Creditors' trusts are becoming more common in their use as companies seek to quickly distance themselves from the voluntary administration process and continue on with their corporate lives. This is often for legitimate reasons, the most common being for publicly listed companies seeking to minimise the impact of voluntary administration on their listed status.

A creditors' trust in its simplest form sees the creditors of a company forego their rights as creditors against that company and in return become beneficiaries under a trust to share in a "trust fund" that is established for this specific purpose. The Administrator usually becomes the trustee of the trust and has the main job of realising the trust fund and distributing it to the beneficiaries.

1. Creditor's Trusts And Deeds Of Company Arrangement

Ordinarily, a creditors' trust is implemented as part of a deed of company arrangement (DoCA) with the practical effect that the DoCA is entered and then, shortly after, terminated and replaced with the creditors' trust. The big advantage of this strategy is that once the DoCA is terminated, the company is no longer subject to any form of external administration and the claims of its previous creditors are gone.

To get off the ground, the strategy has to be approved by creditors at the major meeting held during the voluntary administration process. Where the creditors' trust route provides the best return for creditors, it is not uncommon for creditors to vote in favour of the proposal.

Practitioners have different views on when it is and is not appropriate to use creditors' trusts. ASIC has given some guidance on this by issuing Regulatory Guide 82, which specifically deals with creditors' trusts and their use.

2. Problems With The Use Of Creditor's Trusts

One of the major issues with creditor's trusts is that creditors effectively lose the protections and rights contained in the Corporations Act, which they would have retained under a DoCA. This includes the ability to object and appeal the Administrator's decision on the value of the creditor's claim, the ability for the court to terminate the DoCA and the court's overriding ability to supervise the process.

Under a creditor's trust, the Corporations Act has little operation and creditors are largely limited to the rights actually contained in the trust deed and the general law.

In the recent case of Parkview Constructions Pty Limited [2009] NSWSC 186, the Court was critical of the situation that resulted from the implementation of a creditors' trust. In that case, Parkview, a creditor applied to set aside the DoCA of Sydney Civil Excavation Pty Limited (Sydney Civil) on a variety of grounds.

The Court ultimately found that it was unable to assist Parkview given the DoCA had already been terminated and replaced with the creditors' trust. It was clear from the judgment that the Judge had considerable unease that the creditors' trust had prevented Parkview from obtaining any relief from the Court. The Judge considered it a matter of concern that the "protective aspects of Pt 5.3A...can be avoided by the creation through a deed of company arrangement of a parallel but essentially unregulated regime of administration."

The Court further provided a clear warning to Administrators about their disclosure obligations when recommending a DoCA that will lead to a creditors' trust. In such circumstances, Administrators "bear a heavy burden of explaining to creditors the implications of the shift from a regime incorporating a court administered scheme of creditor protection to one in which creditors become passive trust beneficiaries."

3. Implications

This case provides a timely reminder to Administrators about the use of creditors' trusts. Specifically, practitioners should take note of the Court's comments when preparing reports to creditors about any proposal that includes a creditors' trust. To avoid any uncertainty it may be better to approach the Court for approval to execute the proposed creditors' trust, although the delay in seeking that approval may defeat what is trying to be achieved by the creditors' trust in the first place.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.