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http://www.minterellison.com/articles/development-for-administrators-preserving-business-value-during-covid-19-hibernation

Development for administrators preserving business value during COVID-19 hibernation

12 minute read  06.05.2020 Taline Chater

A Federal Court of Australia decision has set the scene for providing flexibility to administrators in entering into good faith negotiations with commercial or retail landlords.


Key takeouts


This decision demonstrates that the Court is willing to provide administrators some flexibility in respect of their statutory personal liability under s443B(2) and section 443A(1)(c) of the Corporations Act 2001 (Cth) (Act) in these extraordinary COVID-19 circumstances.

It is an important development for administrators who are otherwise facing significant challenges in preserving the value of a business in the current COVID-19 business hibernation period and in a constantly evolving legislative landscape, particularly as it has impacted the retail and hospitality industries.

The NSW Government has now introduced the Retail and other Commercial Leases (COVID -19) Regulation 2020. This will provide administrators with some flexibility in entering into good faith negotiations with commercial or retail landlords and agreeing terms as they seek to preserve the value of a business with a view to achieving either a going concern sale or restructure for the benefit of creditors.

The Federal Court of Australia has recently exercised its powers to:

  • Grant an order that the administrators of the Colette Group are not personal liable for any property leased used or occupied, or for rent or other amounts payable pursuant to certain commercial leases for a limited period; and
  • Direct that the administrators are justified in not paying rent to landlords of tenant companies for a limited period of time.

On 9 April 2020, the Federal Court of Australia published its reasons for granting the above orders made on 1 April 2020 in Strawbridge (Administrator), in the matter of CBCH Group Pty Ltd (Administrators Appointed) (No 2) [2020] FCA 472. Initially the orders were limited to a two week period, expiring on 14 April 2020. MinterEllison understands that on 15 April 2020, these orders were extended by the Court to operate for a further three weeks until 6 May 2020.

The Colette Group is bag, jewellery and accessories retailer. Administrators were appointed to the various companies within the Colette Group on 31 January 2020. The Colette administrators sought the above orders with respect to 93 Australian based stores, owned by 17 different landlords (Landlords).

The stores were trading since the administrators' appointment and the administrators meeting the relevant lease obligations, but a decision was made to close the stores on 26 March 2020 due to the COVID-19 pandemic. The administrators indicated they were unwilling to reopen the store until such time they considered it would be safe for the stores' employees to do so and that, moreover ,it would not be economically viable to open the stores in the climate of the COVID-19 pandemic.

Between 19 and 20 March 2020, the administrators requested a 100% rent reduction from the Landlords until such time that either a buyer for the Colette Group had been identified and a sale agreement executed, or, in the alternative, the commencement of a winding down. However, by close of business on 28 March 2020, the administrators had received rent reductions from the landlords equating to 9% of their total rent liability across their store portfolio.

Significantly, in their evidence to the Court, the administrators presented the modelling of multiple hypothetical alternative scenarios with respect to the potential outcomes of the administration process, which included:

  • Two COVID-19 based shut down and wind up scenarios where stock would either be abandoned at the stores or removed and stored at a distribution centre to attempt to sell the stock in the future.
  • A post COVID-19 sale period after two months of 'mothballing' where the Administrators would retain possession of the 93 stores for a two month period whilst continuing operating an online presence with the stores to be reopened at an appropriate time while conducting a sale process (Mothballing Scenario).

The administrators provided evidence that of all the scenarios modelled they considered that the Mothballing Scenario would provide the most value for creditors because post COVID-19 they would have the option of undertaking a managed wind-down or facilitating a sale or recapitalisation through a Deed of Company Arrangement (DOCA).

Legislative framework

Section 447A of the Corporations Act 2001 (Cth) (Act) enables the Court to make orders which alter the way Part 5.3A of the Act operates in relation to a particular company.

It is well established that the Court has power under section 447A of the Act to make orders limiting an administrator's personal liability under section 443A of the Act in certain circumstances. (see Mentha, in the matter of Griffin Coal Mining Company Pty Ltd (administrators appointed) [2010] FCA 1469 (Griffin Coal) at [29] to [30]). In Griffin Coal the administrators applied for, and were granted, limitation of their personal liability in respect of grants of new mining leases, licences, exploration licences and prospecting licences, including liability for rent, such that they were only liable for debts accrued during, or were attributable to the administration period. As Gilmour J observed in that matter, at that time most of the cases where courts had exercised power under section 447A of the Act to vary an administrator's personal liability under section 443A had involved administrators borrowing funds during the period of the administration and that the orders usually sought had the effect of limiting recourse of the counterparty to the administrator personally to the extent to which he or she was able to be indemnified from the assets of the company [at 30].

Administrators are also able to seek directions from the Court pursuant to section 90-15 of the Insolvency Practice Schedule (Corporations) (Schedule 2 to the Act) in relation to any decision they have made or propose to make. Administrators may apply for such directions for the purposes of seeking protection against claims that they have acted unreasonably or inappropriately or in breach of their duties in making such a decision (see Re Ansett Australia Ltd and Korda [2002] FCA 90; (2002) 115 FCR 409 at [44]).

The Federal Court's reasons

Justice Markovic in granting the first order limiting the personal liability of the administrators between 1 and 14 April 2020, made the following critical comments:

  • It was clear that varying the administrators' personal liability for rent for an initial two week period, in the circumstances of the current uncertain physical, legal and economic landscape of the COVID-19 pandemic, was in the interests of the Colette Group's creditors as a whole as it left open the possibility for the Colette Group's business to trade for the benefit of its creditors. In this regard the Court observed the evidence that the Mothballing Scenario was likely to realise the most value for the Colette Group's creditors because post COVID-19 they will have the option of undertaking a managed wind down or re-engaging with interested parties to facilitate a sale or recapitalisation through a DOCA. It was therefore in the best interests of the creditors as a whole.
  • On balance, there was no prejudice or disadvantage to creditors if the order was made. This was significant in the Court's consideration of prejudice. The Court noted that whilst the landlords would experience the determinant of becoming unsecured creditors with respect to the rental payment due to them for the period the orders operated (initially 1 – 14 April 2020) the Landlords would be in no worse position if the order was made than if the stores were vacated, and the Mothballing Scenario left open the possibility of the Landlord's positions improving.

The Court highlighted that the circumstances of the case 'could not be described as "usual". They are in fact extraordinary' (at [57]) .

The Court's reasons of 9 April 2020 also indicate that her Honour accepted the administrator's submissions that the decision to not cause the Colette Group to meet its future rental obligations was made in the context of:

  • The COVID-19 infection rate in Australia continuing to increase daily so that it is presently unclear when it will be safe to recommence retail operations;
  • Other major jewellery, clothing, footwear, stationery and department store retailers taking action similar to that proposed by them;
  • The uncertainty about the availability or reach of any stimulus package to underwrite commercial rent or any legislative intervention;
  • The Administrators’ largely unsuccessful attempts to negotiate rent reductions with the Landlords; and
  • The fact that notice has been given to the Landlords.

It is to be noted that, having been notified, the Landlords adopted a nuanced but essentially neutral position, either neither consenting or opposing to the orders being made, with others relying on the administrators' undertaking that the affected stores would not be reopened while the orders remained on foot, and that they would continue to re assess the position as events unfolded.

Overall, her Honour was satisfied it was appropriate to order the administrators were justified in not meeting their rental obligations for a two week period up until 14 April 2020 (and then up to 6 May 2020), noting that:

  • Continuing to pay rent in the current client would deplete the Colette Group's cash resources in a significant way;
  • Whilst the Collette administrator's proposed course is unusual and will jeopardise the Colette Group's tenancies, it is 'the preferable course, taking into account the creditors’ interests as a whole in the maximisation of the value of the Colette Group’s business and the current commercial environment in which that business operates." (at [64]).

While the reasons for the Court's decision to extend the above orders to 6 May 2020 are not yet publicly available, we understand that the Administrator's reasons for seeking the further extension included:

  • To assess the impact of, and model, the Commercial Tenancy Code of Conduct (which is not yet legislation in Australian states and territories) and to continue their negotiations with the Landlords.
  • To assess the impact of the Federal Government's Jobkeeper package on the business.

We also understand that the administrators had limited evidence to show the Court that there was no significant interest from alternative tenants, which supported the argument that the landlords would be no worse off than the alternative of the leases being disclaimed in a wind down situation.

Government COVID-19 relief for tenants

The Federal Government has issued the Code which set outs 'good faith leasing principles for application to commercial tenancies' (commercial, retail and industrial leases) where the tenant is eligible for the Commonwealth JobKeeper program and is a business with a turnover or an annual group turnover of up to A$50m and has experienced a COVID-19 related decline in revenue of at least 30%. The principles set out a framework for negotiations of rent requiring rent relief to be determined in proportion to the decline in the tenant’s turnover, with waivers to make up at least 50% of the rent relief and the deferral of the balance, the prohibition of termination of a lease by the landlord and a prohibition on drawing down on security held (including, bank guarantees) during the relevant COVID-19 period and any subsequent reasonable recovery period in circumstances of non-payment of rent.

The Federal Government will expect landlords to act in accordance with the spirit and principles of the Code. We note, however, that legislation and/or regulations are to be introduced in each state and territory in order for the Code to have legal effect and greater clarity in relation to the extent and nature of the mechanics of the Code (in respect of NSW see below). The principles in the Code are broad and open to interpretation, particularly as they may apply in either a voluntary administration or receivership. This framework will however, provide a starting point for Administrators or Receivers to have good faith discussions with landlords as they take steps to sell or recapitalise a business.

The Retail and other Commercial Leases (COVID -19) Regulation 2020 (Regulation) has now commenced in NSW which gives effect to the Code by:

  • Prohibiting and regulating the exercise of certain rights of landlords relating to the enforcement of commercial and retail leases during the COVID-19 pandemic period, and
  • Requiring, in response to the COVID-19 pandemic, that landlords and tenants renegotiate the rent and other terms of those commercial leases in good faith having regard to the leasing principles set out in the Code, before any legal enforcement action of the terms of those commercial leases can be commenced.

Relevantly, clause 6(6) of the Regulation preserves the right of landlords and tenants to agree to take any action in relation to a lease.

As the Regulation was made by way of amendment to both the Retail Leases Act 1994 (NSW) and the Conveyancing Act 1919 (NSW), it covers both retail and commercial leases. The Regulation commenced on 24 April 2020 and will be in force for 6 months, after which time it will be repealed.

Most recently, on 13 April 2020 the NSW Government announced a $440 million COVID-19 package for tenants and landlords. In short the package includes:

  • A six month moratorium for residential tenants providing a moratorium on new forced evictions if the tenant is in rental arrears because they are suffering financial hardship due to COVID-19 and an obligation on landlords to enter into negotiations with a tenant before a landlord is able to terminate a tenancy agreement. Unpaid rent will however continue to accrue as arrears during this period.
  • $440m to be provided by way of tax relief to landlords by either waiving land tax or providing a rebate of up to 25 per cent to be divided between commercial and residential sector landlords if they are accommodating of tenants under financial stress due to COVID-19.
  • Land tax deferrals for commercial landlords if they pass the savings on to tenants through a rent reduction.
  • The Government has said that it will give legal effect to the principles in the Code as soon as possible.

Please get in touch if you wish to know more about how these changes will impact your organisation. 

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http://www.minterellison.com/articles/development-for-administrators-preserving-business-value-during-covid-19-hibernation

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