The economic impacts of COVID-19 are unexpected and significant. The Australian Government has announced a number of reforms to address these impacts including temporary relief from insolvent trading laws. Notwithstanding those measures, there remains risk for directors of companies that are unable to pay their debts as and when they are due. In particular, directors still need to adhere to their regular general law and statutory duties, including to take into account the interests of creditors if the company is in the zone of insolvency. Directors of companies in financial distress should be taking expert advice regardless of the ongoing government reforms. Unfortunately, for some companies, the temporary reforms and safe harbour defence may not be enough. In those circumstances, directors should understand that the voluntary administration process provides a significant degree of flexibility to implement arrangements, including standstill arrangements, pending changes in circumstances. We have outlined some of the options that may be considered.
Voluntary administration
Much like safe harbour, the intention of the voluntary administration regime is to facilitate the survival of a company, corporate group or underlying business. A company may appoint an administrator where the board is of the opinion that the company is, or is likely to become, insolvent at some future time. While the voluntary administration process passes control of the company to administrators, directors and stakeholders including shareholders and secured creditors can play a significant role and influence the outcome through a deed of company arrangement (DOCA).
During the voluntary administration process there are two meetings of creditors. The first meeting is a formality where creditors determine whether to replace the administrator and form a committee of inspection. The second meeting is where creditors decide the fate of the company. That meeting follows a report to creditors issued by the administrators. In that report the administrators are obliged to present creditors with any relevant DOCA proposals, and make an independent recommendation about whether creditors should agree to the DOCA proposal (if any) or resolve to wind up the company in insolvency.
DOCAs
DOCAs are a statutory instrument binding on all unsecured creditors. They are entered between a DOCA proponent (the person proposing the DOCA, usually the directors, shareholder/s or another stakeholder), the company, the administrators, unsecured creditors and, in some circumstances, secured creditors.
DOCAs are a flexible tool that can accommodate the implementation of unique solutions that address the particular financial circumstances of the relevant company or corporate group. While ultimately it is the unsecured creditors of the company that decide whether a DOCA is implemented, generally unsecured creditors will follow the recommendations of the administrator.
The typical DOCA usually involves unsecured creditors participating in a fund that is created by a contribution from a stakeholder or from proceeds of sale of property owned by the company, for example its business. Creditors receive a dividend that is better than a dividend in a liquidation scenario and the company emerges from insolvency to continue to trade. However, DOCAs can be more complex. They may involve:
- Debt for equity swaps;
- Restructuring of long term contractual arrangements;
- Pooling group companies or property;
- Takeovers or restructuring of corporate structures (with consent of shareholders, leave of the court and necessary regulatory approvals); or
- Standstill arrangements pending a further DOCA proposal being made, also known as 'Holding DOCAs'.
Holding DOCAs
Generally, Holding DOCAs only provide for an extension of the statutory moratorium on creditor claims against the company pending further investigations by the administrator and the development of an alternative proposal by key stakeholders. In 2018, in a case called Mighty River International Ltd, the High Court endorsed the use of Holding DOCAs as a legitimate tool that is consistent with the voluntary administration regime. In that case the High Court reasoned that the relevant deed in question fulfilled the object of the voluntary administration process by maximising the chance of the company's survival and otherwise providing a better return to creditors than would result from its immediate winding up.
A Holding DOCA is an effective way to provide insolvent companies breathing space while a permanent restructure is designed by the administrators or other stakeholders. However, Holding DOCAs may not be the best solution for certain creditors, particularly employees. While a company is in voluntary administration or subject to a Holding DOCA, employees are not able to access the Australian Government's Fair Entitlements Guarantee scheme. That scheme allows employees that are terminated because of a company's insolvency to be paid certain unpaid employee entitlements, with the Government taking their place as a creditor in the winding up. In these challenging times, it may be in the best interests of certain creditor classes for other restructuring options to be implemented or the company to be wound up.
If a Holding DOCA is in place, there will be a third meeting of creditors to vote on the ultimate future of the insolvent company. The permanent proposal put to creditors at that meeting will ultimately depend on the circumstances of the relevant company.
The economic challenges arising from COVID-19 may mean that a Holding DOCA is the best option for companies that are or will shortly become insolvent because of COVID-19 and do not presently have capital to contribute, and are unable, in the current market, to sell the underlying business.
No one-size-fits-all solution
There is no one-size-fits all solution for businesses in financial distress. The right solutions depend on the particular circumstances of the relevant company including its underlying business fundamentals, industry and exposure to COVID-19 supply chain, regulatory and finance disruptions. In order to survive these unprecedented challenges over the long term, businesses need to consider the wide range of solutions available to them – some of which may require some lateral thinking.
Our team of insolvency and reconstruction lawyers can provide guidance around some of these options to boards, companies and stakeholders affected by COVID-19 and in what circumstances they may be useful.
