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Legal Briefing No. 4
CORPORATE INSOLVENCY: PROTECTING THE COMMONWEALTH
The Corporations Law deals with a number of different types of insolvency administrations. The Commonwealth is sometimes required to deal with a company which has entered an insolvency administration of one form or another. On other occasions, the Commonwealth may need to consider whether to place a company into administration, and if so, what form of administration is most appropriate. Client Departments who are administering grant schemes may also need to enforce security which has been provided as a condition of the grant. In order to deal with these situations, it is necessary to understand the implications of the different types of corporate insolvency administration.
This Briefing:outlines provisions in the Corporations Law (including the amendments recently introduced by the Corporate Law Reform Act 1992) which need to be taken into account where the Commonwealth has an interest in a company that is, or is likely to become, insolvent. Some practical suggestions for safeguarding the Commonwealth's interests in dealing with companies that are in financial difficulties are also provided.
Relevant Provisions In The Corporations Law
The following types of external administration are addressed in the Corporations Law (the most directly relevant parts of the law are noted in brackets):
(official) liquidation (Part 5.4);
provisional liquidation (Part 5.4);
voluntary liquidation (Part 5.5);
receivers and receiver/managers (Part 5.2);
entry into possession by mortgagee or agent (Part 5.2);
scheme of arrangement (Part 5.1); and
voluntary administration (new Part 5.3A)
Each type of external administration is designed to meet a specific need. A decision to favour one form of administration over another will depend on individual circumstances and the commercial judgement of the creditors and members whose interests are affected. The following paragraphs provide some basic information about the three most important forms of insolvency administration liquidation, receivership and voluntary administration.
Where an insolvent company is placed into liquidation (whether by way of a creditors' voluntary winding up, or an official liquidation under the supervision of the court) the liquidator will have wide investigatory powers, and extensive powers to reverse transactions entered into or recover debts incurred while the company was insolvent. The main constraints are the time taken to initiate the process and the limited power of the liquidator to carry on the business of the company.
Receivership is a remedy available to a major creditor who holds a registered charge over the assets/undertaking of the company. The main advantages of receivership to a secured creditor are the wide and flexible powers commonly conferred on the receiver under the loan instrument, particularly powers in relation to the running of the business, and the capacity for an appointment to be effected quickly and relatively inexpensively after giving adequate notice of demand.
The disadvantages of receivership are the limited investigatory powers of the receiver and that the receiver has no power to reverse relevant transactions entered into while the company was insolvent.
The major advantages of the new voluntary administration scheme (which came into operation on 23 June 1993) are:
from the company's perspective, it provides a "breathing space" in the form of a moratorium from its creditors and protection from winding up without special Court consent; and
it provides creditors with the opportunity to put in place a deed of company arrangement at a significantly reduced cost and more quickly than a scheme of arrangement, principally because the arrangement is not subject to sanction by the Court.
These aspects should benefit all creditors by offering a more flexible approach to solvency difficulties. Secured creditors, however, have certain special rights under the scheme which should be borne in mind by the Commonwealth when it is assessing whether to seek security in respect of a particular debt. In particular creditors with security over all or most of the property of a company can opt out of a deed of voluntary administration scheme and can enforce their security (even during the moratorium period) if they elect to do so within the statutory period.
While there may be social policy reasons for the Commonwealth not to require security over its loan interests, a secured interest is the most effective way legally of protecting Commonwealth loan funds. This is because:
the secured loan will be given priority over unsecured interests in any winding up of the company;
the loan agreement for a secured interest would normally provide for the appointment of a receiver or mortgagee in possession in the event that the company defaults in its loan repayments or fails to comply with other terms and conditions of the loan agreement this enables the Commonwealth to keep in control if problems develop;
the rights of unsecured creditors to take recovery action against the company are restricted from the time the company goes into liquidation unsecured creditors will have a right of claiming by proof of debt against a liquidated company but (except in limited circumstances with the approval of the liquidator) are not able to pursue individual actions against the company.
Where the Commonwealth has no shareholding interest in a debtor company and is not represented on the board of the company, client Departments will also need to consider whether the Commonwealth should require the directors of the company to which the loan is provided to give personal guarantees as security for the loan.
Consideration should be given to whether the loan arrangement ensures that the Commonwealth will be provided with sufficient financial information to enable informed judgements to be made about the financial viability of the company. These judgements will in turn provide the basis on which proper decisions can be made about the most appropriate courses of action available to the Commonwealth.
Where the Commonwealth is the major creditor of a company and is aware that the company is in financial difficulty, one option available is to reach agreement with the company for the appointment of an investigative accountant, usually an insolvency specialist, to review the current financial position of the company and its future commercial viability. Such a review will often initially focus on key financial indicators, such as cash flow, asset structure, and market position, and then develop a rehabilitation plan, including debt restructuring proposals, to preserve the business and to improve its financial position.
One outcome of the appointment of an investigative accountant, and an option which should be considered whenever the Commonwealth is aware that a debtor company has financial problems, is to renegotiate the loan agreement with the objectives of either tightening the degree of Commonwealth supervision of the debtor company and/or to increase the prospects that the company will be able to trade out of its financial difficulties.
Where the Commonwealth becomes aware that a company is or could be in financial difficulties, great care needs to be taken in accepting any payments from the company. Knowledge of the difficulties could expose the Commonwealth to an action by a subsequently appointed liquidator for recovery of the payment on the basis that it was an undue preference in favour of the Commonwealth over the creditors. The Commonwealth should not enter into any transaction with such a company without taking legal advice.
Where the Commonwealth forms the view that a debtor company which has defaulted under the loan agreement is, or is likely to become, insolvent three main options need to be considered:
demand repayment of the debt subject to the comments in the previous paragraph;
initiate formal insolvency administration procedures; or
negotiate alternative arrangements (for example, debt restructuring).
The traditional forms of external administration (that is, those available prior to commencement of the new voluntary administration procedures in Part 5.3A) provide limited opportunity for the restructuring of debts and for measures to be put in place for the rehabilitation of the debtor company. The new voluntary administration procedures offer scope for rehabilitation plans to be put in place within a formal administration process, although it will be necessary for the Commonwealth to be secured over the whole or substantially the whole of the company's assets before it will itself be in a position to initiate the voluntary administration procedures.
The Commonwealth's capacity to protect its equity investment will be limited by the extent of its representation on the board of the company. Where the Commonwealth has complete ownership and control of a company, the interests of the Commonwealth and the interests of the company largely coincide. Where, however, Commonwealth officers are appointed as directors of a company in which the Commonwealth has less than a 100% interest, the directors will be obliged to safeguard the interests of the company as a whole, even if there is a divergence between those interests and the interests of the Commonwealth, and the Commonwealth will therefore not have complete control over the funds that it has invested in the company.
To comply with their duties and liabilities under the Corporations Law, particularly in relation to insolvent trading liability, Commonwealth officers who are representing the Commonwealth on the board of a company should consider whether the board of the company is supplied with relevant accounting information ahead of regular board meetings at which key financial decisions are to be made. Where a significant borrowing is to be undertaken, it may be appropriate for the management to supply the board with a statement of the company's current financial position, as well as particulars of the way in which the principal, interest and other charges are to be serviced over the anticipated term of the loan. Where the nature of the business may expose the company to a high risk of sudden liquidity restriction, or the company is known by the director to be in financial difficulties, extra care and more rigorous safeguards should be adopted.
In conclusion, the most important point to be emphasised is the need for the Commonwealth to act commercially in its dealings with companies and to make informed commercial judgements within the legislative framework of the Corporations Law.
It is essential that the Commonwealth put in place appropriate loan arrangements, preferably those which give security over the assets of the debtor company, and which ensure that the Commonwealth receives relevant financial information to allow it to make commercial judgements about the ongoing financial position of the company. The Commonwealth also needs to make such judgements in identifying problem loans, renegotiating loan agreements and deciding whether to enforce legal rights under the loan agreement or to negotiate alternative arrangements with the company.
Similarly, Commonwealth representatives on the board of government companies need to make commercial judgements about the ongoing financial position of those companies in order to comply with their duties and liabilities under the Corporations Law, particularly in relation to insolvent trading liability.