Spinning around – Formal Reorganisation in Australia

Michael Quinlan Partner Deputy Leader Corporate and Allens Arthur Robinson

1. Introduction

This paper looks at the principal formal reorganisation structures for corporations in Australia and concentrates on those available to financially troubled companies. In Australia, personal and corporate are administered under separate legislation. Generally, the word ‘bankrupt’ relates only to individuals. Individual is governed by the Bankruptcy Act and is not considered in this paper. When a company becomes insolvent it may be placed in one of the forms of external whereby the directors of the company relinquish control to an who conducts the affairs of the company. There are three main forms of external administration available to such companies: (1) voluntary administration (VA): VA is a process begun by the appointment of an administrator to a company which is in financial difficulties (but could possibly be saved), during which the administrator investigates its affairs to recommend to whether it should enter into a Deed of Company Arrangement (DOCA) approved by its creditors, be wound up or revert to normal operation by its directors. A company need not be presently insolvent to enter into VA. The methods by which a company can go into a VA are set out at 2.2 below, but the most common method is for the board to resolve that in the opinion of the directors voting for the resolution, the company is insolvent, or is likely to become insolvent at some future time. (2) : receivership is usually instituted by a secured appointing a receiver to enforce a security. The right to appoint is contractual so that there may be a range of triggers to permit the to exercise its entitlements – actual insolvency, deemed insolvency under the Corporations Act 2001 (the Act) or the appointment of an external administrator to some or all of the assets of the company are some common triggers. (3) court winding-up (also called ): this refers to a winding up of a company pursuant to a court order, halting its business, realising its assets, discharging its liabilities (or a percentage of them when the liabilities outweigh the assets) and dividing any surplus assets to its members. Reorganisations can also be effected by: (1) schemes of arrangement (Schemes); (2) creditors' voluntary winding-up; (3) court-appointed receivers; or (4) . qzls S0111430115v1 150520 21.3.2005 Page 1 These forms of external administration are discussed in this paper. All of these external administration procedures are governed by the provisions of the Act which is Commonwealth legislation which regulates companies throughout Australia. In addition to the Act there is other legislation which can be relevant to certain insolvencies such as the Insurance Act 1973 (the Insurance Act) and the Law Reform Miscellaneous Provisions Act 1946 (NSW).

2. Voluntary administration

VA is by far the most common method of reorganisation in Australia, primarily because of the speed and ease by which it can be commenced. VA is a procedure designed to salvage insolvent or near-insolvent companies so that the company can return to trading or provide a better return for creditors and shareholders. It is the only formal process in Australia with rehabilitation as one of its express goals. The objects of part 5.3 of the Act (which deals with VAs) are set out in section 435A as follows: "The object of this part is to provide for the business, property and affairs of an insolvent company to be administered in a way that: (a) maximises the chances of the company or as much as possible of its business, continuing in existence; or (b) if it is not possible for the company or its business to continue in existence – results in a better return for the company's creditors and members than would result from an immediate winding up of the company." There are two stages to the VA process. The first is the administration phase in which the company comes under control of an insolvency practitioner who must investigate the company’s affairs and then recommend to the company’s creditors whether the company should be: • salvaged under a DOCA; • wound up; or • returned to the control of those who controlled it prior to administration. The second stage, if the creditors so decide, is the period after a DOCA is entered into, which is known as ‘deed administration’.

2.1 Requirements There are three ways in which an administrator can be appointed to a company. An administrator can be appointed by: • the company itself at the instigation of the directors, if the board has resolved to the effect that in the opinion of the directors voting for the resolution, the company is insolvent, or is likely to become insolvent at some future time; • a or provisional liquidator appointed to the company, if he or she thinks that the company is insolvent, or is likely to become insolvent at some future time; or

qzls S0111430115v1 150520 21.3.2005 Page 2 • a chargee holding a charge over the whole, or substantially the whole of the company’s property if the charge has become and is still enforceable.

2.2 Procedure When VA initially commences, the administrator, irrespective of how appointed, must lodge a notice of appointment with the Australian Securities and Investment Commission (ASIC) before the end of the next business day after appointment and the notice must be published within three business days after the appointment in a national newspaper or in the daily newspaper of each state or territory in which the company has its registered office or carries on business. Where a chargee has appointed the administrator, the chargee is required to give written notice of the appointment to the company before the end of the next business day. Where the company or the liquidator or the provisional liquidator of the company has made the appointment, the company or the liquidator is required to give written notice of the appointment to a chargee who holds a charge over the whole or substantially the whole of the company’s property. A company under administration must set out in every public document and in every negotiable instrument of the company the expression “(administrator appointed)” after the company’s name where it first appears. The first meeting of creditors must be held within five business days of the initial appointment of the administrator. At least two business days before the meeting the administrator must give written notice of the meeting to as many of the company’s creditors as reasonably practicable and cause notice of the meeting to be published. The business of the first meeting of creditors is to decide whether there should be a committee of creditors and to provide creditors with a chance to appoint someone else as administrator (if they do not want the administrator appointed by the board of directors or liquidator, provisional liquidator or chargeholder (as the case may be)). A committee of inspection can act for creditors in consultations with the administrator about the administration and can receive and consider his or her reports but it cannot interfere with the administration by giving directions in contrast to the position in a winding-up. The administrator must convene the second meeting of creditors within five business days of the end of the convening period. The convening period is: (a) if the administration begins on a day that is in December, or is less than 28 days before Good Friday – the period of 28 days beginning on that day; or (b) otherwise – the period of 21 days beginning on the day when the administration begins. The business of the second meeting of creditors is to decide the company’s fate. The administrator will decide the creditors eligible to vote at the second meeting on the basis of the company’s records and from the evidence of liability submitted by those who are claiming to be creditors.

qzls S0111430115v1 150520 21.3.2005 Page 3 2.3 Effects While a company is under administration it cannot be wound up and legal proceedings and enforcement processes cannot be started or continued unless the administrator or the court agrees. In this way, this rehabilitation procedure can be entered before the company is in liquidation. Secured creditors cannot enforce their security except in limited circumstances. Secured creditors who have a charge over all or substantially all of the company’s property must enforce their charge within 10 days of the appointment of the administrator or they are prohibited from enforcing their security during the administration phase without the administrator’s consent or the leave of the court. Creditors with a charge over perishable property are allowed to enforce their security. Similarly, creditors who have begun enforcement prior to the commencement of the administrator are allowed to enforce their security. Shareholders have no part to play in the administration process (unless they are also creditors) and any transfer of shares in a company, or an alteration in the status of a member of a company that is made during the administration of the company is void unless the court otherwise orders. Within five business days of his or her appointment, the administrator must hold a meeting of creditors. At this meeting the creditors can vote to establish a creditors’ committee and/or replace the voluntary administrator. Within five business days of the convening period, the administrator must hold the second meeting of creditors (the ‘decision meeting’); however, this meeting can be adjourned for up to 60 days without court approval. The administrator must obtain court approval if a longer period is required. At the second creditors’ meeting the creditors vote on three alternative courses of action, namely that the company: (1) goes into liquidation; (2) be returned to the directors, which would normally only happen if the company is found to be solvent; or (3) enter into a DOCA. A DOCA is effectively a compromise agreement between the company and its creditors. It can in essence contain whatever agreement the creditors want it to although the court has power to set aside a DOCA if, for example, it believes it to be contrary to public policy. It can provide a very flexible mechanism for the reorganisation of corporations. If a DOCA has been executed following the administration period and within the period prescribed by the Act, the DOCA is binding on all creditors (secured creditors who did not vote for the deed are not barred from enforcing their security), the company, its officers and members, and the administrator of the DOCA. Anyone who is bound by the DOCA cannot, without court permission: • apply to have the company wound up; • start legal proceedings against the company; or • prosecute any enforcement process against the company’s property. qzls S0111430115v1 150520 21.3.2005 Page 4 2.4 Involuntary voluntary administrations Despite its name, there is scope for VA to be ‘involuntary’ on the part of the company, as an administrator can be appointed by a chargee of all, or substantially, all of the assets of the company and by a liquidator or provisional liquidator. However appointed, when an administrator is appointed the administration would then proceed as discussed at 2.2 above.

2.5 Doing business in reorganisations The powers of administrators are set out in the Act and allow for the carrying on of the business. An administrator acts as an agent of the company and is thereby able to bind the company during the administration period. A committee of creditors may be appointed during the VA. Such a committee has largely an advisory role. The creditors do not have a role in the day to day management of the company during VA but they make the critical decision at the second creditors’ meeting (see 2.2 above). Where a company is operating under a DOCA, the terms of the DOCA will govern the extent to which the deed administrator can carry on the business of the company and the approvals that are required. During the VA and DOCA administration there is no need for any court involvement and no court approval is required with some limited exceptions (eg where the VA wishes to sell a third party’s property other than in the ordinary course of business or with that party’s consent). The administrator or deed administrator may, however, seek court directions or approval as needed and creditors or any other interested person adversely affected by a DOCA can seek court intervention in certain circumstances (see 2.14 below). Unlike liquidators (see 4.2 below), voluntary administrators do not have power to seek court relief in relation to insolvent trading, unfair preferences, uncommercial transactions or other statutory voidable transactions.

2.6 Stays of proceedings/moratoriums When a company is under administration: • No proceeding in a court against the company or in relation to property of the company can begin or proceed except with the administrator’s consent or the leave of the court. • No enforcement process in relation to property of the company can begin or proceed except with leave of the court. • A charge cannot be enforced on property of the company except with the administrator’s written consent or with the leave of the court, unless the chargee holds a charge over the whole or substantially the whole of the company’s property and enforces the charge within 10 days of the administrator’s appointment, or the chargee has commenced enforcement of the charge prior to the administrator’s appointment. • A chargee who has security over perishable property can enforce its security.

qzls S0111430115v1 150520 21.3.2005 Page 5 • The owner or lessor of property that is used or occupied by, or is in the possession of the company cannot take possession or otherwise recover it, except with the administrator’s written consent or with the leave of the court. • Suppliers of essential services (electricity, gas, water and telecommunications) cannot refuse services to a company under administration by reason only of there being a debt owing to them and they cannot make further supply conditional on payment of outstanding debt. • An officer of the court, upon receiving written notice of the fact that the company is under administration is restricted from taking action under an execution or attachment process. • A guarantee of a liability of the company cannot be enforced against a director of the company who is a natural person, or a spouse, de facto or relative of such a director. • The courts may grant leave allowing the commencement or continuation of proceedings against a company under administration if the claim has a solid foundation and gives rise to a serious dispute. However, generally, the courts will refuse leave to proceed, so as to prevent the unnecessary hindrance to the administrator of the need to defend legal proceedings. Importantly, there is no stay on the ability of contracting parties to exercise their rights to terminate contracts of supply or purchase of goods or service when a company is under administration. As this can be a significant impediment to successful reorganisation, reform in this area has been recommended (see 9.2 below). Many contracts give counter- parties the right to terminate on the actual insolvency or deemed insolvency of the other contracting party or on the appointment of an external administrator. For some companies the major value of the company resides in its contracts. The appointment of an administrator can see that value rapidly disappear.

2.7 Sale of assets Once appointed, the administrator acts as the agent of the company and has broad powers to run the company. During the administration procedure, the administrator has control of the company’s business, property and affairs and may: terminate or dispose of all or part of that business; dispose of any of that property; and perform any function, and exercise any power, that a company or any of its officers could perform or exercise if the company were not under administration. The powers of other officers are suspended, except with the administrator’s written approval and only an administrator can (with some exceptions, such as encumbered property) deal with the company’s property. Under a DOCA, the deed administrator’s powers will depend on the terms of the DOCA; however, they are usually very broad. Administrators and deed administrators are normally extremely reluctant to provide warranties or indemnities in contracts of sale because they are reluctant to expose themselves to personal liability should those warranties or indemnities ultimately prove to qzls S0111430115v1 150520 21.3.2005 Page 6 be incorrect. This can have a significant impact on the realisable value of assets. Where the main assets of a company are intangibles or intellectual property, the lack of warranties and indemnities can very dramatically impact on the ability of the company to sell those assets at all and, if they can be sold, on the realisable value.

2.8 Set-off and netting There is no statutory right to set-off in VAs. The parties remain entitled to exercise such contractual, equitable or legal rights of set-off as are available to them in the same way as they would have been able to do prior to VA. While under a DOCA the right to set-off will be determined by reference to the terms of the DOCA; most DOCAs import the language of the Act governing set-off in respect of .

2.9 Post-filing credit The administration phase of VA is intended to be an interim administration which generally results in either a DOCA or a winding-up occurring. During the administration phase, an administrator has power to obtain credit or take loans on behalf of the company. Unless the company has significant assets it is likely that a company in VA will have real difficulties in obtaining new finance. The administrator of a company under VA is liable for debts he or she incurs in the performance or exercise, or purported performance or exercise, of any of his or her functions as administrator for: • services rendered; • goods bought; or • property hired, leased, used or occupied. In exchange the administrator has an indemnity out of the company’s assets for the payment of such liabilities. This indemnity has priority over all unsecured debts and floating charges of the company. Significantly, the taking of a loan by the company during an administration has been held not to be the rendering of a service. This means that if a company in administration borrows money, the company, but not the administrator, will be liable to repay the debt. In a recent decision1 the Court was prepared to vary this result and, for the purposes only of the administration before it, to rule that the taking of a loan was the rendering of a service. The effect of the orders made by the Court was that: • the loan became a service under section 443A; • in obtaining the loan from the creditors, the administrators were entitled to the indemnity under section 443D(a) CA; • the administrator would not be liable for any shortfall if the company's assets were not sufficient to enable the loan to be repaid; and • the lenders were to obtain an priority for the repayment of their monies. This was to occur indirectly through the administrator's indemnity.

1 Mentha, in the matter of Spyglass Management Group Pty Ltd (Administrators Appointed) [2004] FCA 1469 qzls S0111430115v1 150520 21.3.2005 Page 7 The Court was able to achieve this result by use of section 447A, the so-called "magic provision". Section 447A gives the Court power to make such orders as it thinks appropriate about how the relevant part of the Act is to operate in relation to a particular company. Spyglass is an example of the potential breadth of the use of section 447A to amend Part 5.3A of the CA to suit the administration of a particular company. An important consideration for the Court was that all of the parties and most importantly the majority of creditors, agreed with the orders that were proposed. The case shows that the Court will be prepared to make orders to modify the common law interpretation of provisions of Part 5.3A CA, but will first wish to ensure that the interests of the creditors will be served by such a modification. If this approach is followed in other cases it may improve the ability of a company in VA to borrow although, again, in the absence of significant assets residing in the company in VA, the administrator is unlikely to support such an application and by doing so become exposed to personal liability. If, following an administration, the creditors resolve to wind up the company rather than enter into a DOCA then the rules of priority payment that relate to winding-up will apply (see 2.15). If a DOCA is executed, the ability of the deed administrator to take loans or obtain credit on behalf of the company will depend on the terms of the DOCA. Any DOCA which gave the deed administrator power to enter into loans on behalf of the company or to obtain credit would be likely to provide that the deed administrator could repay that loan in priority to other debts and to indemnify the deed administrator from personal liability or alternatively to provide the deed administrator with a and indemnity over the company's assets. The particular order of priorities is specified in the DOCA itself (or implied by the regulations unless excluded) and normally will incorporate the order of priorities that applies in relation to a company that is being wound up.

2.10 Successful reorganisations The creditors must resolve that the company enter into a DOCA if the company is to be reorganised by that method. A successful resolution requires a majority of the creditors voting on the resolution to vote in favour of the resolution and the value of the debts owing by the company to those creditors voting in favour to be more than half of the total value of the debts owed by the company to those creditors voting on the resolution. If the creditors decide to enter into a DOCA, the DOCA can essentially contain whatever agreement the creditors want. The regulations of the Act set out prescribed terms of operation of that arrangement and those terms apply unless the creditors determine otherwise. The prescribed terms provide that priorities in respect of creditors are determined with reference to the priorities regime set out in the Act (see 2.15 below). A creditor who is dissatisfied with a DOCA can seek orders from the court to set it aside in certain circumstances, including, for example that the DOCA was contrary to public policy (see 2.14 below).

qzls S0111430115v1 150520 21.3.2005 Page 8 2.11 Expedited reorganisations Critical to the potential success of any reorganisation is that the directors identify a need for restructuring and seek to put in place mechanisms to achieve it before it is too late – it may be too late to resuscitate a business if it is insolvent, particularly if it has failed to ensure payment of key suppliers and delivery to key customers. Section 436A(1) enables directors to appoint a voluntary administrator when, in the opinion of the directors voting for the resolution, the company is insolvent or is likely to become insolvent at some future time. Directors of companies generally do not recognise the need to consider restructuring alternatives until restructuring is much more difficult than it might have been with earlier intervention. This is certainly the case with many Australian directors and this has led to recommendations that the resolution which directors are required to pass to put a company into VA be changed from the present "that the company is or is likely to become insolvent at some future time" to "that the company is or may become insolvent at some future time" (see 9.1 below). Once commenced, the VA process proceeds quickly and without the need for any court involvement in the process at all. In the first stage, the administration stage, an administrator is appointed. As soon as practicable after the administration begins, the administrator must investigate the company’s business and form an opinion about whether to recommend to creditors: • the execution of a DOCA; • ending the administration and returning control to directors; or • the winding up of the company. This opinion must be presented to the creditors at the second meeting which must be held no later than five business days after the convening period. The meeting can be adjourned without the approval of the court, but it must be held within 60 days from the day of the second meeting (as first convened) unless further court extensions are sought first. If the creditors decide at the second meeting that the company should execute a DOCA, the administrator must prepare a document containing the terms that the creditors voted for. The document must be executed by the company and the administrator within 21 days after the end of the second creditors’ meeting. It is important to recognise though that the present section 436A(1) does not limit voluntary administration to situations of actual or present insolvency and the extent to which the process can be used for presently solvent companies which satisfy the second limb of section 436A(1) remains to be fully explored. The obiter comments made in the decision in Crimmins v Glenview Home Units Pty Ltd [2001] NSWSC 599 (unreported 17 August 2001) support the view that the likelihood of insolvency occurring many years in the future would suffice to satisfy section 436A(1). If this decision is followed it seems to afford directors of companies an opportunity to appoint a voluntary administrator well prior to actual insolvency. These issues are discussed in more detail in 9.1 below.

qzls S0111430115v1 150520 21.3.2005 Page 9 2.12 Unsuccessful reorganisations In a VA, the fate of the company depends on what the creditors decide at the second meeting of the creditors (see 2.2 above). The chairperson of the meeting is the sole judge of whether a resolution has been carried or lost and must declare the result of the vote. A declaration is conclusive evidence of the result without proof of the number or proportion of votes for or against the resolution, unless a poll is demanded. On a poll, the creditors’ resolution is passed if a majority in number and value of those present and voting, vote in favour of the resolution. Where the majority of creditors (in number) vote one way, but the majority of creditors (in terms of value of the total claims) vote the other way (or vice versa), the administrator may caste the deciding vote. If the creditors resolve to execute a DOCA, then the DOCA must be executed within 21 days. If the instrument is not executed within this period then the company is deemed to be in a creditors’ voluntary winding-up. Termination of an executed DOCA can follow: • an order of the court; • a resolution of a creditors’ meeting; or • an occurrence of circumstances specified in the DOCA in which case the DOCA should identify what then happens eg liquidation, deregistration or return to the directors. If the DOCA is silent on what happens on termination, control of the company will return to its directors. On the application of the company, a creditor or other interested person, an executed DOCA may be terminated by an order of the court, if the court is satisfied that: • there was misleading information or a material omission in statements or reports to creditors; • there has been a material contravention of the deed by a person bound; • effect cannot be given to the deed without injustice or undue delay; • the deed or something done under it is: • oppressive or unfairly prejudicial to, or unfairly discriminatory against, a creditor; or • contrary to the interests of the creditors of the company as a whole; or • the deed should be terminated for some other reason such as public policy. Where a DOCA is terminated, there will be a transition to a creditors' voluntary winding-up (see 6 below) where: • after the DOCA has been executed and the creditors later resolve that the company be wound up; • the court orders termination of the DOCA; and

qzls S0111430115v1 150520 21.3.2005 Page 10 • the DOCA itself specifies the circumstances in which the DOCA is terminated and that on termination the company will be wound up and those circumstances exist at a particular time.

2.13 Claims and appeals During the administration phase of a VA, creditors may not vote at creditors meetings unless their claims have been admitted by the administrator or the creditors have lodged particulars of their claims with the chairperson. The administrator may call for formal proofs of debts or claims to be lodged before the meeting. Under the regulations the chairperson may admit or reject a proof of debt or claim for the purpose of voting. If the chairperson is in doubt whether a proof of debt or claim should be admitted or rejected, he or she must mark the proof as objected to and allow the creditor to vote, subject to the vote being declared invalid if the objection is sustained. If the creditor has not provided the administrator with sufficient information to enable him or her to determine whether the purported creditor is or is not in fact a creditor or sufficient to enable to him or her to make a just estimate, the administrator is entitled to reject the proof for voting purposes2. An appeal to the court from a decision of the chairperson to admit or reject a proof of debt or claim for the purposes of voting may be taken within 14 days. Where the administrator does not call for formal proof of claims and creditors lodge particulars of their claims, the chairperson can properly reject, without further investigation, any claim in respect of which the lodged particulars are inadequate. Creditors for unliquidated or contingent debts or claims, or a debt the value of which has not been established, cannot vote unless a just estimate of the value of the debt or claim has been made.

2.14 Claims and appeals regarding DOCA When a DOCA commences, the effect on unsecured creditors is: • they are bound, as provided by the DOCA, so far as concerns claims arising on or before the day specified in the DOCA; • if bound by the DOCA, they cannot apply to wind up the company or proceed with such an application made before the DOCA became binding. Secured creditors, and owners and lessors of property are not bound by the DOCA unless: • they voted in favour of the resolution of creditors and because of which the company executed the DOCA; or • unless the court so orders. A DOCA releases the company from a debt only insofar as the DOCA provides for its release and the creditor concerned is bound by the DOCA.

2 Re Pan Pharmaceuticals Ltd (2003) 47 ACSR 139 qzls S0111430115v1 150520 21.3.2005 Page 11 The administrator of the DOCA needs to apply the funds coming in to those persons entitled to receive it (as specified in the DOCA) during the period of the DOCA’s operation, and in the priorities specified in the DOCA. The DOCA will set out the procedure for receiving proof from creditors, admitting creditors to rank for repayment and paying dividends. The actual procedures may be similar to the position in winding-up (see below), but the provisions of the DOCA itself will determine the procedures. The DOCA may incorporate a provision so that a person who advances funds to the company to enable it to meet its employee entitlements will assume the position of those employees, to the extent that their entitlements were met, with respect to the priority of payment of debts owed by the company. Unless the DOCA includes such a provision, the equivalent provision which would apply in a winding-up (section 560 of the Act) will not be implied.

2.15 Priority claims The manner and method of distribution of funds under a DOCA will be governed by the provisions of the instrument itself and, under the Act, the DOCA is required to specify the order in which proceeds are to be distributed among creditors bound by the DOCA. Unless the DOCA provides otherwise, the prescribed provisions contained in the Regulations apply and they provide that the administrator of the DOCA must distribute the funds in the order of priority specified in a winding-up (see 4 below).

2.16 Distributions If, at the second meeting (see 2.2 above), the creditors elect to wind up the company then the order and distribution of payment will be according to the statutory order of payment applying in a liquidation (see 4 below). If the creditors elect to execute a DOCA, it is the terms of the DOCA that the creditors agreed to that will determine the order and payment of distributions. The order of priority prescribed by the Act is often adopted in provisions of a DOCA for ordering priorities between unsecured creditors who have claims against the company that has executed the DOCA.

2.17 Conclusion of VA The administration phase of the VA procedure concludes after the second meeting of the creditors. If, at the second meeting, the creditors resolve to: • enter a DOCA, then the administration phase does not end until the company executes the DOCA; • end the administration, then the control of the company reverts back to the directors of the company at the time the administration ends; • wind up the company, then there is an immediate transition from administration to a creditors’ voluntary winding-up. An administration will also end where: qzls S0111430115v1 150520 21.3.2005 Page 12 • The creditors resolve at the second meeting to execute a DOCA, but the company does not comply with its statutory obligation to execute the DOCA within the prescribed time, in which case there is an immediate transition to a creditors’ voluntary winding-up. • The convening period for the creditors’ second meeting ends without the meeting being convened and without an application being made to the court. In this case, the control of the company reverts back to those who were controlling the company prior to the appointment of the administrator.

2.18 Conclusion of a DOCA Administration under a DOCA will end if: • the company goes into liquidation; or • the DOCA is terminated without the company going into liquidation. A DOCA can be terminated by: • an order of the court; • a resolution of a creditors’ meeting; or • the occurrence of circumstances specified in the DOCA. When a DOCA is terminated, the DOCA should provide for what then happens, eg liquidation, deregistration or return to the directors. If the DOCA is silent, the company will be returned to the management of the persons who managed it when the administrator was appointed, free from monitoring by the administrator of the DOCA.

2.19 How useful is VA for reorganisation? As a process which can be voluntarily commenced by a company's directors and lead to a tailor made solution comprised by a DOCA voted on by the company's creditors, VA is by far the most flexible option for formal reorganisation in Australia. As it can take place without the need for any court intervention, it can be done in a cost effective way. It is the great flexibility of the process which is its greatest asset as a turnaround mechanism. There are features of the process which do make successful reorganisation more difficult to achieve, some of which are a result of the legislation which introduced VAs and some of which are the result of a failure to utilise the process early enough. The fact that the process does not prevent the exercise of contractual rights of termination and does not facilitate the granting of new credit to companies in VA can make restructuring difficult. The requirements for creditors meetings to be held in short time frames can also make the procedure difficult to manage in large corporate collapses.

3. Receivership

There are a number of categories of . A common purpose is to appoint an independent person, known as a receiver or receiver/manager, to collect or make safe income or qzls S0111430115v1 150520 21.3.2005 Page 13 assets or both, usually for the purpose of realisation or at least protection, so as to benefit a particular party, or parties, or protect his or her (their) contractual rights. The mode of receivership which is most akin to a rehabilitation procedure is that of a court receivership (discussed at 7 below), that is, a receiver may be appointed by the Court during the course of a protracted litigation to settle a dispute between parties or to protect the "public interest" Alternatively, a privately appointed receiver's role is accurately described as being concerned with the interests of the appointee. A privately appointed receiver's role is not to rehabilitate the company or to act in the best interests of the company (subject to some exceptions which are discussed below). We have however, included a discussion of privately appointed receivers so as to depict the broader picture of the Australian rehabilitation processes. This is due to the fact that in Australia a private receiver can be appointed at the same time as a "rehabilitator" such as a voluntary administrator. Indeed, as discussed at 3.8 below, a substantial secured creditor may make a dual appointment of a receiver and voluntary administrator.

3.1 Role of a privately appointed receiver The role and duties of a privately appointed receiver arise primarily under contract law, although their powers and duties are regulated to some extent by Part 5.2 of the Act. A receiver and manager's primary role is to gather in, manage and realise the assets charged with a view to liquidating the secured creditor's debt3. Although he/she is required to act in good faith to serve the purposes for which he was appointed4 and to take all reasonable care to sell company property for not less than its market value or otherwise for the best price that is reasonably obtainable5, the receiver's primary duty is to take such steps as are required to ensure that the secured creditor who appointed him or her is repaid and then to cease to act as receiver as soon as that objective has been achieved.

3.2 Procedure The process of initiating a receivership will depend upon the rights available to parties who might seek the appointment and, arising from those rights, the types of receiverships possible. At its simplest, a receivership may be initiated by the private documentary appointment of a receiver pursuant to powers contained in an earlier contract between the company and a supplier/lender. A private appointment will be effective unless there are grounds for questioning its validity and it is successfully challenged. Where the company is insolvent, the administration of company property by a receiver will obviously be of interest to creditors since they are the dominant financial parties while members are likely to receive nothing. But while, depending upon the nature of the receivership, the receiver may attempt to protect their interests, his or her prime

3 Gosling v Gaskell [1897] AC 575

4 Expo International Pty Limited v Chant [1979] 2 NSWLR 820 at 834

5 s420A qzls S0111430115v1 150520 21.3.2005 Page 14 responsibility will seldom be to ordinary unsecured creditors. Such creditors must therefore give consideration to the appointment of a liquidator or some other insolvency administrator who may better look after their interests.

3.3 Doing business in receivership The Act sets out a broad range of powers which a receiver may exercise, being powers additional to any powers contained in the secured creditor's charge under which he is appointed. These powers can however be limited by the terms of the charge6, although most modern charges are drafted with a view to maximising the powers of a receiver and contain a provision that the receiver can exercise any power, over the property which is subject to the charge, that the Act permits a receiver to exercise. The powers which the Act confers on a receiver include: • to enter into possession and take control of property of the company in accordance with the terms of the charge; • to carry on any business of the company; • to dispose of property of the company; • to engage or discharge employees; • to bring or defend any proceedings in the name of the company; and • to make or defend an application for the winding up of the company. (s420 of the Act). Depending upon the nature of the receivership, it may include: • carrying on the corporate business; • winding up the affairs of a business; • a distribution of corporate property to a particular person, or among particular persons; • especially where the receiver has the power to continue business, an examination of trading performance and financial position. Like VA, receivership of itself does not bring into operation the various recovery possibilities made available by corporate legislation to liquidators, eg insolvent trading, voidable preferences and other transactions (see 4.2 below). A power to appoint a receiver conferred pursuant to a charge must be exercised honestly and for ends that the chargor and chargee mutually intended, usually being the realisation of the security and the repayment of the secured debt. An appointment for an ulterior motive can be challenged on the grounds of bad faith7.

6 s420(2)

7 See Shamji v Johnson Matthey Bankers Ltd [1986] FTLR 329; Pollnow v Garden Mews St Leonards Ltd (1984) 9 ACLR 82 at 86 qzls S0111430115v1 150520 21.3.2005 Page 15 Receivers are not directed to exercise their discretions in any particular way. While creditors exercising powers as mortgagees are, at general law, obliged to act "in good faith without any intention of dealing unfairly" and therefore receivers are correspondingly liable to mortgagor companies, receivers are only liable if they exceed or abuse or wrongfully fail to use their powers. In this way, their role can be compared to that of a fiduciary as they are obliged not to: • overreach their permitted functions; • unjustly enrich themselves; and • act for an impermissible purpose. As discussed in more detail below, the extensive powers of a receiver to realise property of a corporation are generally preserved under the Act where a voluntary administrator or a liquidator is also appointed, save for circumstances where a voluntary administrator is appointed and the secured creditor's charge is over some part of, but not substantially the whole of the property of the company.

3.4 Remedies including sale of assets The different ways to enforce a charge can be placed into two categories: • remedies that are available to the creditor pursuant to the deed of charge; and • remedies that are available to the creditor pursuant to the Act. The method of enforcement will depend upon the individual circumstances. Remedies that are available to the creditor pursuant to the deed of charge: The charge document itself will set out the creditor's remedies which should include: (a) the power to enter into possession of the secured property (which brings with it the entitlement to receive any cash flow from the property – for example, rents on mortgaged land, or dividends on mortgaged shares) and sell them or foreclose. Foreclosure means that the creditor becomes the outright owner of the goods free of the 's right of redemption; (b) the power to appoint a receiver (more specifically the power to appoint a receiver out of court: that is, without having to seek an order from the court to do so); and (c) a power of sale out of court (that is, again, the right to sell the property without having to seek a court order to do so). Generally speaking (that is, in the absence of any statutory provisions to the contrary), it is possible to confer all these powers by agreement between the creditor and the customer in a charge document. Remedies that are available to the creditor pursuant to the Act: As well as the ability to appoint a receiver pursuant to a deed of charge, if the creditor has a charge over all, or substantially all of the assets of the debtor, it also has the option of appointing an administrator or a dual appointment of an administrator and a receiver.

qzls S0111430115v1 150520 21.3.2005 Page 16 3.5 Post-appointment credit A receiver who has the power to carry on business will consider the benefits and possibilities of carrying on business when compared with a strategy of realising the company's assets. He or she may carry on business to complete work-in-progress or to be in a position to offer the business for sale as a going concern. He or she will be able to employ any or all of the company's previous management, and as provided by Section 420(d) of the Act: "to borrow money on the security of the property of the corporation." He or she has no obligation to carry on business, but if it is in the interest of the debenture- holder or mortgagee, he or she may choose to do so. If it is not in their interests, he or she commits no breach of duty to the company by refusing to do so, even though such discontinuance may be detrimental to the company. However, when it is certain that the secured creditor will be paid in full and that the risks of carrying on will be borne by unsecured creditors, wider responsibilities come into play. If a receiver enters into a loan to carry on the business, or otherwise, such a borrowing would be subject to the same limitations as discussed in relation to VAs at 2.9 above. The main difference, however, is that a receiver does not have recourse to the "magic provision" of section 447A (see 2.9 above) which gives the court power to make such orders as it thinks appropriate about how the part of the Act relevant to VAs is to operate in relation to a particular company.

3.6 Distribution of assets Subject to his/her obligation to pay from the realisation of property subject to a certain priority debts8, a privately appointed receiver is under no obligation to distribute any of the funds obtained from realising the assets of the company to any of the unsecured creditors, even if those funds exceed the amount due to the secured creditor. There are no provisions in the Act which empowers a private receiver to call for or deal with proofs of debt, however, a deed of charge usually specifies the order in which proceeds of enforcement will be applied. This applies to both proceeds of selling the secured property, and proceeds derived while the chargee or receiver is in possession of them (eg rents received under leases of mortgaged real property). In addition, mandatory orders of application of proceeds may be applicable in some instances, for example, in Victoria, Transfer of Land Act 1958 (Vic), section 77(3), which deals with Torrens land, contains a mandatory order of application of proceeds, which will override the relevant clause in a deed of charge. These considerations will change depending upon the nature of the asset charged.

3.7 Agency While the Act does not contain a provision that a receiver will be taken as acting as the agent of the company (unlike administrators who, by section 437B of the Act are expressly taken to be acting as the company's agent when exercising a power as administrator),

8 See s433 qzls S0111430115v1 150520 21.3.2005 Page 17 most modern charges contain a provision to the effect that the secured creditor and the company agree that, despite being appointed by the secured creditor, the receiver is to act as the agent of the borrower company. The charge usually goes on to provide that the company is solely responsible for anything done or not done by the receiver and for the receiver's remuneration and costs.

3.8 Substantial secured creditor who acts during the decision period As to a secured creditor who has a charge over the whole or substantially the whole of the property of the company, (a substantial secured creditor), where such a substantial secured creditor who enforces its charge and appoints a receiver and manager before or during the 10 business day period after notice of the appointment of the voluntary administrator is given to it under section 450A(3) of the Act, the receiver and manager can continue in possession of, can manage and can realise that property for the benefit of the substantial secured creditor. In that situation, the receiver's powers and functions over the property of the company takes precedence over the administrator's powers and functions over the property of the company9. Thus the exercise by a substantial secured creditor of its right to appoint a receiver and manager will generally deny an administrator any effective continuing role in the affairs of the company, other than reporting to unsecured creditors on how the actions of the receiver and manager appointed by the substantial secured creditor affect their position and holding the meetings of creditors required under Part 5.3A.

3.9 Conduct of litigation in the name of the company Modern company charges usually gives receivers the power to conduct litigation in the name of and as agents of the company. Subject to any restrictions in the charge, section 420(2)(k) of the Act also grants a receiver power to bring any proceedings in the name of and on behalf of the company. Upon the making of the winding up order, receivers can use either of these powers to continue the conduct of litigation in the name of the company, but no longer as agents of the company10. Indeed a receiver or a secured creditor can even resume control of litigation where the liquidator assumed control of that litigation upon the initial retirement of the receiver.

3.10 Restrictions imposed by conveyancing legislation on the right to appoint a receiver Various conveyancing and real property legislation of the Australian States govern the exercise of powers in relation to real property.

3.11 Cessation of receivership The deed of charge will usually provide for the circumstances of the receiver's resignation. Any receiver, whether appointed privately or by the court, must, within seven days after his or her appointment ceases as receiver, file notice of cessation with the Commission (Form

9 s441A(3) and s441A(4)

10 Kelaw Pty Ltd v Catco Developments Pty Ltd (1989) 15 NSWLR 587 qzls S0111430115v1 150520 21.3.2005 Page 18 505). Additionally, he or she must cause a notice to be placed in the Gazette within 21 days of ceasing to act (section 427 of the Act). In the case of a receiver who remains in control of property of a company in circumstances where the objectives for which he was appointed have already been achieved, the Act empowers a liquidator who has been appointed to the company to apply to the court for an order that the receiver give up such control11. In deciding whether to order the removal of the receiver from control of property of a company, the court must have regard to the interests of the company, the secured creditor and the other creditors12.

3.12 Successful reorganisations and bringing it to an end The person appointing a receiver, being the court or otherwise, may terminate a receiver's appointment either because the appointment's objective has been fulfilled or the company has reached other arrangements satisfactory to those persons who sought the appointment of the receiver. A receiver may resign having completed his or her duties. A court-appointed receiver can only be "discharged'' by its order. As a matter of practice, before a receivership is terminated the receiver will usually attempt to: • inform the company of the termination; • obtain accounts from and pay all persons who have extended credit to the receiver during the receivership administration; • notify suppliers, lenders and customers that the receivership is to terminate where the company's business is to continue; • set aside moneys sufficient to discharge any outstanding liabilities or, at worst, obtain an indemnity in respect of such outstandings; • distribute assets in the manner required by law; and • ensure that all statutory filing requirements are fulfilled. If there are surplus assets available after repaying the secured creditor, notify subsequent chargeholders or unsecured creditors. If necessary to protect the assets, the receiver may present in the company's name a petition for winding up the company, but normally this would be left to unsecured creditors. The company's books and records should be returned to the custody of the directors or made available to the liquidator, except for the receiver's personal records which will be retained by him or her.

11 s434B

12 s434B(3) qzls S0111430115v1 150520 21.3.2005 Page 19 3.13 Expedited reorganisations Where urgency is required, receivership, administration or provisional liquidation can offer a relatively speedy appointment to gain breathing space until further information can be gathered. As directors face civil and potentially criminal exposure for incurring debts when the company is insolvent in situations of insolvency the directors should be keen to appoint an external administrator quickly to avoid personal liability for debts incurred after appointment. Where a contractual right exists to appoint a receiver and a person with that right is particularly concerned for his or her own position, he or she may wish to initiate a receivership immediately rather than to allow the directors to select and/or appoint their own voluntary administrator or allow the situation to deteriorate further. Unlike a VA, there are no specific statutory time periods which apply to receivers to prompt an expedited process, however, the personal liability of receivers for goods and services (and through contractual indemnities the liability of the appointer for the receiver's debts) provide a strong incentive for receivers to endeavour to achieve a repayment of their appointor's debt in whole or in part as quickly as possible.

3.14 Unsuccessful reorganisations The receiver may be removed by the court for misconduct, or because the receiver is redundant. Where there are no assets available and directors do not propose any action in relation to the company, the receiver may notify ASIC so that the company may be struck off the register (sections 572 to 574 of the Act).

3.15 How useful is receivership for restructuring? Receivership is not a process designed to facilitate restructuring but rather it is designed to facilitate the recovery by a secured creditor of its debt (in the case of private appointments) or to maintain the status quo (normally in the case of Court appointments). Like a voluntary administrator, a receiver can be appointed without the need for court intervention where the right to appoint receivers arises as a matter of contract. Receivership can be a process which results in restructuring by, for example, the receiver selling a profitable business out of an unprofitable corporate shell. There are also occasions where the secured lender is willing to fund the receiver to turn an unprofitable or less profitable business into a more profitable business, even in at least one instance funding the acquisition of competitive businesses to secure economies of scale. Whilst reorganisation can occur in a privately appointed receivership, that is not its aim and so when it occurs that result will be more of a subsidiary benefit to the goal of ensuring the repayment of the secured debt.

4. Court winding up

4.1 Requirements A compulsory winding-up in insolvency is a winding-up of an insolvent company that begins with a court order. A company is insolvent when it is unable to pay all its debts as and

qzls S0111430115v1 150520 21.3.2005 Page 20 when they become due and payable. Any one of the following may apply to the court for a company to be wound up in insolvency: • the company; • a creditor; • a contributory; • a director; • a liquidator or provisional liquidator of the company; • the ASIC; or • a prescribed agency. A court will make an order to commence winding-up of a company if it is proved that the company is insolvent. Most commonly, insolvency is proven by failure to comply with a statutory demand which may be served on a company by a creditor owed at least A$2000. A company is presumed insolvent if it fails to comply with a statutory demand within 21 days of service unless within that period it has commenced proceedings to have the demand set aside or it has paid or compromised the claim. The most common basis on which such demands are set aside in that there is a genuine dispute about the debt or that the debtor has a counterclaim against the creditor sufficient to reduce its indebtedness to the creditor to less than A$2,000. The court also has the power to wind up a company on grounds other than insolvency. These grounds include where: • the company has not commenced business within one year from its incorporation or has suspended its business for a whole year; • the company has no members; • the directors have acted in the affairs of the company in their own interests rather than the interests of the members as a whole, or in any other manner that appears to be unfair or unjust to other members; or • the court is of the opinion that it is just and equitable that the company be wound up. A court liquidation may be used because: • a voluntary liquidation while available to any corporation, might, because of large or opposed membership, be too slow or too cumbersome as an alternative to court liquidation; and • schemes of arrangement and DOCAs require the voting sanction of creditors and their voting preference may need to be sought before proposing such administrations.

4.2 Procedure Once appointed, the liquidator must lodge a notice of appointment with the ASIC and the Commission of Taxation. qzls S0111430115v1 150520 21.3.2005 Page 21 A company that is being wound up must set out in every public document and in every negotiable instrument of the company the expression “(in liquidation)” after the company’s name where it first appears. The liquidator has a duty to act impartially and a duty to identify the creditors of the company. The liquidator has a duty to inquire whether a claim is being pressed. The duty is not merely to advertise but to write to creditors whose existence is known to the liquidator. Otherwise, the liquidator may be personally liable to meet the claims of those creditors. However, if after sending them notice the creditors do not prove, the liquidator is under no duty to make them prove. The general body of creditors may elect a committee of inspection. A committee of inspection is a group of creditors and contributories or their attorneys under power elected by the general body of creditors and contributories to approve action by the liquidator. It is a useful option where there are many creditors and contributories and it is inconvenient to summon frequent general meetings to approve action by the liquidator. Any creditor or contributory may request the liquidator to convene separate meetings of creditors and contributories for the purpose of determining whether they desire the appointment of a committee of inspection and, if so, who are to be its members. If the determinations of the meetings differ, the difference is decided by the court. The court also has the power to direct meetings of creditors and contributories to be convened so that the court can ascertain the wishes of the creditors and contributories. Members of a committee have a fiduciary character. Generally, they are not entitled to any benefits for acting in the committee; however, where in exceptional circumstances they provide special services to the court, the court has the power to give leave to award remuneration to the members of the committee. The liquidator has the power to bring a wide range of proceedings in the name of, and on behalf of the company including specific statutory rights of recovery such as insolvent trading and voidable transactions including unfair loans, , uncommercial transactions, improper director benefits and related party transactions. In the course of controlling a liquidator’s exercise of power, the court may make an order authorising another person, such as a creditor or contributory, to sue in the company’s name upon giving the liquidator and the company an indemnity. A liquidator may assign the proceeds of an action for recovery or sell a bare right of action to another party. The ability of a company’s external administrator to do this represents an exception to the general law doctrine against maintenance and champerty.

4.3 Effects A compulsory liquidation essentially has the same effect on the company, shareholders and creditors as a voluntary liquidation.

4.4 Sale of assets In the process of winding up, a liquidator’s broad powers are subject to consents where:

qzls S0111430115v1 150520 21.3.2005 Page 22 • a liquidator compromises a debt owed to the company where that amount is greater than A$20,000; or • a liquidator enters into an agreement on the company’s behalf if the term of that agreement or the obligations of a party under that agreement extend for more than three months after the agreement is entered into. For the liquidator to enter into an agreement exceeding those thresholds he or she requires consent in the form of either: • approval of the court; • approval of the committee of inspection; or • a resolution of the creditors in favour of the action.

4.5 Set-off and netting The Act specifically provides for a set-off or netting of debts and credits arising from mutual dealings, mutual credits or mutual debts between the insolvent company and a creditor. The effect of this section is that it is only the balance that remains a provable debt against the company (or is owed to the company depending on the result of the netting). The right to set-off is specifically excluded, however, if at the time of giving credit to the company, or receiving credit, the creditor had notice of the fact that the company was insolvent. For example the appointment of a liquidator would prevent the creditor from setting off mutual debts or mutual credits arising under mutual dealings entered into after knowledge of such appointment.

4.6 Post-filing credit As described in 4.9 below, there is a statutory order of payment of unsecured creditors and the Act requires that certain unsecured debts and claims must be paid in priority to all other unsecured debts and claims. These debts and claims are, in general, only provable if the circumstances that gave rise to the debt occurred before the commencement of the winding-up. It is possible, however, that a debt incurred by a company may still be payable in a winding-up if the expense was entered into with the authority of the liquidator. In the statutory order of payment of unsecured creditors, first priority of repayment is afforded to expenses, other than ‘deferred expenses’. If the liquidator took out a loan or obtained credit that liability would form part of that highest level of priority. If a debt is incurred by the company after the commencement of the liquidation and is not authorised by the liquidator, it is unlikely to be provable and would not rank for priority repayment.

4.7 Stays of proceedings/moratoriums When a company is being wound up: • individual claimants lose the right to litigate their claims in court and instead must lodge a proof of debt with the liquidator. In order to achieve this, a stay is imposed to prevent the assets of the company being wasted by litigation.

qzls S0111430115v1 150520 21.3.2005 Page 23 • the leave of the court must be obtained in order to bring or continue proceedings against a company, or in relation to the property of the company. • factors which the courts will take into account when considering whether to grant leave include the potential disruption to the orderly liquidation of the company, the extent to which other creditors of the company may be prejudiced by the grant of leave and the seriousness of any question to be tried. • enforcement processes in relation to the property of the company cannot be begun or continued against a company. • an applicant, seeking leave to obtain a remedy against a company that is being wound up, must prove to the court that there is some good reason why its claim against the company should be pursued by a court action rather than by lodging a proof of debt with the liquidator. • a secured creditor does not require the leave of the court to deal with the property charged. On liquidation, unsecured creditors have no rights to specific items of the company’s assets; they have a right to have a fund of assets protected and properly administered.

4.8 Claims and appeals A creditor proves its debt by submitting a ‘proof of debt’ to the liquidator. A debt or claim must have arisen from circumstances occurring before the day on which the winding-up is taken to have begun. After the liquidator receives a proof the liquidator must admit it or reject it wholly, or in part, or require further evidence supporting it. The liquidator’s duty when examining a proof is to require some satisfactory evidence that the debt on which the proof is based is a real debt. In some cases of real doubt the liquidator may be able to obtain directions from the court. If the creditor is unhappy with the liquidator’s subsequent decision, the question can be determined in an appeal to the court by the creditor. A liquidator who rejects a claim wholly, or in part, is to state in writing to the creditor the ground of objection. If the liquidator rejects the proof of debt, the creditor may appeal to the court. If the liquidator admits it, a creditor or contributory can appeal to the court, as can a receiver enforcing a charge (where the debt which has been admitted has priority over the secured creditor the receiver represents). Any time limit is dictated by the rules of the court before which the appeal will be heard. Section 560 of the Act allows persons who advance funds to the company for the purposes of the company meeting its employee entitlement obligations to step into the shoes of the employees to the extent that their entitlements were meant, for the purposes of priority of payment of their claim.

4.9 Priority claims In general, the starting point under the Act is that, unless otherwise provided, all unsecured debts proved in a winding-up rank equally and, if the property of the company is insufficient to meet them in full then they are to be paid rateably. There is, however, where a company

qzls S0111430115v1 150520 21.3.2005 Page 24 is being wound up, a statutory order of priority in which the funds are distributed. The order is as follows: (a) secured creditors under fixed charges; then (b) expenses of the winding-up (including the liquidator’s and any prior receiver or voluntary administrator or deed administrator’s remuneration); then (c) unpaid wages, unpaid superannuation contributions, and other employee entitlement (persons who advance funds to pay those claims have the priorities for those payments which the employees otherwise enjoy); then (d) secured creditors under a floating charge; then (e) unsecured creditors; then finally (f) shareholders. Although under common law the Crown is entitled to priority for its debts, the Act specifically applies the provisions in respect of insolvency to the Crown and, as such, the inherent right to Crown priority is avoided. There are specific provisions in relation to insolvent insurance companies and in relation to insurance and reinsurance recoveries.

4.10 Distributions After collecting the assets and the time fixed for the proving of claims has expired, the liquidator can distribute to creditors. Depending upon the complexity and size of the company, liquidation can last for several years and the liquidator may make several payments over that time. In an insolvent company there is a prescribed order of payment of debts as described in part 4.9 above. Even in a company which appears to be solvent, a liquidator should follow the statutory order.

4.11 Conclusion of winding-up In the case of winding-up, the final step to be taken in the process is the deregistration of the company. The steps for deregistration are governed by the Act and once deregistered the company ceases to exist and the liquidator’s role comes to an end.

4.12 How useful are liquidations for restructuring? Liquidation is a process designed to facilitate the distribution of the assets of an insolvent company to its creditors. Like receivership, it is not a process designed to facilitate restructuring. In some liquidations the liquidator may be successful in identifying some profitable business of the company which can be sold and continue in operation. However, the aim of liquidation is not rehabilitation and like receivership if this goal is achieved it is a subsidiary benefit to the goal of realising the company's assets for the benefit of its creditors.

qzls S0111430115v1 150520 21.3.2005 Page 25 5. Schemes of arrangement (Schemes)

5.1 Voluntary Schemes Following the introduction of VA, Schemes are now rarely used in Australia in situations of insolvency because they are governed by technical rules and involve at least two court applications. A VA is less expensive and quicker to commence than Schemes and for this reason, Schemes are not a procedure which is recommended for smaller private companies nor are Schemes now normally used for a rehabilitation where there are solvency issues. In brief, there are two different types of schemes: members’ schemes and creditors’ Schemes. Before either type of scheme can be implemented it must be approved by the court, the ASIC and the creditors. A creditors’ Scheme is a binding agreement between the creditors and the company whereby the company’s obligations to the creditors are deferred, rearranged or extinguished. This type of arrangement might be preferable where there are a large number of creditors and individual arrangements with creditors are not feasible. A scheme will bind all creditors, even those who oppose it. Members’ Schemes will inevitably involve some restructuring of the company and their rights and obligations as members. The Scheme will be binding on dissenting members.

5.2 Involuntary Schemes A Scheme may be proposed by the company, the liquidator of a company, or a creditor or member. In practice, the company will usually be cooperatively involved and is required to prepare an explanatory document.

5.3 Procedure Before the court will order a meeting of creditors or members to be convened to consider the proposed scheme, an applicant must secure or prepare various items of preparatory documentation and might also contact major creditors and members to convene an informal meeting to ascertain their interest prior to approaching the court. Once the documents proposed to be sent to creditors have been prepared and other prerequisites have been completed, the applicant applies to the court for an order authorising the convening of meetings. Having secured court approval to the convening of a meeting or meetings, the required documents must be posted to creditors and, where relevant, members. Voting majorities of creditors or members must approve the scheme. The format for meetings is not uniform, but it must permit the interests of all of the various classes of creditors and members to be fairly discussed and separately voted on. Once the Scheme meeting has been held, if the requisite voting majority is obtained, the applicant then returns to the court to seek approval of the scheme. The Scheme does not come into operation until the court approves it and a copy of the court order is filed with the ASIC.

qzls S0111430115v1 150520 21.3.2005 Page 26 A committee of inspection or management may be provided for by the Scheme either as a mandatory measure or, if desired, by participating creditors or the scheme administrator. The committee is intended to represent the general body of creditors, and, where relevant, members. The powers of the committee will be specified in the Scheme document. The scheme may require the administrator to follow the committee’s instructions or generally in relation to any particular matter.

5.4 Doing business in reorganisations and post-filing credit The Scheme administrator’s powers will stem from the formal document which, following sanction by the court, will effectively act as a court-sanctioned contract between the company and its creditors. Therefore, whether the administrator has, for example, the power to sell assets, and is so, what assets this includes, will depend upon the terms of the Scheme. This is also the case with financial restructuring of the company's finances or its equity base or to contracts and work-in-progress. In this way, the Scheme may give the administrator power to carry on business or it may: • leave the conduct of business to existing company management; • envisage discontinuation of the existing business; or • transfer control of the business to a new purchaser. There are no statutory restraints to carrying on business under a Scheme. As to whether business is to be carried on at all or under the supervision of the Scheme administrator, or otherwise, one must refer to the scheme itself.

5.5 Setting off Where, before the commencement of Scheme, a creditor also owes money to the company, the creditor will normally be entitled to set off amounts owing against the debt payable to the company. As with a DOCA, the right to set-off will be determined by reference to the terms of the deed.

5.6 Successful reorganisations For creditors to adopt a Scheme, a majority of the creditors, or a majority in each class of creditors (where applicable), must vote in favour of the resolution and the total value of the debts of those voting in favour must be at least 75 per cent of the total debts owed by the company to all creditors voting, or 75 per cent of the debts owed by the company to the class of creditors voting. A Scheme only takes affect upon a court order, made following the passage of the necessary resolution(s).

5.7 Expedited reorganisations The Act does not set guidelines for a Scheme; it provides the machinery for a Scheme to be agreed to, which is at the discretionary sanction of the court. Unlike VA, a Scheme cannot be initiated quickly as it requires the scrutiny of the ASIC, the court, and the convening of formal meetings.

qzls S0111430115v1 150520 21.3.2005 Page 27 5.8 Unsuccessful reorganisations In order to propose a Scheme, the person proposing the scheme must: • supply certain information to the ASIC and the court; • with the court’s permission, convene a meeting of creditors and, where relevant, members; • secure a requisite majority vote in favour of the scheme from the meeting or meetings (see 2.3); and • reapply to the court for final sanction. The proposed Scheme may be defeated at any of these stages, and if this occurs, the control of the company reverts to the directors. The effect of a failed Scheme depends on what has actually been provided for in the scheme itself. The Scheme may provide for liquidation should it fail to meet its objectives. Even where it does not specifically provide for that contingency, a liquidation may take place, depending on the company’s circumstances.

5.9 Priority claims The manner and method of distribution of funds under a Scheme will be governed by the provisions of the scheme itself. A scheme must attempt to treat participating unsecured creditors equally, subject to the exceptions normally provided for in a winding-up. If it does otherwise, the court, the ASIC or the creditors concerned may object to the Scheme.

5.10 Conclusion of Scheme The termination of a Scheme should be provided for in the document itself. On termination of a Scheme, the company reverts to the control of the directors, however, the Scheme may provide for a liquidation should it fail to meet its objectives, and even when the Scheme has not provided for that contingency, a winding-up may take place.

5.11 How useful are schemes for reorganisation? Schemes can certainly be an effective method of formal reorganisation. For financially troubled companies though, a VA is much easier to commence and because of the fact that no court application is mandatory, can be a cheaper and a more effective method of achieving similar goals to a Scheme. Unlike a Scheme, all creditors of a company in VA vote so that there is no need to identify individual classes of creditors or to achieve majorities in different clauses.

6. Creditors voluntary winding up

6.1 Commencement A voluntary winding-up may be commenced by the company’s members or creditors.

qzls S0111430115v1 150520 21.3.2005 Page 28 A voluntary winding-up may be undertaken by a resolution of the members in general meeting if the company is solvent. The directors are required to make a written declaration of the company’s solvency before sending out the notice of meeting. A creditors’ voluntary winding-up is similar to a members’ voluntary winding-up, except that the directors have not made a solvency declaration and the company is insolvent. Creditors’ voluntary winding-up occurs infrequently, other than as a result of the creditors voting in favour of liquidation at the second creditors’ or decision-making meeting in a VA (see 2.2 above).

6.2 Effects The liquidator assumes control of the company and proceedings against the company cannot be continued or begun except with the leave of the court. The powers of the directors are suspended; they do not lose office but they can only act with the written approval of the liquidator or the approval of the court. An order for winding up a company operates in favour of all of the creditors and contributories of the company. A secured creditor does not require leave of the court to deal with the property charged. Unsecured creditors have no rights to specific items of the company’s assets other than pursuant to retention of title or other rights if applicable. Transfers of shares after the date of the order are void as against the company unless the court orders otherwise. There can be no change in the status of a member unless the court orders otherwise. Members who hold partly-paid shares will be called upon the pay the unpaid part.

6.3 How useful are creditors voluntary winding up for reorganisation? Like court appointed liquidation, voluntary winding up is a process designed to achieve the selling up and distribution of a company's assets. It is not a tool designed for or to be proffered for reorganisation other than the deregistration of non-operating companies.

7. Court-appointed receivers

7.1 When will the court appoint a receiver? A receiver may be appointed by the court as an equitable remedy whenever it is just and convenient to do so. A receiver can be sought by any party to a cause or matter involving the court's jurisdiction. In practice, applicants are usually mortgagees or debenture-holders, but the appointment could be sought in unusual circumstances by ordinary creditors and even by the company itself. For example, a receiver may be appointed by the court: • during the course of a protracted litigation to settle a dispute between parties or to protect the "public interest" • under the Act where ASIC is conducting an investigation and it is necessary to freeze the assets of companies or ASIC may apply to the court for an order appointing a receiver of the property owned by or held by a securities industry dealer.

qzls S0111430115v1 150520 21.3.2005 Page 29 • at the request of a liquidator or provisional liquidator, to an officer's or related entities property in circumstances where the officer or related entity may otherwise avoid liability to the company. The distinction between a privately appointed receiver and a court appointed receiver was summed up in the case of Duffy v Super Centre Development Corp Ltd13: There is some contrast to be borne in mind between the function of a privately appointed receiver and the function of a court appointed receiver, and I use the word `receiver' as a compendious word encompassing a receiver and manager. To some extent, the privately appointed receiver, particularly in current commercial practice, makes an effort to restore the financial prosperity of the company whose affairs he has been appointed to administer by a debenture holder. A court appointed receiver does not fill the same position. He is not what might be described as a company doctor, but rather his function is that of company caretaker

7.2 Procedure Persons may seek a court-appointed receiver where there are difficulties in appointing a receiver by another mode, or where they have no power to appoint a receiver except by application to the court The actual procedure for securing a court order will depend upon the circumstances in which the order is sought. In a court appointment, the court will always exercise a discretion as to whether a receiver should be appointed. The requirements for notification by the receiver and by the person appointing him or her are the same as for a receiver appointed from powers arising out of a document (see part 3 above).

7.3 Successful reorganisations and bringing it to an end The way a receivership ends and the way in which this effects a reorganisation is discussed at 3.11 above. The appointment of a receiver does not prevent creditors or the company itself from seeking to initiate liquidation, administration, provisional liquidation, proposing a scheme of arrangement, or even appointing a receiver under a mortgage deed with prior rights. In this way other reorganisation processes can be taken advantage of so as to rehabilitate the company, however, whether this ultimately benefits the rehabilitation is dependent upon the parties that seek the alternate process (for example secured creditors may enforce their security thereby making rehabilitation difficult or impossible).

7.4 Expedited reorganisations The appointment of a receiver pursuant to a court order is usually associated with a requirement to furnish security. The Supreme Court Rules in all States provide that a

13 (1967) 1 NSWR 382, per Street J at 383 to 384 qzls S0111430115v1 150520 21.3.2005 Page 30 person shall not be appointed receiver ``pursuant to a direction of the court until he has filed an instrument of security''14. The court may, inter alia: • order that the appointment of the receiver take effect immediately but that he or she is not to receive any property until he or she provides security15 ; • make the appointment but direct the receiver not to provide security or take possession for a fixed period of time16; • waive security if deemed not to be required; • appoint a person without security — this is often done in New South Wales when an official liquidator is appointed as receiver. The receivership will commence as specified in the court order, or when security is provided.

7.5 How useful are court appointed receiverships for reorganisation? A court appointed receiver has a limited role which is reflected in the limitations to his/her powers, for example, a court-appointed receiver often has no power of sale, except with the permission of the court. In addition, the fact that a moratorium does not exist when a court appoints a receiver means that while the court appointed receiver may be working towards resolving protracted litigation to settle a dispute between parties or to protect the "public interest", a creditor of all or substantially all of the company's assets may step in destroy any hope of rehabilitation. Court appointed receivers are not normally appointed to arrange or facilitate a restructuring. A court could give a court appointed receiver power to act in that way (in a similar way to the power afforded to the provisional liquidator in UMP (see 8.7 below)) but this is not the normal role of a court appointed receiver.

8. Provisional liquidation

The procedure known as ''provisional liquidation'' exists to allow interim control over the affairs of a corporation after an application to wind up the corporation has been filed, but before the hearing of the winding up application has taken place or has been concluded. A provisional liquidator may also be appointed after a winding up order has been made, but where there is an appeal against the order and the decision on the appeal has not yet been made. Such appeals are rare, and the appointment of a provisional liquidator during the course of such an appeal even rarer. The procedure of provisional liquidation exists to protect the interest of financial participants in a corporation until such time as an application for winding up is determined.

14 NSW Pt Pt 29, r 2(2); Vic O 50 r 16; Qld O 54 r 13; SA O 50 r 14(1); WA O 51 r 3(1); Tas O 57 r 2; ACT O 52 r 17

15 Re Pountain (1888) 37 ChD 609 at 610

16 Re Crompton & Co Ltd (1914) 1 Ch 954 qzls S0111430115v1 150520 21.3.2005 Page 31 A provisional liquidation may be forced on a corporation against the wishes of its management or ownership. This facility is particularly helpful to creditors and to oppressed minorities. Creditors seek the appointment of a provisional liquidator in situations where it would be unwise to leave company affairs under the control of directors or shareholders who might effect a dissipation of corporate assets before a winding up application is heard. In practice, provisional liquidation is not normally used for the rehabilitation of a company, rather, a provisional liquidator usually has a short "caretaker" role. An exception to this is the case of Re United Medical Protection & Ors [2003] NSWSC 1031 which is discussed at 8.5 below which provides a, to date, rare example of how provisional liquidation has been used to rehabilitate a company.

8.1 Procedure To initiate a provisional liquidation there must have been previously (even if immediately previously) a winding up application filed with the court. An application to appoint a provisional liquidator is filed with the court usually by a creditor or the company itself. The court then exercises its discretion as to whether a provisional liquidator is to be appointed. The exercise of this discretion is premised on demonstrating to the court that the appointment is necessary to prevent dissipation of assets or to preserve the position of creditors or contributories until the decision as to the winding up order is made. It has this discretionary power whether the application for the provisional liquidator or the application for a winding up order is opposed by the company or not. The application to appoint the provisional liquidator does not need to be made by the applicant for winding up, although in most cases they will be the same person. The court will normally grant an order for the appointment of a provisional liquidator where that order is, or may be, in the interests of the dominant financial parties concerned. Where the company is insolvent, creditors are the dominant financial parties as members are to receive nothing in the event of a liquidation.

8.2 Effect and moratorium A company entering into provisional liquidation continues its legal existence, but with certain restrictions, some flowing from the application to wind up itself and some flowing from the appointment of the provisional liquidator. The company is described as being in provisional liquidation or as having a provisional liquidator appointed. Directors' powers cease on the appointment of a provisional liquidator, and the company's control is clearly entrusted to him or her. While a provisional liquidator of a company is acting, a person cannot perform or exercise, and must not purport to perform or exercise, a function or power as an officer of the company except: (a) as a provisional liquidator of the company; or (b) as an administrator appointed for purposes of an administration of the company beginning after the provisional liquidator was appointed; or (c) with the provisional liquidator's written approval; or

qzls S0111430115v1 150520 21.3.2005 Page 32 (d) with the approval of the court. Where a provisional liquidator is acting, a person cannot begin or proceed with: • a proceeding in a court against the company or in relation to the property of the company; or • enforcement process in relation to such property; except with the leave of the court and in accordance with such terms (if any) as the court imposes. The moratorium or suspension of officers' powers affects a secured creditor's right to realise or otherwise deal with his or her security. Leave might be given to continue with or commence proceedings in areas where the judicial forum is the most convenient way to settle the claim. The effect of an appointment of a provisional liquidator on other forms of administrations would be as follows: (a) Receivership: a provisional liquidator may coexist with a receiver, whether the receiver be appointed before or after the provisional liquidator. Where the receiver was acting previously, his corporate agency is revoked, but this is unlikely to interfere with his power to hold and dispose of corporate assets charged to his client. It does, however, eliminate the receiver's right of indemnification, as an agent, from the company should the assets charged to his client be used up. (b) VA: not compatible with provisional liquidation, but the provisional liquidator may initiate a VA. (c) Schemes: not compatible with liquidation, but a provisional liquidation may precede it or follow it and coexist temporarily until the winding up order has been considered. The making of a winding up order terminates provisional liquidation. The court liquidator may or may not be the same person as the provisional liquidator.

8.1 Distribution of property Except in unusual circumstances, there will be no distribution of corporate property during the course of the provisional liquidation. However, a provisional liquidator may need to seek court permission to wind up some of a corporation's affairs if it is in the interests of financial participants to do so. The provisional liquidator may also take the opportunity during his interim control period to investigate the affairs of the company in order to inform the court of the company's position at the relevant hearing.

8.2 Voluntary provisional liquidation Provisional liquidation is not necessarily involuntary. A corporation may seek its own provisional liquidation as an interim alternative to a subsequent administration. This will particularly be the case where there is some urgency to freeze the company's position vis- à-vis its creditors or other financial contributors.

qzls S0111430115v1 150520 21.3.2005 Page 33 8.3 Provisional liquidator's powers The provisional liquidator's powers are somewhat akin to those of a liquidator, except as restricted by statutory provision, court order and generally by the knowledge that a winding up order may eventually be refused. The provisional liquidator will have the power to administer company affairs, but is unlikely to be given initially the power to realise assets (except in the ordinary course of business) or to pay dividends. He will usually undertake the activity of investigating the company's affairs to establish whether there is some reason for the company's not being wound up. The company's property does not automatically vest in its provisional liquidator, but his administrative powers are sufficient to replace existing management control of corporate property for the interim period of his appointment.

8.4 Post-appointment credit A provisional liquidator's powers generally include taking possession of a company's assets (section 474(1)), control of its affairs until the winding up application is decided and preserving the company's assets until they become available to a liquidator or are ultimately returned to the control of directors. The provisional liquidator's capacity to realise assets other than in the ordinary course of business is usually limited. However, s472(4) of the Act states that a provisional liquidator has the powers of a liquidator derived from s477(2). Section 477(2)(g) states: Subject to this section a liquidator of a company may: … (g) obtain credit, whether on the security of the property of the company or otherwise." However, such a loan would be subject to the same limitations discussed at 4.6 above.

8.5 Successful reorganisation As mentioned above, a provisional liquidation is not normally used for the rehabilitation of a company, rather, a provisional liquidator usually has a short "caretaker" role. An exception to this is the case of Re United Medical Protection & Ors17 which provides a, to date, rare example of how provisional liquidation has been used in Australia to rehabilitate a company. This case involved United Medical Protection (UMP), the largest medical defence organisation in Australia. Mr David Lombe, a partner of Deloitte Touche Tohmatso in Sydney, was appointed the provisional liquidator of the five companies in the UMP group. The winding-up applications had not been made on the grounds of insolvency but, rather, on just and equitable grounds because the circumstances were such that, there was a risk that the company "would be unable to continue to operate in the manner envisaged by the corporators and the present membership". The court's power to appoint a liquidator provisionally is conferred by section 472(2) of the Act.

17 [2003] NSWSC 1031 qzls S0111430115v1 150520 21.3.2005 Page 34 The Commonwealth government provided various indemnities to UMP to enable it to continue in operation because of the significant consequences to the Australian community were UMP to collapse, leaving medical practitioners uninsured and unwilling to continue to practice as doctors. As a consequence of the Commonwealth indemnity the court closely supervised the provisional liquidation and made orders pursuant to which the companies continued in operation and continued to write cover notwithstanding the fact that they were in provisional liquidation. As a result Legislative tort reform and the extension of federal assistance meant that UMP's forecast exposure to claims were significantly lowered and the four companies in question were over 17 months ultimately successfully turned around and the provisional liquidator formed the view that they were then solvent. Mr Lombe applied to the New South Wales Supreme Court for orders terminating his appointment over four of the companies, and for leave to discontinue winding-up proceedings against them. Section 482 of the Act authorises the court to terminate the winding-up of a company and Section 467(1) of the Act authorises the court on hearing a winding-up application to dismiss the application. There is no express provision in the Act for the court to terminate the appointment of the provisional liquidator, but the court rules give it power to set aside its interlocutory orders. It is rare for a company in Australia to remain in provisional liquidation for a substantial period of time and there is very little case law dealing with the termination of a provisional liquidator's appointment. Justice Austin took the view the cases that deal with termination of winding-up and receivership were helpful by analogy, which led to his Honour to consider several factors relevant to the exercise of the court's discretion. • whether the purposes for which the appointment was made had been exhausted, and whether there was a reasonable prospect that matters might arise in the future with which a provisional liquidator should deal; • the effect of the termination on creditors, contributories and the provisional liquidator; and • whether the termination of the appointment was in the public interest. Mr Lombe applied to the court for his position as provisional liquidator of the companies to be terminated on several grounds. The consideration of the above issues led the court to agree with Mr Lombe's submission that the key questions were whether the companies were, in fact, solvent and whether (having regard to the interests of creditors and members) the company would comply with the requirements of the Australian Prudential Regulation Authority (APRA), the insurance regulator. Mr Lombe submitted that, even though he had not been appointed on insolvency grounds, the "confluence of factors, ranging from difficulties in maintaining capital and spiralling claims", no longer existed. Additionally, the court heard the difficulties arising from the amalgamation that created the UMP group had been overcome. The court was satisfied that these factors had contributed to the value of the group and that sufficient action had

qzls S0111430115v1 150520 21.3.2005 Page 35 been taken to remedy them. It was also satisfied on the evidence that UMP could meet APRA's prudential requirements in the future. On the question of solvency, Justice Austin also accepted the evidence before him from Mr Lombe, APRA, ASIC and others. Justice Austin was satisfied that the four companies were, in fact, solvent and they were reasonable grounds for predicting that they would remain so, thus avoiding protection of the rights of unsecured creditors. This was based on a wealth of documentary evidence, forecasts, and the impact of legislative reform. This case demonstrates that the court is empowered under section 482 of the Act to terminate the appointment of a provisional liquidator. The court will carefully consider a range of factors before doing so, including the solvency of the company in the impact of the termination on creditors, contributories and the provisional liquidator. It is a rare example in Australia of the court supervising the provisional liquidator of a company in the actual continuation of its business operations and the successful turning around of that company to the extent that it can be taken out of external control.

8.6 Expedited reorganisation The ``date'' of provisional liquidation is the date on which the court order appointing the provisional liquidator is made. This is to be distinguished from the ``commencement'' of liquidation, if an order is ultimately made for liquidation, which will usually be the date of the winding up order is made. However, should an application for the appointment of a provisional liquidator be made immediately after, ie contemporaneous with, the filing of an application for winding up, then in the event of a subsequent liquidation the date of provisional liquidation will be the same as the ``relation-back day'', being the day from which, or in respect of which, certain antecedent transactions may be set aside by the liquidator. In practice the filing of an application for winding up, and the application to appoint a provisional liquidator are often made at the same time. The timing of a provisional liquidation is often difficult to predict. While it is an interim measure, some provisional liquidations have continued for a number of years. It is interim to: • a court liquidation; • the withdrawal or dismissal of a winding up application; or • some other form of administration which might be proposed to resolve the company's affairs, eg a court approved scheme of arrangement; or • a voluntary administration leading to a deed of company arrangement. While the provisional liquidation may take considerable time, the appointment of a provisional liquidator can be done quickly and one if its advantages if the speed of appointment. This is such so that a company, a creditor and even a contributory might seek the appointment of a provisional liquidator where assets are in danger of dissipation, deterioration or otherwise in jeopardy unless placed under independent control. There might, for example, be the need to immediately stay a creditors' action against the company. qzls S0111430115v1 150520 21.3.2005 Page 36 Where urgency is not required or assets do not need immediate protection, there will be no need to appoint a provisional liquidator as a precursor to liquidation or as an alternative to other forms of administration such as receivership, official management or a scheme of arrangement. It might be determined that provisional liquidation or Administration is necessary in the interests of urgent protection or as a means of permitting an independent person to examine the company's affairs to consider possible alternatives prior to the hearing of the winding up application.

8.7 Unsuccessful reorganisation The introduction of the VA process in 1993 provided companies with a vehicle to initiate an interim administration without the need for a court application. VA, Schemes, receivership, controllership or even voluntary liquidation, may be more suitable to a company than the interim administration of ``provisional liquidation''. Whatever the administration recommended, even if it be a provisional liquidation, the expected effect of appointing a provisional liquidator or some other administrator may be frustrated by the contractual right of a secured creditor to appoint a receiver, and for these reasons it may be necessary to canvass the attitude of that secured creditor prior to appointment.

8.8 Termination of provisional liquidation A provisional liquidator's appointment will conclude if a winding up application is dismissed or withdrawn, as it is a prerequisite to the appointment of a provisional liquidator that a winding up application be still under consideration. It will also terminate if a winding up order is made, unless there is an appeal against the winding up order and the court has appointed a provisional liquidator pending the decision in that appeal or determined to continue the appointment of a provisional liquidator pending such decision. A provisional liquidator might also have his appointment appealed against or be removed. Where a provisional liquidator is removed and not replaced by another liquidator, the provisional liquidation will terminate. The court might make an order for the removal of the provisional liquidator and the termination of the provisional liquidation if it is the company's interests. On completing his term of office and accounting to the liquidator (if any), the provisional liquidator is entitled to be paid out of company property for all costs, charges and expenses (including the remuneration) incurred by him as may be authorised by the court, and he may retain sufficient to defray such costs.

8.9 How useful is provisional liquidation for reorganisation? Provisional liquidation is normally not used in Australia as a restructuring process. The UPM example is probably not a herald for provisional liquidation becoming a favoured means of restructuring, primarily because of the amount of court involvement in the process in comparison to VA.

qzls S0111430115v1 150520 21.3.2005 Page 37 9. Government discussion papers

There are two government committees who have issued papers relating to suggested charges to the current Australian rehabilitation regime. The two government committees and the related papers are: 1. the Joint Parliamentary Committee's Inquiry into Australia's Corporate Insolvency Laws and Companies entitled "Stocktake on Corporate Insolvency Laws" (the Paper); and 2. the Markets Advisory Committee (CAMAC) entitled "Rehabilitating Large and Complex Enterprises in Financial Difficulty". Two of the main issues that were discussed in the Parliamentary' Joint Committee's paper (and also raised by CAMAC) were: (a) the need for early intervention for rehabilitation; and (b) ipso facto clauses, which are discussed at 9.1 and 9.2 below.

9.1 Early intervention for rehabilitation The Paper recommends that the threshold test to permit directors to make the initial appointment of an administrator be altered by rewording the legislation from, if the company ‘is or is likely to become insolvent at some future time’ to ‘is insolvent or may become insolvent’. It is submitted that if the change were to be made, it would not be beneficial to the rehabilitation of a company for the following reasons: (a) It would not itself result in early intervention. The reason why the Paper suggests this change is that it would like to see companies in need of rehabilitation taking advantage of the voluntary administration regime and the turnaround options it provides sooner rather than later. While corporate turnaround options are normally severely limited by the time directors come to seek them because they regularly leave it too late, this problem is largely caused by an unbridled optimism of most directors who always assume that things will work out and fail to seek professional help early enough. Legislative reform of the type proposed will not of itself cause directors to move more promptly to explore turnaround options. (b) The present wording permits earlier intervention than we presently see. The proposal displays a narrow view of the meaning of the expression "likely to become insolvent at some future time." (c) A free for all. The Australian VA process is a relatively effective and efficient process and it should be available essentially for financially troubled companies or for companies for which real financial difficulty is likely even if not immediate - in short, for companies which are insolvent or likely to become insolvent at some time in the future. qzls S0111430115v1 150520 21.3.2005 Page 38 It is submitted that the rights of owners, lessors, secured creditors, litigants and others should not be interfered with in circumstances other than those presently permitted by Part 5.3A. To allow any company which might become insolvent at some future time to go into VA permits most companies to use the procedure. It is too vague a test and opens the procedure unnecessarily to potential abuse. (d) The present form of declaration – insolvent or likely to become insolvent at some future time. As the appointment of a voluntary administrator is a decision taken by the directors rather than the court the legitimacy of the reasoning process behind the directors' decision is not a matter which is likely to often come before the court. Such cases as there have been have primarily dealt with whether the directors have followed the form of section 436A ie have they passed a resolution to the effect that: (i) in the opinion of the directors voting for the resolution, the company is insolvent, or is likely to become insolvent at some future time; and (ii) an administrator of the company should be appointed or whether the resolution has been properly passed by property appointed directors. Such procedural errors have sometimes been cured by a court and sometimes not 18. For example, the court did have cause to consider the legitimacy of an administrator's appointment in a case in which moves were afoot to replace the incumbent directors for the dominant purpose of preserving their position19. There the court found that the administrator's appointment was voidable and terminated a DOCA which had been the result of the VA process. It is probably sufficient for the directors to form a single opinion about "actual or likely insolvency" rather than forming separate opinions as to present and future insolvency: Kazaar v Duus (unrep) AG 3005/1998; Re Ray Davis Contracting Pty Ltd (unrep) QSC 221. Whilst the expression "likely to become insolvent at some future time" has not been considered on many occasions by the courts in the particular context of the requirements of the resolutions for the appointment of a voluntary administrator, the expression "likely" appears in other legislation and has been considered by the courts on a number of different occasions in different contexts. For example, Heery J's decision in Munroe Toople & Associates Pty Limited v The Institute of Chartered Accountants (Australia) [2002] FC ASC 197; [2002] 122 FCR 110; ATPR 41-879 supports the view that 'likely', at least in the context of in sections 45, 46 and 47 of the Trade Practices Act, does not require a standard of more likely than

18 Re Continental Pacific Insurance Co (Australia) Ltd (unrep) NSWSC Barrett J (26/8/02) (appointment validated); Glen Morton Holdings Pty Ltd v D'Aloia (unrep) FAC per Merkel J 14/9/01 (appointment validated); Wagner & Anor v International Health Promotions & Ors (1994) 12 ACLC 986 (appointment invalid and not cured); Gordon v Allied Meridian Pty Ltd [1999] NSWSC 558 (appointment invalid and not cured); DCT v Portinex [2000] NSWSC 99 (7/6/2000) (appointment validated); Re Wood Parson Pty Ltd (in liq) (2003) 21 ACLC 111 (appointment validated); Shirlaw v Graham [2001] NSWSC 612 (10/7/01) (appointment validated); Panasystems Ltd v Voodoo Tech Pty Ltd [2003] 21 ACLC 842 (appointment validated)

19 Cadwallader v Bajco Pty Ltd NSWSC Austin J (unrep); NSWCA [2002] NSWCA 328 per Heydon, Santow JJA and Gzell J qzls S0111430115v1 150520 21.3.2005 Page 39 not but rather simply a real chance or possibility. In Tillman's Butcheries Pty Limited v Australasian Meat Industry Employees Union (1979) 42 FLR 331 at 339 Bowen CJ said:

The word 'likely' is one which has various shades of meaning. It may mean 'probably' in the sense 'more probable than not – more than a 50% chance'. It may mean 'material risk' as seen by a reasonable man 'such as might happen'. It may mean 'some possibility – more than a remote or bare chance'. Or, it may mean that the conduct engaged in is apparently of such character that it would ordinarily cause the effect specified'.

In the same case, Justice Deane said at 346:

The word 'likely' can, in some contexts mean 'probably' in a sense in which that word is commonly used by lawyers and laymen, that is to say, more likely than not, or more than a 50% chance' … it can also, in an appropriate context refer to a real or not remote chance or possibility regardless of whether it is less or more than 50%. When used with the latter meaning in a phrase which is descriptive of conduct, the word is equivalent to 'prone' , 'with a propensity' or 'liable'. …

As noted above, section 436A(1) enables directors to appoint a voluntary administrator when, in the opinion of the directors voting for the resolution, the company is insolvent or is likely to become insolvent at some future time. If the directors of a company want to appoint a voluntary administrator to the company under Part 5.3A of the Act they need to pass a resolution that in their opinion the company is insolvent or is likely to become insolvent at some future time. The provision does not limit VA to situations of actual or present insolvency and the extent to which the process can be used for presently solvent companies which satisfy the second limb of s436A(1) remains to be fully explored. The obiter comments made in Crimmins v Glenview Home Units Pty Ltd [2001] NSWSC 599 (unreported 17 August 2001) support the view that the likelihood of insolvency occurring many years in the future would suffice to satisfy s436A(1). If this decision is followed it affords directors of companies an opportunity to appoint a voluntary administrator well prior to actual insolvency. In Crimmins the court made the following observations:

"There is no test prescribed in s. 436A which assists a director as to what matters are to be taken into account in forming the opinion that a company is likely to become insolvent, nor as to who imminent insolvency should be before a director is justified in invoking the drastic remedy of administration. This is hardly surprising. The circumstances in which companies find themselves in difficulty and their prospects of financial survival or extinction are infinitely various. (para 47)

It is for this reason that the only criterion for judging whether an opinion as to likely insolvency has properly been formed for the purposes of s. 436A is whether that opinion has been formed genuinely and in good faith: see e.g. Kazar v Duus …

qzls S0111430115v1 150520 21.3.2005 Page 40 Clearly, determining whether an opinion as to likely insolvency has been genuinely formed involves both subjective and objective elements. The subjective element requires that the court be satisfied that the requisite opinion is actually held by the director. The objective element requires that the court be satisfied that a competent director in the position of the director concerned could reasonably have formed the opinion on the facts known to that director …

However, it must be borne in mind that forming an opinion whether insolvency is 'likely' for the purposes of s. 436A does not involve the same test as determining whether reasonable grounds exist for suspecting that a company is insolvent or will become insolvent for the purposes of s. 588G. The scope for forming an opinion of likely insolvency is very broad under s. 436A. For example, a director may legitimately form the view that insolvency is likely ten years hence because the company's business is founded upon a particular technology which will be completely obsolete by that time and the company's business is already dwindling at such a rate that continuing liabilities will inevitably outstrip the company's ability to pay. Such a view would not, in itself, render the director liable under s. 588G for a debt incurred by the company the day after that view was formed, but it may well justify the director in immediately invoking the aid of s. 436A." (paras 49-51)

It is submitted that under present law, directors of a company which was not presently insolvent but had inadequate resources to meet expected debts as they fell due for payment in the future could, in appropriate circumstances, appoint an administrator before the debts had in fact fallen due for payment. It is worth taking into account the fact that in Associated Dominions 20 in the High Court found that a life insurance company which would only run out of money in 7 years time was then presently insolvent21. So long as the directors form a genuine or bona fide view of present insolvency, or the likelihood of insolvency at some time in the future, it would be difficult to say how such an appointment could be challenged on the grounds of improper purpose 22. (e) Does the present wording require amendment?

While the present wording in section 436A has been interpreted by some judges as being very flexible (for example in Crimmins v Glenview Home Units Pty Ltd [2001] NSWSC 599 (17 August 2001) recommendation 14 is designed to alleviate perceptions that the VA procedure is only available to insolvent companies. For reasons including those set out in above, it is submitted that the amendment is a very crude way of seeking to bring about that end and that it has the real potential of facilitating abuse of the process by healthy companies.

20 The Insurance Commissioner v Associated Dominions Assurance Society Pty Limited (1953) 89 CLR 78

21 The decision in Edwards & Ors v Attorney General & Anor (unreported) [2004] NSWCA 272 suggests a different result may obtain where the future liabilities are not contractual certainties but potential future tort claims.

22 see Taylor, T Australian Insolvency Management Practice at ¶l 54-560 qzls S0111430115v1 150520 21.3.2005 Page 41 On 30 June 2004, the Parliamentary Joint Committee tabled its final report (the Final Report) in Parliament on the operation of Australia's insolvency laws and recommended that the threshold test permitting directors to make the initial appointment of an administrator under the VA procedure be revised in order to alleviate perceptions that the VA procedure is only available to insolvent companies. However the Parliamentary Joint Committee did not state with as much certainty its position regarding a new threshold test for the initiation of the procedure by directors, that is, changing the test from "the company is insolvent or likely to become insolvent at some future time" to "the company is insolvent to may become insolvent". While the Parliamentary Joint Committee conceded that the VA procedure could be moderated, it did not specifically accept the revised test and simply "noted" the suggestion. The report reads: The Committee notes the suggestion that the test be reworded to read 'the company is insolvent or may become insolvent'. Unfortunately this result does not clarify the way in which this area may evolve in Australia, however, it will be interesting to note the way in which this area progresses and, perhaps, a sign of things to come.

9.2 Ipso facto clauses The Paper made a proposal that creditors should be prohibited from enforcing ipso facto clauses, unless the court grants leave in certain defined circumstances. While there can be real difficulties for companies in VA where contracting parties exercise termination rights on appointment, it is submitted that any legislative response has to attempt to draw a boundary line somewhere between the wish to rehabilitate companies, the rights of secured creditors, the availability of funding for healthy companies and the rights of creditors and contracting parties. It is submitted that Part 5.3A does a good job and fixes that boundary line at around the right place at the moment. Counter-parties with contracts with companies in administration should have the right to decide if they want to continue to trade with them or not. If they form the view that the company can be turned around they may well not exercise their ipso facto rights and certainly, in the author's experience, many counter-parties would much prefer that a company with which they trade remain in business and continue to use their goods and services. No doubt preventing the exercise of contractual termination rights could have a real role to play in the successful turnaround of some businesses – One-Tel may be an example – but such a provision would be a substantial interference in the rights of counter-parties and may well have deleterious effects on their own financial situation and on the economy as a whole. One might ask the question: shouldn't market forces determine with whom companies trade rather than administrators and courts? A hesitation may be that any provisions seeking to curb the rights of counter-parties to exercise rights under ipso facto clause would need to be very carefully put together to avoid the situation in which counter-parties include immediate termination provisions on insolvency events or include provisions giving rights to terminate earlier than on the appointment of an administrator. It would be difficult for a court to interfere, for example, if qzls S0111430115v1 150520 21.3.2005 Page 42 a counter-party has terminated in accordance with its contractual rights and contracted with an innocent third party before the administration has begun or before the administrator gets the matter before the court. The Final Report concluded that it is more appropriate for a court to consider whether, in a particular situation, contracts should be kept on-foot rather than introducing legislation to automatically overriding ipso facto clauses in a VA.

9.3 An indication of things to come? – Other conclusions of the Final Report Other key recommendations of the Final Report, in addition to those discussed at 9.1 and 9.2, were:- • directors to be made more accountable for failing to keep proper records and unpaid employee entitlements; • uncommercial transactions to be extended by removing insolvency as a prerequisite; • the timetable for VAs to be extended; • an insolvency procedure modelled on Chapter 11 of the US Bankruptcy Code is not appropriate for Australia; • provisions for disqualification of directors for dishonest conduct to be broadened; and • the Australia Taxation Office to be given broader powers with respect to outstanding Superannuation Guarantee Charge.

10. Conclusion

Australia has a range of formal external control procedures for corporations. This paper gives an overview of each of them and briefly comments on how useful each area is as a tool for restructuring. Only VA was specifically designed to, if possible, facilitate reorganisation. VA is a flexible process which can be cost effective. There are recommendations to reform the process, some of which may improve it.

qzls S0111430115v1 150520 21.3.2005 Page 43 NOTE: This document is intended only to provide a general review on matters of concern or interest to readers. The text of this document should not be relied upon as legal advice. Matters differ according to their facts. The law changes. You should seek legal advice on specific fact situations as they arise. Parts of this paper have been extracted from the Allens Arthur Robinson Annual Reviews of Insolvency and Restructuring Law 2002 and 2003.

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