that the success of the new provisions will be heavily dependent upon what the courts do.

A court will be able to approve a pooling arrangement if it believes that "it is just and equitable to do so". The Act would list factors for the court to take into consideration:

• the extent to which a group company and its officers and employees were involved in the management or operations of other group companies;
• the conduct of a group company and its officers or employees towards the creditors of other group companies;
• the extent to which the administration of winding up of a group company was attributable to the acts or omissions of other group companies or their officers or employees;
• the extent to which the activities and business of the group companies in the group were intermingled;
• the extent to which pooling would advantage or disadvantage creditors;
• "any other relevant matters".

The high degree of emphasis on the pre-insolvency activities of group companies is a little surprising. Pooling disputes in court will generally be a battle between creditors. Therefore, it is difficult to see why one creditor should suffer a loss of entitlement because of the activities of the company with which it was dealing. This also appears to have the potential to punish diligent creditors: why should a creditor who carefully examines orders, receipts and payment details suffer because other creditors were less careful about whom they were dealing with?

In the initial stages, at least, the courts are going to have their work cut out for them, trying to distil a coherent set of principles from this list of factors.

Informing the creditors

One also suspects that there will be a large number of complaints from creditors who don't understand what pooling is or how a particular pooling proposal affects their interests.

Before implementing a pooling arrangement, an administrator or liquidator will have to send each creditor a notice setting out the administrator's or liquidator's opinion as to:

• whether the pooling would be in the creditors’ interests generally;
• the extent to which the pooling would be likely to disadvantage particular creditors;
• the likely return to creditors if the pooling were made and if it were not made.

This notice will trigger a creditor's right to object to the pooling. There will undoubtedly be litigation about whether the notice has fully met the statutory requirements, particularly if a pooling proposal produces markedly different outcomes from those predicted in the notice.

Conclusion

The policy objectives behind pooling are laudable, and a great deal of thought has undoubtedly gone into the proposals.

The reliance on the role of the court is a weak spot. While it's not for Parliament to determine what's just and equitable in individual cases, the list of factors for the court to consider provides little real direction for the court. It will be interesting to see whether that factor will encourage creditors to resist pooling proposals, on the basis that they won't be any worse off by forcing the administrator or liquidator to go to court.

For further information, please contact David Cowling.