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Restructuring and insolvency

Australia is a common law jurisdiction with a federal government. The incorporation, governance and insolvency of companies is governed nationally by the Corporations Act 2001 (Cth). The Australian Securities and Investments Commission (ASIC) is the main regulatory authority for companies, and the federal, state and territory courts share judicial oversight of the Corporations Act.

Last updated: October 2018

Introduction

Australia is a common law jurisdiction with a federal government. The incorporation, governance and insolvency of companies is governed nationally by the Corporations Act 2001 (Cth). The Australian Securities and Investments Commission (ASIC) is the main regulatory authority for companies, and the federal, state and territory courts share judicial oversight of the Corporations Act. Interests in real and personal property in Australia are also regulated by legislation. Real property is regulated state by state, and personal property nationally under the Personal Property Securities Act 2009 (Cth).

The significance of insolvency in Australia

A company is considered insolvent in Australia if it is unable to pay all of its debts as and when they fall due.

Solvency is assessed primarily on a cash flow basis but the company’s balance sheet may also be considered. Australian law seeks to protect creditors and third parties dealing with insolvent companies.

Directors and officers who trade a company while it is insolvent potentially expose themselves to civil and criminal liability under Australian law. Civil liability is more common and, if established, typically requires the directors to compensate the company (by then in liquidation) for the trading debts incurred during the period of insolvency. However, insolvent trading laws have recently been reformed to include a ‘safe harbour’ carve-out for directors from personal liability.

Under Australian law, insolvent companies may be subject to one of several forms of external administration, which aim to protect and maximise value for creditors.

Restructuring in Australia

Most modern international restructuring techniques used in the United Kingdom and the United States are available in a similar form under Australian law.

Although there is no Australian equivalent of Chapter 11 of the United States Bankruptcy Code which involves the proposal and adoption of a plan of re-organisation, many of the benefits of that system can be achieved in Australia (including via creditor enforcement moratoriums and priority lending).

Restructuring can occur as part of, or separate to, external administration in Australia. Certain forms of external administration may be required to implement a restructuring plan. This will depend on the company’s solvency and whether the company wishes to take advantage of statutory protections or rights available in certain forms of external administration to implement the restructure. Examples of protections or rights include a moratorium on creditor enforcement, a mechanism to extinguish creditor claims, and the suspension of the powers of directors in favour of an external administrator.

A company may also engage a chief restructuring officer or turnaround manager to assist with, manage or implement a restructuring plan. External legal and accounting advisers will typically be engaged to advise on the preparation and implementation of the restructuring plan.

External administration

The most common forms of external administration in Australia are:

  • receivership
  • voluntary administration
  • deed of company arrangement
  • liquidation.

In all of these forms of external administration, the external administrator appointed to the company or its assets will be an independent third party, typically a specialised insolvency accountant, with official accreditation to hold such a role. The external administrator’s remuneration, costs and expenses will usually be a first-ranking priority from company’s assets protected by a lien.

If a company is under external administration, that status will appear in company records maintained by ASIC. The Corporations Act also requires that the company state that status after its name in all communications.

A receivership is a form of external administration in which a receiver, or a receiver and manager (also referred to as a controller), is appointed by a secured creditor or the court to administer certain or all of a company’s property.

The most common form of appointment is made by a secured creditor pursuant to a contractual right within a security instrument granted in its favour by the company. The court may also appoint a receiver where it considers it appropriate (typically where the security instrument does not contain a power to appoint a receiver), but this is not common.

The role of the receiver is to take possession of and sell the company’s property subject to the security and to apply sale proceeds to the amount owed to the secured creditor. The receiver is required by law to take all reasonable care to sell the property for its market value or the best price obtainable in the circumstances.

The powers of a company’s directors are limited during a receivership. A receiver has all the rights and powers to deal with the assets that are the subject of their appointment, to the exclusion of the directors.

A receivership ends when the appointing secured creditor is paid in full or all of the secured assets have been realised, or on order of the court.

Voluntary administration is a form of external administration in which a qualified insolvency accountant is appointed to take control of a company to investigate its financial affairs and report to creditors.

The voluntary administrator has a statutory timeframe for investigations, reporting to creditors, and convening and holding meetings of creditors. The whole process typically takes 25–30 days unless extended by court order (which, in the case of complex corporate structures, is common).

To assist in this process, the administrator has all the powers of the company’s directors (which are suspended during that period) and the benefit of a statutory moratorium preventing creditors or third parties taking action against the company or its property without the consent of the administrator or the leave of the court.

The administrator must ultimately recommend to, and have creditors vote on, the future direction of the company, namely whether the company should:

  1. be returned to its directors
  2. enter into a deed of company arrangement (see below), or
  3. be placed in liquidation.

A secured creditor, with security over the whole (or substantially the whole) of a company's assets, may appoint a receiver or controller to the company’s property within 13 business days of the appointment of a voluntary administrator. The receiver’s rights and powers in relation to that property will be superior to those of the voluntary administrator.

A deed of company arrangement (DOCA) is a form of external administration in which a deed administrator manages a contractual compromise between a company and its creditors. As noted above, a DOCA is one the potential outcomes of a voluntary administration.

A voluntary administrator will seek DOCA proposals prior to convening the second meeting of creditors in the administration, with the aim of tabling a proposal for creditors to vote on at that meeting. For a DOCA proposal to succeed, it usually needs to demonstrate to creditors that they will receive a greater return on their debts in a DOCA than they would in a liquidation scenario.

The typical objective of a DOCA is for the deed administrator to generate a monetary fund from the company’s assets or through a contribution from a third party (often the directors or their associates) to be distributed to admitted creditors in full and final satisfaction of their claims (which will then be extinguished). The company would then be returned to its existing or new directors free from debt.

There is no standard form of DOCA. The Corporations Act provides significant flexibility for a DOCA to be tailored to suit most restructuring situations. These may involve selling or transferring assets, issuing shares, compromising debts and agreeing priority payments to creditors outside the usual statutory order in a liquidation scenario.

Liquidation is a terminal process by which an appointed specialist insolvency accountant winds up a company’s affairs, realises its assets, distributes the proceeds to admitted creditors in accordance with statutory priorities under the Corporations Act and ultimately de-registers the company.

A company can be placed in liquidation in one of three ways: by resolution of its members, by resolution of its creditors or by order of the court. Liquidation most commonly occurs where the company is insolvent. The liquidator will control the company during liquidation, and the powers of the directors and other office holders will cease.

In producing a fund for distributing to admitted creditors, a liquidator is also empowered to apply to the court to seek orders:

  • requiring a director to compensate the company where that director has traded the company while it was insolvent, and
  • to have certain company transactions declared void – such as unfair preferences, uncommercial transactions, unfair loans and unreasonable directed related transactions.

A liquidator will call for proofs of debt from potential creditors, and formally adjudicate each proof to determine whether each party is a creditor. The liquidator also determines if creditors should be afforded any priority for payment under the Corporations Act, and the total amount of each creditor’s admitted debt. There will be no return to shareholders unless all claims of admitted creditors are satisfied in full.

A secured creditor may appoint a receiver or controller to all or some of a company’s property during a liquidation. The receiver’s rights and powers to that property will be superior to those of the liquidator.

Recent Australian Insolvency Law Reform

Safe harbour

Often, directors prematurely appoint a voluntary administrator to viable companies due to the risk of liability for potential insolvent trading and the uncertainty associated with determining whether a company is insolvent.

The recently passed safe harbour amendments to the Corporations Act aim to encourage directors to remain in control and take steps to restructure and turn around the company.

To take advantage of the safe harbour carve-out, a director must at the time the debts are incurred, suspect that the company is or may become insolvent, and must be developing or implementing one or more courses of action that are reasonably likely to lead to a better outcome for the company than an immediate voluntary administration or liquidation.

A director seeking safe harbour protection must also ensure that financial records are adequately maintained, and payments for employee entitlements and tax liabilities are up to date.

The Corporations Act includes non-exhaustive factors that should be considered when determining whether a course of action by directors is  reasonably likely to lead to a better outcome for a company. The list of factors include taking appropriate steps to develop a restructuring plan, being kept informed of the company’s financial position and obtaining appropriate advice from a qualified entity, which may include a restructuring specialist.    

Ipso facto

An ipso facto clause in a contract allows one party to terminate the contract or exercise other rights as a result of certain events, including the insolvency of the counterparty. Such a clause allows termination or other steps despite the counterparty otherwise not being in default and being able to perform all obligations under the contract. The ability to terminate contracts (or exercise other rights) in such circumstances can have a detrimental impact on a financially distressed company’s ability to restructure or to successfully sell its business as a going concern.

A party to a contract is now prohibited from enforcing any rights in a contract entered into after 1 July 2018 that are enlivened due to a voluntary administrator or a managing controller being appointed or the company being subject to a scheme of arrangement (proposed to avoid an insolvent winding-up). If one of these appointments occurs, the 'ipso facto' stay will also apply if, a counterparty enforces a right for a reason that:

  • relates to the financial position of the company
  • is prescribed by the regulations, or
  • is in substance contrary to 'ipso facto' provisions of the Corporations Act.

Amendments to the Corporation Regulations and Ministerial Regulations exclude a significant number of contracts and types of rights from the operation of the 'ipso facto' stay. Excluded contracts include certain debt capital markets arrangements, government licences and permits.

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