Investing in distressed companies in Australia: a practical guide for potential acquirers

When a company enters voluntary administration, most investors run for cover – but for those with the right strategy and risk appetite, these moments of distress can offer rare opportunities to acquire valuable assets at a compelling price point. The key mechanisms available to potential acquirers – including deeds of company arrangement and asset acquisitions from insolvency processes – and highlights the critical considerations that arise in respect of secured creditors, unsecured creditors, royalty holders, continuing contracts, employees, and other stakeholders.

The voluntary administration process

When a company enters voluntary administration, the voluntary administrators assume control of the company's business, assets and affairs. A moratorium prevents most creditors from enforcing their claims, commencing proceedings, or taking steps to wind up the company during the administration period. Certain secured creditors may separately appoint receivers if the security covers all or substantially all of the company's assets.

At the second meeting of creditors, required to be 25 business days from the date the administration commenced (unless extended by court order), creditors resolve the company's future: they may vote for the company to execute a deed of company arrangement, for the administration to end, or for the company to be wound up. A proponent who wishes to acquire a distressed business through a DOCA must therefore develop a proposal that is attractive enough to secure the support of a majority in value of voting creditors.

Acquisition through a deed of company arrangement

Structure and objectives

A deed of company arrangement is the primary restructuring mechanism under Part 5.3A. Its overarching objectives typically include providing:

• unsecured creditors with a greater, more certain and timely return than would result from an immediate winding up;

• trade creditors with the opportunity for future work and supply prospects;

• employees with continued employment;

and maximising the chances of the company's business continuing in existence.

In practice, a DOCA-based acquisition involves a proponent contributing funds (a "Proponent Contribution") to a deed fund or trust fund, in exchange for the transfer of the company's shares (and therefore control of its underlying assets, contracts and operations) to the proponent or its nominee. This structure allows the company to emerge from external administration as a going concern under new ownership.

The share transfer mechanism (section 444GA)

A critical feature of many DOCA acquisitions is the transfer of the company's shares to the proponent under section 444GA of the Corporations Act. The deed administrators may first request the unconditional written consent of existing shareholders to the share transfer. If that is not practical (from the number or type of shareholders) or shareholder consent is not forthcoming within the required timeframe, the deed administrators apply to the Court for an order under section 444GA(1) permitting the transfer.

The deed fund and creditor returns

The property available to pay creditors' claims under a DOCA is typically defined by the deed fund. The deed fund typically comprises contributions from the proponent, the company's existing cash (if any) and potentially other receivables.

In mining company DOCAs, the deed will commonly exclude from the property available to creditors those operational assets that the proponent requires for ongoing operations. For example, excluded assets may comprise all the mining leases, permits, licences, plant and equipment, infrastructure and intellectual property related to the operation of the mine, as well as specified tenements. These assets remain with the company and pass to the proponent's control upon completion of the share transfer.

Key considerations for acquirers

Secured creditors

Secured creditors hold a privileged position in Australian insolvency law. A secured claim is any claim secured by a valid security interest, including any interest registered under the Personal Property Securities Act 2009 (Cth) (PPSA). Under section 444D of the Corporations Act, a DOCA binds all creditors, but a secured creditor is only bound to the extent that it voted in favour of the resolution to execute the deed, or the court orders otherwise under section 444F.

In practice, this means that proponents must negotiate directly with secured creditors to obtain their consent to the DOCA and the release of their security interests. This is typically contained within conditions precedent.

The acquirer must carefully assess the PPSR registrations and any other encumbrances over the target company's assets. In some cases, equipment lessors or owners whose property is required for operations may be treated as "non-participating creditors" – their pre-appointment claims continue against the company post-completion, and their lease agreements continue. This means the acquirer inherits those obligations.

Unsecured creditors

An acquirer must work with the Deed Administrator to identify the unsecured creditors and the provable claims (ie. which arose prior to the administration) – remembering that it is the creditors which hold the power to decide whether to enter into the DOCA, or not. An acquirer must consider how the deed fund will be distributed to creditors and the potential returns. The Administrators will prepare a recommendation to creditors and compare the returns to creditors in a liquidation – but it is the creditors that hold the power. It is also important to canvass creditors which the acquirer considers to be key to continuing operations.

The use of creditor pools with capped distributions may allow the proponent to limit its overall exposure while directing funds to those creditor classes whose support is most important. However, this structuring must be carefully considered, as an unfairly prejudicial DOCA may be at risk of being later set aside by a disgruntled creditor.

Unsecured creditors are the primary beneficiaries of a DOCA fund.

Their claims are typically released and extinguished upon completion, with their entitlements transferred to a creditors' trust. The deed fund is distributed in accordance with a priority waterfall, which commonly mirrors the statutory priority regime in sections 556, 560 and 561 of the Corporations Act.

As an example of a waterfall:

• first, payment of administrators' and deed administrators' remuneration and liabilities;

• secondly, payment of admitted priority claims (principally employee entitlements);

• thirdly, payment on a pari passu basis to other creditors.

The acquirer must ensure that the proposed return to unsecured creditors exceeds what they would receive in a liquidation as this is generally the threshold creditors will apply when voting on the DOCA proposal.

It is not uncommon for creditors' claims to be transferred to a creditors' trust. The administrators take the role of the trustees to hold and potentially recover additional amounts for distribution for the benefit of creditors, and distribute to creditors in accordance with the priority as stated in the DOCA. The reason for this structure is to allow the completion of the DOCA sooner and enable the acquirer to then manage the restructured company.

The moratorium

During the deed period, a comprehensive moratorium prevents creditors from taking enforcement action. A creditor must not make an application to wind up the company, commence or continue proceedings against the company or its property, begin or proceed with an enforcement process, or take any action to recover or enforce their claim.

This moratorium provides the acquirer with a stable operating environment during the period between execution of the DOCA and completion of the share transfer, shielding the business from creditor enforcement that could disrupt operations or erode asset value.

Royalty holders

Royalty holders present a unique challenge for acquirers of mining companies in distress. They may hold both unsecured contractual claims (in respect of royalties that have accrued but remain unpaid) and ongoing entitlements under royalty agreements that, absent termination, would survive any change of ownership. Alternatively, where a royalty claim is characterised as either an unpaid vendors' lien, a rentcharge, a profit à prendre or otherwise protected by a registered tenement mortgage, the royalty may be a secured claim.

There are several ways to deal with royalty holders, but acquirers are recommended to consider how to deal with them well ahead of the second meeting of creditors.

Terminating contracts and continuing contracts

Acquirers must carefully assess the target company's existing contractual relationships. In a DOCA structure, the deed administrators typically have the power to novate, release, repudiate, terminate or disclaim contracts entered into by the company. However, this power must be exercised strategically, having regard to which contracts the proponent wishes to preserve and which it wishes to terminate.

For those contracts which the acquirer does not wish to continue, the completion conditions may require evidence that each off-take agreement had been terminated. Upon termination, the counterparty would then become a participating creditor entitled to distribution from the creditors' trust in relation to any claim arising upon the termination.

For key counterparties whose continued performance is essential to operations (such as operators, stevedores, and equipment providers), the acquirer must negotiate binding agreements or term sheets on acceptable terms as a condition precedent to completion.

Equipment lessors, owners and PPSA interests

Where the company uses or possesses property owned by third parties, including goods subject to a lease giving rise to a PPSA security interest, the acquirer must determine which property it requires for ongoing operations.

One way to address owners or lessors of property required for operations became "non-participating creditors" whose pre-appointment claims continue against the companies post-completion, with the relevant lease agreements continuing.

Conversely, where property is not required for operations, the lease or hire arrangement can be terminated, and the owner or lessor becomes a participating creditor entitled to a distribution from the creditors' trust. Payments to owners, lessors or secured creditors that fall due between the effective date and completion are typically payable from the holding costs or company cash.

Importantly, during the period of the DOCA, owners and lessors bound by the deed are generally required to permit the company continued and uninterrupted use, occupation and possession of the relevant property during the deed period, and are unable to bring enforcement processes without the consent of the deed administrators or leave of the court.

Employees

Employee entitlements are given statutory priority under sections 556(1)(e) to (h) of the Corporations Act. Section 444DA(1) requires that the deed fund be applied so that an admitted creditor with an admitted priority claim (including employee entitlements) receives at least the priority they would have been entitled to in a liquidation.

Proponents typically structure their DOCAs to preserve continuing employment. By way of example, all continuing employees may retain their full accrued entitlements, which continue as obligations of the companies post-completion and are payable in the ordinary course of business. For eligible employee creditors who are not continuing employees, their priority claims are satisfied from the deed fund.

This approach serves dual purposes: it satisfies the statutory priority requirements and provides the acquirer with an experienced workforce capable of continuing operations without disruption.

Alternative acquisition pathway: asset purchase from administration

As an alternative to a DOCA-based share acquisition, an acquirer may acquire assets directly from the voluntary administrators. This pathway involves purchasing specific assets (plant, equipment, mining tenements, intellectual property, contracts) by way of a sale agreement with the administrators, rather than acquiring the company itself. The proceeds of sale form part of the fund available for distribution to creditors.

An asset acquisition offers several advantages: the acquirer can select the assets it wishes to acquire and leave behind unwanted liabilities; there is no need to obtain shareholder consent or a section 444GA order; and the acquirer takes the assets free from the claims of unsecured creditors (subject to the position of secured creditors with registered interests over the relevant assets).

However, there are also material disadvantages: individual asset transfers may trigger stamp duty; mining tenements typically require ministerial consent to transfer; contracts cannot be assigned without counterparty consent; employee entitlements do not automatically transfer; and the acquirer does not benefit from the company's existing regulatory approvals, licences and permits unless they are specifically assigned.

Practical tips for corporate acquirers

Due diligence

Corporate acquirers should conduct thorough due diligence covering the Personal Property Securities Register, mining tenement register, real property registers and all material contracts. The acquirer must identify secured creditors, understand the extent and priority of their security interests, and assess whether those creditors are likely to consent to a DOCA proposal. Special attention should be paid to royalty agreements (both government and private), off-take agreements, and key operational contracts that may be difficult to replace.

Structuring the proposal

The proponent contribution must be calibrated to achieve two objectives: first, it must offer creditors a better return than they would receive in liquidation (to secure the creditors' vote); secondly, it must be commercially acceptable having regard to the value the acquirer places on the target business.

Conditions precedent

Acquirers should insist on robust conditions precedent to protect against the risk that the transaction cannot be completed on acceptable terms. Typical conditions include the section 444GA order or shareholder consent, release of security interests by secured creditors, termination or novation of unwanted contracts, settlement of key counterparty claims, execution of a creditors' trust deed, and an absence of regulatory intervention or litigation.

Timeline and sunset dates

DOCAs typically include sunset dates by which all conditions must be satisfied, which may be extendable by agreement. Acquirers should ensure they have sufficient time to obtain necessary court orders, negotiate with counterparties, and satisfy regulatory requirements.