Australia: Saving businesses using a deed of company arrangement

Last Updated: 6 November 2016
Article by Peter Krejci

As the Australian Government considers insolvency law reforms as part of its Innovation and Science Agenda, it's worth reflecting on the existing law relating to corporate restructuring via voluntary administration (VA) and deeds of company arrangement (DOCA).

While the VA regime has existed since 1993, not all insolvency practitioners have embraced the legislation to achieve its primary objective – saving businesses.

Those practitioners who have adopted a commercial approach to their appointments as administrator of a going concern have had, at their disposal, a unique instrument in the form of DOCA to restructure distressed businesses and salvage value for stakeholders.

Indeed, such outcomes are insisted upon by the current market, which is jaded by the value destruction that occurred with bygone practices where some stakeholders would win at the expense of others.

This cultural shift in the market insists on salvaging value for all stakeholders of distressed companies, and ideally results in saving the distressed business.

A DOCA is the ideal instrument to achieve these outcomes.

How a DOCA is achieved?

A DOCA is one option that can follow a VA appointment.

The VA process normally takes 3-5 weeks, although the court can extend it to run for some months if investigations or the scale of the issues dictate.

During a VA, an independent administrator takes control of the business. This administrator can make any decision about the business and is personally liable for liabilities incurred. At the same time, a range of enforcement steps and creditors' rights are temporarily suspended.

If additional time is required, the administrator can use a 'holding DOCA'. This is a DOCA entered into for the purpose of holding the status quo, pending a final solution, although DOCAs can be amended by creditor approval.

The primary outcomes of a VA are an administrator's report (which provides recommendations about options) and a creditors' meeting.

The creditors' meeting considers three options:

  1. returning the company to the directors (i.e. 'leave as is'),
  2. put the company into liquidation, or
  3. accept a DOCA.

The outcome must command the support of majorities in terms of both value and number. If no majority is obtained, the administrator exercises a casting vote in the best interests of the creditors generally.

The pillars of a successful reconstruction

To use a DOCA to save a business, an administrator should keep in mind the principles, or 'pillars', of a successful reconstruction.

These four pillars are:

  1. The business must be potentially viable. For example, there has to be identifiable opportunities to achieve operating surplus cash flows, a market must exist for the company's products or services, and the business mustn't be speculating with someone else's money.
  2. The business must have honest, competent managers.
  3. The business must have the trust of key stakeholders (so far as trust is necessary), including the trust of financiers, suppliers, customers and employees.
  4. All stakeholders, including the directors, must be open to a fundamental change in the way the business operates. There has to be an acknowledgement from all parties that something needs to change.

Without these pillars in place, any attempt to restructure the business will invariably fail.

Using a DOCA as a reconstruction tool

A deed of company arrangement, as a mechanism for business reconstruction under the Corporations Act, can achieve many objectives and/or provide solutions to the challenges a corporation may face.

Applied in a variety of circumstances, a DOCA is a dynamic and flexible legal solution for commercial problems. As such, its implementation must focus on inherently commercial outcomes.

Where an administrator tries to implement an inappropriate DOCA, misunderstands the commercial problems, or attempts to impose a legal solution where there is no commercial solution, the outcome will lead to failure for stakeholders.

Implementing a DOCA is not straightforward. There will be issues to be dealt with, including:

  • creditors' claims
  • retaining control
  • selective termination of leases and other contracts, and their conversion into money
  • salvaging contractural rights that may otherwise be forfeited and avoid incurring interruption penalties.

I'll address these issues in future articles.

Used astutely, a DOCA can provide the best opportunity to maintain the enterprise value of a trading entity. Trading businesses recover the greatest value by trading, and not breaking up.

Selling off a company's assets separately will destroy the enterprise value, result in less for stakeholders and may trigger additional claims (e.g. employee redundancy, loss of customer contracts, and loss of favourable supply terms).

A DOCA, therefore, can be an effective way to restructure the viable business of a troubled company under Australian law. It's a proven mechanism for saving companies when applied by skilled practitioners with a mix of relevant commercial and technical expertise.

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.

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