Australia: An Introduction To Insolvency Law - Part Two

5. Receivership

5.1 Introduction

Receivership is a form of administration which may apply to corporations, partnerships and individuals. However, receivership most commonly applies to corporate bodies. As a result, this paper will focus on corporate receivership.

A Receiver is appointed in respect of a corporation to take control of property, or to secure property (i.e. retrieve), in order to protect the rights of a party entitled to the property. This form of administration may encompass all of the property of a corporation or be limited to one or a number of items of property.

5.2 Appointment of a Receiver

Receivers may be appointed privately by a secured creditor under an instrument of appointment or by the Court on application being made by a party who seeks to protect its interests.

(a) Private appointment

A private appointment is the most common form of appointment. It is less costly, less formal and usually much quicker than seeking an appointment by a Court.

Private appointments are made pursuant to statutory powers or contractual authority, for example, under real property legislation, or pursuant to powers contained in a debenture deed. They most often occur where a secured creditor holds a fixed or floating charge over the assets of the company pursuant to a debenture deed, and then appoints a Receiver under the deed upon the occurrence of some default.

(b) Court appointment

The Court is usually called upon to appoint a Receiver in circumstances where an application is made by a person who holds a debenture that is invalid, gives no right to appoint a Receiver privately, or in which the power to appoint is flawed. Although they are empowered to do so, the Courts are usually reluctant to interfere with the internal affairs of a company unless they cannot avoid it as a matter of equity. Courts have shown a willingness to exercise their jurisdiction and appoint a Receiver in cases where the following situations have arisen:

1. where the security is in jeopardy and needs to be preserved but the mortgage is not yet enforceable;
2. where assets other than those that constitute the lender's security are in peril and need to be safeguarded;
3. where the lender's security is enforceable;
4. where a Receiver is sought by way of equitable execution.

A Court will generally not appoint a Receiver if another more appropriate equitable remedy is available, or when it is more appropriate for the company to be placed into liquidation.

5.3 Role of a Receiver

As referred to above, a person who is appointed as a Receiver is appointed to take possession or recover property for the benefit of persons who are entitled to it, typically secured creditors. The specific position and powers of any particular Receiver will vary, depending largely upon whether the Receiver was privately appointed or Court appointed.¹⁶

(a) Private appointment

The source of the Receiver's appointment, such as a debenture deed, will usually state that the Receiver is to act as agent of the company. If the deed does not state this, the Receiver will be taken to be acting as an agent of the debenture holder. The company is unable to revoke the authority provided to the Receiver because the appointor's right to appoint is akin to a charge over the company's property.

Typically the Receiver is not a manager of the company but rather a manager of the company's property and therefore property does not vest in the Receiver on appointment.

(b) Court appointed

The role and powers of a Court appointed Receiver will depend upon any orders made by the Court, and generally differ from that of a Receiver that has been appointed privately. The Receiver does not act as an agent of any party, but rather, is an officer of the Court and acts as a principal, so that if the Receiver is empowered to manage the company and is able to make contracts the Receiver makes them as principal and is personally liable on them. It is important to note however, that a Receiver will usually seek and be provided with an indemnity from the appointing party in respect of any actions undertaken by the Receiver.

5.4 Powers of a Receiver

Depending on the manner of appointment, the powers of the Receiver will be found in the debenture deed under which they were appointed, or will be determined under the Court order pursuant to which they were appointed.

Some of the general powers that will usually be granted to receivers include the power:

1. to enter into possession and control the property charged;
2. to make calls on shareholders;
3. to protect the property;
4. to maintain and carry out repairs on the property;
5. to borrow;
6. to lease or sell the property;
7. to insure the property;
8. to initiate legal proceedings;
9. to carry on the business of the company;
10. to employ or discharge employees in relation to conducting the business;
11. to execute documents on behalf of the company;
12. to do all things which the company is empowered to do;
13. to engage the assistance of professionals; and
14. to obtain indemnification from the property of the company in relation to his or her remuneration and expenses.

5.5 Duties of a Receiver

The main duty of the Receiver is to realise or profitably manage the assets of the debtor company, in order to produce cash and to apply it towards payment of the preferential creditors. The Receiver must meet his or her own expenses and remuneration, pay off any security ranking ahead of the debenture and repay the amount owing under the debenture. Thereafter, he or she must account to the company for any surplus funds.

The duties are very similar to the duties of a mortgagee exercising a power of sale:

• to exercise powers in good faith by acting honestly, fairly and without fraud or collusion;
• to act strictly within the conditions of the appointment;
• to account to the debtor company for any surplus after discharging the chargee's security interest.

Under s 420A of the Act, receivers are also required to take reasonable case in selling company property at market value, or at the best price reasonably obtainable.

6. Schemes of Arrangement

6.1 Objective

The aim of a Scheme of Arrangement (Scheme) is to obtain a binding agreement between a company and its creditors pursuant to which the legal rights of the company and creditors are adjusted or modified and to allow the company to continue to trade.

The main benefit of a Scheme is that the company's creditors may receive a financial benefit which may not have been otherwise available where such an arrangement was not entered into. In other words, Schemes have the potential to maximise the value of the company's property and to provide creditors with a better return, all whilst the company continues to trade and is (hopefully) being restored to good financial health.

6.2 Types of Schemes

The nature of a Scheme depends entirely upon the contents of the Scheme document. Schemes have the potential, and often can be, very innovative and flexible creations. Generally however, all Schemes will entail some reduction of creditors' rights or claims against the company. Examples of how some Schemes operate include:

• placing a moratorium on creditors' claims for a set period;
• a composition of creditors' claims whereby creditors agree to accept less that the full amount owed to them in satisfaction of their claims;
• the company and its creditors may agree that the debts owed to creditors be paid in instalments over a period of time;
• the creditors and the company may agree that the company be provided with an interest free period to pay its debts, and allow the company time to trade out of its financial difficulties;
• creditors may be provided with an interest in the company i.e. a debt for equity swap; and
• a combination of any of the above.

6.3 Advantages of a Scheme

As has been referred to previously, perhaps the most distinct advantage of a Scheme is that it allows the company to continue to trade, thereby (in some cases) providing a better prospect of return to the company's creditors. Other advantages include:

• the company and its creditors can continue to develop their trading relationship ;
• creditors have the right to select a Scheme Administrator, an independent person who can advise and safeguard the interests of creditors;
• agreements, such as supply or construction agreements, that would otherwise be terminated, may be able to continue on as a consequence of the appointment of a Scheme Administrator;
• the flexibility of Schemes allow companies to continue to trade, enabling them to generate profits under less stressful circumstances;
• due to the fact that the company is not wound up, a Liquidator will not investigate voidable transactions, insolvent trading claims and claims against directors for breaches of directors' duties and so on; and
• the Scheme may alleviate some of the pressure placed on the company and its board by creditors pressing for payment.

6.4 Disadvantages of a Scheme

Schemes are generally suited to larger companies and necessitate a costly and time consuming analysis of a company's affairs so that they may be reconstructed effectively. Any number of complications may arise and as a result, Schemes do have their disadvantages. Some of these disadvantages include:

• as pointed out above, Schemes can be time consuming to implement and some creditors may not be willing to wait for the Scheme to run its course;

• in entering into a Scheme, the company may find that it is in breach of certain covenants provided for in various funding agreements with funders;
• some of the company's financiers may demand to be paid more than the company proposes under the Scheme which may render the Scheme unworkable; and
• some suppliers may cease to service the company, even where goods are provided on a cash on delivery basis.

6.5 Implementation of a Scheme

There are six broad steps that may by involved in the implementation of a Scheme. These are set out in this section in turn.

(a) Preparation of a Proposal for a Scheme of Arrangement (Proposal)

The proposer of the Scheme, together with an Insolvency Practitioner, will formulate a Proposal for the Scheme of Arrangement. The contents of the Proposal will depend upon the nature of the Scheme that the company wishes to enter into. Generally however, a Proposal will contain the following details:

• the extent of the forgiveness of the company's debt;
• details of when creditors can expect to receive payment under the Scheme;
• the powers and the duties of the Scheme Administrator;
• the duration of the Scheme;
• consequences of breaches by the company of the Scheme; and
• procedures to extend the time of the Scheme.

(b) Explanatory Statement of the Proposal (Explanatory Statement)

In addition to the Proposal, the company and the Insolvency Practitioner will work together to produce an Explanatory Statement. Together, the Proposal and the Explanatory Statement will be sent to the creditors of the company. The purpose of the Explanatory Statement is self descriptive - being to explain to creditors the effect of the Proposal on the company and its creditors. The company is also required to prepare a Report As To Affairs (RATA) to be annexed to the Explanatory Statement. A RATA contains an summary of the company's financial position as at a specified date.

(c) Court application

The company, a creditor of the company, a shareholder of the company or in the case of a company that's being wound up, the Liquidator of a company, can apply to the court for an order convening a meeting of the company's creditors. The party making the application is required to provide the company's creditors with the Proposal and Explanatory Statement at least 14 days before the date of the application.

(d) Meeting of creditors

Where the court orders that a meeting of creditors is to be convened, the creditors of the company must be notified and provided with details of where and when the meeting is to be held. At the meeting, the creditors of the company can accept the Proposal if:

• a majority (more than 50%) in number of creditors present at the meeting of creditors vote in favour of the Proposal; and
• the value of the debts of those creditors who voted in favour of the Proposal amount to at least 75% of the debts of all the creditors at the meeting.

(e) Court hearing

If the creditors of the company accept the Proposal another court attendance is required so that the court may formally approve the Scheme. In determining whether to approve the Scheme, the court will look into the following matters:

• whether the Scheme complies with the Act;
• whether creditors have been fairly represented at the meeting of creditors;
• whether those creditors at the meeting of creditors acted in good faith; and
• whether the Scheme is a scheme which would be approved by a reasonable creditor.

Generally, where a Scheme is considered oppressive to minority creditors or contrary to the public interest, the court will withhold its approval. At the hearing, the court may also form the view that the company's insolvency should be investigated. The court will also withhold approval where it is thought that a Scheme has been designed to avoid tax liabilities.

(f) ASIC

For a Scheme to become effective, the order of the court approving the Scheme is required to be filed with ASIC.

6.6 The Scheme Administrator

Although there is no requirement to appoint a Scheme Administrator under section 411 of the Act, for commercial practicality and to protect the interests of creditors, the court and ASIC will often require an appointment to be made prior to approving a Scheme. The Scheme Administrator is required to be a registered Liquidator, unless the court orders otherwise. Both creditors and ASIC are entitled to object to the court about the appointment of a particular Scheme Administrator.

(a) Powers and Duties

The powers and duties of a Scheme Administrator will be set out in the Scheme document and the agreement between the Scheme Administrator and the company. General powers and duties can also be found in common law and under the Act. Subject to certain modifications, the powers and duties of a Scheme Administrator tend to be the same powers as are conferred upon a deed Administrator or Liquidator under the Act. By way of example, the Scheme Administrator may be required to report to the creditors of the company about the management and implementation of the Scheme and can require the directors of the company to provide him with the books and records of the company. The Scheme Administrator is also required to lodge 6 monthly accounts with ASIC.

(b) fficer of the Company

Under section 9 of the Act, the Scheme Administrator is deemed to be an officer of the company and will be bound by sections 180 to 183 of the Act in relation to directors duties. A complaint about the Scheme Administrator may be made by ASIC, a creditor, or a member, and the court may order that the Scheme Administrator compensate the Scheme for any loss incurred as a result of any negligence, omission or misfeasance on the part of the Scheme Administrator. In some extreme circumstances the Scheme Administrator may also be held liable for insolvent trading under section 588FG of the Act.

6.7 Administration of a Scheme

The company's public documents must indicate that a company is subject to a Scheme. During the administration of a Scheme, the Scheme Administrator may:

Payment to creditors under a Scheme will generally be governed by the Scheme document or may otherwise be dealt with in a similar manner as would apply in a winding up or deed of company arrangement scenario. Creditors will still be required to prove their claims and the Scheme Administrator will adjudicate upon those claims.

6.8 Termination of a Scheme of Arrangement

Generally, the Scheme document will stipulate a time for termination of the Scheme. For example, a Scheme may terminate:

7. INFORMAL WORKOUTS

7.1 Introduction

Informal workouts outside the insolvency regime are becoming progressively popular due to current economic circumstances. Creditors are increasingly seeking to avoid the formal insolvency appointment process, and its consequent delay and expense, and entering into informal work out arrangements directly with debtors.

Informal arrangements are privately negotiated agreements between a company and its creditor (or a group of its creditors). Although generally informal and arranged directly between a creditor and a debtor, a workout can also involve an insolvency practitioner, solicitor or a corporate reconstruction specialist.

For an informal workout to succeed, a good working relationship between the company debtor (together with its advisors) and its creditors is required. Furthermore, for the informal workout to be effective, an agreement between the company and its creditor(s) should be documented in an agreement.

7.2 Types of Informal Workouts

An informal workout can include various types of agreements and/or renegotiations of the company's trading terms with its creditors. Examples of informal work outs can include the following types of informal workouts (or any combination):

7.3 Advantages of Informal Workouts

A distinct advantage of an informal workout is that the cost and timing of the informal workout can be significantly less than a DOCA and/or a Scheme of Arrangement under the Corporations Act.

Other advantages of informal workouts are:

7.4 Disadvantages of Informal Workouts

The main disadvantage of an informal workout is the degree of uncertainty that may arise if the company's creditors do not agree to the proposed arrangement. It may lead to a more costly Voluntary Administration process or a Scheme of Arrangement or at worst a winding up of the company. Other disadvantages of informal workouts are:

7.5 Conclusion

The success of an informal workout will largely depend on the attitude of the company's creditors who are participants to the informal workout. Generally creditors of a company in financial distress have a mistrust in the company and its management due to the prior history between the parties.

However, due to the current economic circumstances, informal workouts are likely to become increasingly popular, particularly with larger secured creditors such as financial institutions seeking to avoid the expense and notoriety consequent to the appointment of a Receiver or Administrator. There is a noticeable push in the current market for financial institutions to implement informal workouts outside the provisions of the Corporations Act.

APPENDIX A

Time period within which a transaction can be voidable under pt 5.7B of the Corporations Act

Types of voidable transaction

Source: Keay, McPherson The Law of Company Liquidation (4 ed, LBC, Sydney, 1999)

Footnotes

1. s.95A Corporations Act 2001 (Cth)

2. Keay, McPherson The Law of Company Liquidation (4 ed, LBC, Sydney, 1999), from page 10.

3. Ford, Austin and Ramsay, Fords Principals of Corporations Law, Butterworths 2000, at 26.020

4. MYT Engineering Pty Ltd v Mulcon Pty Limited (1999) 162-ALR-441

5. Re Brashs Pty Limited (1994) 15ASCR447

6. J & B Records Limited v Brashs Pty Limited (1995) 36 NSWLR 172

7. Keay, McPherson The Law of Company Liquidation (4 ed, LBC, Sydney, 1999), from page 1

8. Keay, McPherson The Law of Company Liquidation (4 ed, LBC, Sydney, 1999), from page 251.

9. Duns, John, Insolvency Law and Policy, Oxford University Press, 2002, at page 89

10. Duns, John, Insolvency Law and Policy, Oxford University Press, 2002, at page 56

11. Keay, Andrew, The Law of Company Liquidation 4^th ed, LBC Information Services, page 289

12. Keay, Andrew, The Law of Company Liquidation 4^th ed, LBC Information Services, page 622

13. Keay, McPherson The Law of Company Liquidation (4 ed, LBC, Sydney, 1999), from page 303.

14. Keay, McPherson The Law of Company Liquidation (4 ed, LBC, Sydney, 1999), from page 309.

15. Duns, John, Insolvency Law and Policy, Oxford University Press, 2002, at page 391

16. Duns, John, Insolvency Law and Policy, Oxford University Press, 2002, at page 365