Insolvency Law Reform – Key Changes

The Parliamentary Secretary to the Treasurer released an exposure draft of proposed reforms last Friday that are set to modernise, streamline and strengthen Australia's insolvency laws.

Representing the first substantive changes to our corporate insolvency laws since 1993, the provisions contained in the exposure draft of the Corporations Amendment (insolvency) Bill 2007 (draft Bill) reflect the four broad themes for insolvency reform identified in previous reviews of insolvency laws (conducted between 1997 and 2004):

• improving outcomes for creditors

• deterring misconduct by company officers

• improving regulation of insolvency practitioners

• fine-tuning voluntary administration.

Comments on the exposure draft have been sought by 23 February 2007.

Key aspects are:

1. Scrutiny of administrators' independence and remuneration
2. Regulating insolvency practitioners including registration, case management and reporting requirements
3. Procedural changes to the administration regime
4. Administrators' ability to borrow money
5. Statutory moratorium expanded to cover liens or pledges
6. Mandatory preservation of employee entitlements
7. Pooling of assets and claims in corporate groups
8. Measures to assist in the reconstruction of insolvent companies
9. Enhancement of creditor protection
10. ASIC v Rich: removal of penalty privilege
11. Other changes

The reforms will bring about greater scrutiny of administrators' independence and remuneration.

Administrators will be required to make a statement of independence in the form of a "declaration of relevant relationships" they have with the company, its associates, any former liquidators or any charge holder. The statement will need to explain why none of the relevant relationships result in the administrator having a conflict of interest or duty.

Administrators are also required to make a "declaration of indemnities" they have been given for their remuneration and in respect of debts for which they have a personal liability. The declaration must reveal the identity of the indemnifier and the extent and nature of the indemnity.

The existing prohibition on inducements offered to insolvency practitioners for referral of work will be extended beyond members and creditors of the company to directors, providers of professional services (eg accountants and lawyers) and associates of those persons.

The process for approving administrators' remuneration will be changed to codify and improve the information made available to creditors and the court. It is proposed that there be a report provided by the administrator to creditors to assist them in determining whether the proposed remuneration is reasonable. If the matter cannot be resolved by the creditors, it will be referred to the court, which can take several matters into account including:

• the quality of work performed

• the complexity of the work

• whether extraordinary issues are involved

• whether a high level of risk or responsibility is involved

• the value and nature of property dealt.

Most controversially where remuneration is calculated on a time basis, the court will need information about market rates.

Mirroring the position in liquidation, a creditors' committee in voluntary administration and committee of inspection under a DOCA will have the power to approve remuneration, which can now happen only when power has been conferred by court order.

Membership of the Institute of Chartered Accountants or CPA Australia will no longer be sufficient qualification for registration as a liquidator. Instead, emphasis will be placed on existing requirements for academic study and practical experience, which will be expanded to include all kinds of external administration, not just liquidations. The previous triennial statement under section 1288 will be replaced with a modified annual statement.

Changes are being made to procedures before the Companies Auditors and Liquidator's Disciplinary Board to facilitate better case management and for the publication of reasons for their decisions.

ASIC will be given an express power to investigate a liquidator's conduct if it has reason to suspect he or she has not faithfully performed their duties.

The reforms provide for the electronic distribution of notices and other information. Lenders will need to ensure the electronic notices are directed appropriately to the right people, including alternates if the initial recipient is away.

The time periods in the voluntary administration process will also be extended and consistent use of business days when calculating time periods will be implemented. The new notice periods for meetings are:

At the second meeting to wind up the company, creditors will be permitted to appoint a different practitioner as liquidator. At present the voluntary administrator becomes the liquidator.

The law will be clarified so that corporate creditors can become members of a creditors' committee and committees of inspection and be represented by an officer or employee or some other authorised person, obviating the need for a named individual to be appointed.

Voluntary administrators are personally liable for and have an indemnity for debts arising from goods bought, services rendered or property hired, leased used or occupied. The absence of a similar provision for any money borrowed by a voluntary administrator was an impediment to them borrowing to fund a trade on. Until now, the issue could only be addressed by applying to the court under section 447A, as occurred in Pasminco and Spyglass Management Group.

The draft Bill proposes to make voluntary administrators personally liable for borrowings made during the administration period. The borrowings will be secured directly by the administrator's statutory indemnity and lien and this priority will survive liquidation.

Despite this change, where there is a pre-existing floating charge the administrator's right of indemnity will only have priority for the money borrowed, interest on it and borrowing costs if the floating charge holder has consented.

At present the statutory moratorium imposed when a voluntary administrator is appointed only applies to charge holders, and owners and lessors of property. The draft Bill proposes to extend the moratorium to cover liens or pledges.

A voluntary administrator will also have power to dispose of assets which are subject to liens, or pledges or retention of title clauses. Bankers' liens over unpresented cheques and bills of exchange are, however, specifically exempted from this extension of the law.

Reflecting current practice, preservation of the insolvency priority of employee entitlements contained in s.550, 560 and 561 of the Corporations Act will become mandatory in DOCAs, able to be changed only if the affected employee creditors agree. Consent can only be obtained if the administrator first convenes a meeting of eligible employee creditors. The employee creditors must by a majority in number support the proposed change. This meeting of eligible employee creditors must be held prior to the administrator proposing the DOCA, and, holding the second creditors meeting to vote on the DOCA.

The Australian Tax Office's liability for the superannuation guarantee charge will be treated in the same way as the liability for superannuation contributions generally. The priority of GEERS or any other creditor who makes advances to fund the payment of those entitlements is to be confirmed, along with their entitlement to participate as a creditor in the same way as the employee could before they were paid.

The draft Bill sets out a new statutory 'pooling' mechanism to facilitate the administration of corporate groups in administration and liquidation. The new mechanism preserves the separate legal entities of each member company in the group while permitting pooling, with the effect that each company in the 'pool' will be taken to be jointly and severally liable for each debt payable by every other company in the group, and inter-company debts are extinguished.

Pooling is initiated by the administrator and can occur whether or not the company has executed a deed of company arrangement (DOCA). The thresholds for pooling seem to be relatively low: The company must be in administration, and any of a number of tests satisfied, including whether the companies in the group jointly own or operate particular property used in connection with a business, or whether there is a scheme or undertaking carried on jointly by the companies in the group.

If one of those tests is satisfied the administrator may determine in writing that, in the event that each of the companies in the group execute a deed of company arrangement, the group will become a pooled group. The administrator can modify the impact of the pooling determination for particular companies in the group.

The pooling determination will not apply to a secured creditor, although this exemption does not apply to a secured intra-group debt.

Prior to making the pooling determination, the administrator must give creditors notice of the proposed determination with a report setting out its reasons for the determination and identifying potential disadvantage to creditors if pooling proceeds. If a creditor objects to the proposed pooling determination it cannot proceed unless the court otherwise orders.

The court has jurisdiction to approve a pooling determination if it is just and equitable to do so having regard to a range of factors including the:

• extent of common management of the companies in the group
• conduct of a company, its officers and employees towards creditors of other companies in the group

• extent to which activities and businesses of the companies in the group have been intermingled

• advantage or disadvantage to creditors of a pooling order.

The exposure draft also provides for pooling in liquidation by either voluntary pooling, where every eligible unsecured creditor consents, or, by court ordered pooling, where a court makes a pooling order despite the objections of creditors.

The same thresholds used for pooling in administration apply to pooling in a winding up.

The exposure draft proposes changes that will bring the position on share transfers into line across the three insolvency regimes: voluntary administration, voluntary winding up and court ordered winding up. Transfers of shares in a company, or alterations in the status of the members of a company during administration are currently void unless the court otherwise orders. This contrasts with voluntary winding up where share transfers are permitted with the consent of the liquidator.

Nevertheless the ability to transfer existing shares may be a critical element in a work out or a reconstruction which seeks to improve the balance sheet or extract value from a disposal of the corporate shell.

Under the proposed reforms a transfer of shares or an alteration in the status of members can occur with the voluntary administrator's consent (mirroring the position in liquidation) provided the administrator is satisfied it is in the best interests of creditors as a whole. If the administrator does not consent then a court order can be sought to overcome the refusal. An administrator cannot agree to any proposed change to the status of a member that does not comply with the rules for alteration of class rights in Part 2F.2 of the Corporations Act. Nor is the court empowered to enforce any change to a member's status that would contravene Part 2F.2.

Compulsory sale powers may be beneficial to deed administrators to ensure share trading resumes. It may also be essential to the success of a DOCA that a share sale proceeds, where for example an investor proposes to acquire all shares in a company in return for a lump sum payment to creditors.

Under a DOCA the administrator will be able to dispose of shares of an existing shareholder with their consent, or without shareholder consent by court order, if the sale will not unfairly prejudice the interests of shareholders.

Currently any offer to substitute equity for debt must comply with the takeover provisions of the Corporations Act (Part 6D.2). The draft Bill proposes to remove this requirement, bringing DOCAs into line with Schemes of Arrangement and thereby removing the need for a meeting of Shareholders or ASIC's consent as a precursor to an offer to swap debt for equity.

External administrators will able to apply to the court to change the name of a company without having to hold a members meeting. This will facilitate company name changes where the cooperation of members cannot be obtained. As a further protection against "phoenix" activities if a company's name has been changed during, or six months prior, to external administration both the former and current name must be used in all public documents.

Claw back periods will be better defined when a voluntary administrator is appointed after a winding up application has been filed. In that scenario the relation back day will be the day when the application is filed, as opposed to when the voluntary administrator is appointed.

When liquidation follows a voluntary administration, the three years in which claw back proceedings must be brought starts from the date the voluntary administrator was appointed, not the date of liquidation. This will assist where liquidation has followed a lengthy period in administration or under a DOCA.

It will also be possible to challenge uncommercial transactions - even if they occurred during administration or while the company was under a DOCA - if the transactions were not authorised by the administrator or deed administrator.

In ASIC v Rich the High Court decided that proceedings to impose a banning or like order were essentially penal in nature and so the defendant was entitled to avoid filing evidence and giving discovery in those proceedings.

The draft Bill provides that a broad range of proceedings available to ASIC are deemed to not be penal in nature for the purposes of privilege laws. This includes proceedings for the suspension of a liquidator, and the disqualification of a person from managing corporations and/or holding certain financial services licences.

The removal of the penalty privilege will mean that any claim for penalty privilege by a person during an ASIC investigation, or in complying with discovery orders or answering interrogatories during those proceedings, will not prevent the material provided by the person from being used by ASIC in proceedings for disqualification, banning, suspension or cancellation orders.

Companies in external administration will be exempt from holding an annual general meeting if ASIC in its discretion waives the requirement.

Liquidators will be required to lodge section 533 reports concerning the possible commission of offences by liquidators, company officers or members within 6 months from the commencement of liquidation. Failure to do so will result in a fine or CALDB proceedings.

The $20,000 limit for the compromise of claims by a liquidator without the approval of a committee of inspection or the Court will be lifted to $100,000.

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.