Australia is a very attractive place for distressed investors at the moment. A number of sectors of our economy continue to be vulnerable: property, construction, retail and mining. Traditional local lenders are looking to reduce their exposure to those sectors, frequently because of increased regulatory requirements, and so can be willing to sell their positions sometimes at a considerable discount.
Against that background it's not surprising that in recent years a number of global hedge funds and privately equity firms have opened offices in Australia. These dynamics have meant a significant increase in debt for equity restructurings in Australia in recent years. The tools used include schemes of arrangement and deeds of company arrangements.
Before discussing those tools I want you to know that Australian directors face one of the harshest insolvent trading regimes in the world. By that I mean an Australian company director will be liable for new debts incurred by his or her company at a time when the company is cashflow insolvent. That's often said to be one of the principal impediments to the successful restructuring of financially distressed businesses in this country. The theory goes that because directors are so concerned about their potential liability on a personal level for insolvent trading they move to put their company into some form of insolvent administration sooner than would otherwise be required.
But that's all about to change, or so the Government hopes, with the introduction of the safe harbour reforms. The idea here is that those directors who are honestly and diligently working towards restoring their company to solvency will be protected. So if at the time the new debts are incurred the director is developing or taking a course of action which is reasonably likely to lead to a better outcome for the company than immediate formal insolvency, the director will be protected.
As I've said the two tools most often used for equity restructurings in Australia are schemes of arrangement and deeds of company arrangement or DOCAs. Because the DOCA is a peculiarly antipodean technique I want to say something about it.
It always has to be preceded by the administration. That's a normal insolvency procedure under which an independent qualified accountant is appointed to take control of the company, investigate its financial affairs and report to creditors as to what the best outcome for them is. Creditors vote on that recommendation and report. The DOCA is nothing more than the contractual compromise between the insolvent company and its creditors. Typically the DOCA proponent will want to demonstrate to creditors that they will receive more in respect of their debts under the DOCA than they would if the company went straight into liquidation.
In a debt for equity play the DOCA will always be conditional on the Court approving the transfer of the shares in the company to the DOCA proponent usually for nil consideration. The Court will give its approval only if it's satisfied that the proposed transaction won't unfairly prejudice shareholders. The case law makes it clear that shareholders will not be unfairly prejudiced if it can be demonstrated that on the only viable alternative ‒ that is, liquidation ‒ the shareholders are unlikely to receive any return at all.