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COMMENTS ON THE EXPOSURE DRAFT CORPORATIONS AMENDMENT (CORPORATE INSOLVENCY REFORMS) REGULATIONS 2020 AND RULES 2020

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KEY ASPECTS FOR PRACTITIONERS, PPSA ISSUES AND OTHER MATTERS WORTH NOTING

Introduction

  1. The Corporations Amendment (Corporate Insolvency Reforms) Bill 2020 (the Bill) was introduced in Parliament on Thursday 12 November 2020. I have previously commented on the exposure draft of the Bill here and made a submission to Treasury concerning that Bill here.
  2. The text of the Bill as read in Parliament is available at the parliamentary website here, with a mark up against the exposure draft available here.
  3. On 17 November 2020 the Treasury released exposure drafts of the proposed regulations and rules that will be introduced with the Bill once enacted, which are available here.  The content of the regulations and rules and the revised Bill have been summarised extensively elsewhere, see for example an excellent summary by HWL Ebsworth at their website here.
  4. In this article I comment on particular aspects of the regulations that are of interest to insolvency practitioners in operating under the reforms, aspects of the reforms that impact on PPSA issues and other matters of interest.  This article is not intended to be a general review of the regulations or rules, which can be obtained by referring to the sources noted above.

Issue:  employee entitlements and tax lodgment

  1. Despite many submissions to government to exclude these thresholds, they remain.  In short, companies will have to have their employee entitlements paid up and have lodged all outstanding federal tax returns and similar documents before being eligible to take part in a restructuring process.

Issue:  debts incurred in the restructuring are provable in a subsequent winding up

  1. The Bill has amended s553(1A) of the Act so that debts incurred by the company when it is under restructuring or under a restructuring plan are provable.  See the Bill, schedule 1, Part 2 item 48.  The text of the existing sub-section is repealed and replaced to that effect.   
  1. The Bill has amended s553(1A) of the Act so that debts incurred by the company when it is under restructuring or under a restructuring plan are provable.  See the Bill, schedule 1, Part 2 item 48.  The text of the existing sub-section is repealed and replaced to that effect.   

Issue:  Temporary protection of insolvent small businesses from statutory demands to eligible companies, where declaration is made

  1. There will be an extension of the effective moratorium on statutory demands to 31 July 2021 for companies eligible for temporary restructuring relief:  see regulation 5.4.01AAA. 
  2. The government anticipates a shortage of practitioners available to take appointments from 1 January 2021.  This measure is a device to shelter companies from statutory demands whilst waiting to line up an appointee. 
  3. The meaning of the phrase “eligible for temporary restructuring relief” is given by s 458 of the Act.  To qualify, directors must make and publish a written declaration of three matters:
    • Insolvency of the company and the company would meet the eligibility criteria for restructuring;
    • The board has resolved to appoint a restructuring practitioner;
    • There is no other current insolvency appointment (Restructuring Practitioner, VA or liquidator).
  4. Once made a company has made a declaration, the company is eligible for temporary restructuring relief for three months, which can be extended a further month if directors have been unable, despite trying, to appoint a restructuring practitioner.
  5. How are creditors supposed to know whether any particular debtor is eligible for restructuring when they are not insiders of the company?  Some relief will come from the publication of the notice.  One would need to know that the company has less than $1m in liabilities excluding contingent claims.  This will add a degree of uncertainty for people proposing to use a statutory demand process.

Issue:  Restrictions on voidable transactions in simplified liquidation

  1. In regulation 5.5.04, the restrictions on unfair preference recoveries have been set out.  In essence, unfair preference recoveries will be restricted to debts that exceed $30,000 in total or in cumulative series of related transactions, and will be restricted to transactions entered into on the three month period ending on the relation back day rather than 6 months.
  2. Preference recoveries against related entities of the company will be unaffected.

Issue:  Restructuring appointment triggers PPSA Vesting

  1. The Bill as read in parliament now amends s 267 of the Personal Property Securities Act 2009 (Cth) (PPSA) so that the effect of a restructuring appointment is to trigger vesting of unperfected security interests in the company.  See items 115 to 117 of the Bill. This was left out of the exposure draft.

Issue:  Determining the amount of liabilities to be counted in the $1 million cap for restructuring – still messy

  1. Two issues that were open from the exposure draft of the Bill were the types of debts to be counted into the $1 million threshold, whether other indicia might be used (eg turnover opr employee numbers) and whether the amount of the threshold might be changed.
  2. By the regulations, contingent debts are to be excluded from calculation but future debts remain: see r 5.3B.03(1).  The threshold is confirmed to be $1m, to be calculated on the day the restructuring begins.  No other indica are to be used.
  3. The total will accordingly exclude contingent debts where the contingency has yet to crystallise but include future non-contingent debts, for example rent, which whilst not yet due are certain to arise.
  4. Query the position of contingent debts that crystallise on an insolvency appointment or associated act of default.  The wording of the regulation is ambivalent as to whether crystallised debts of that sort are to be included, since the calculation is to be taken on the day the restructuring begins, not upon the commencement of the restructuring.  It would seem to me that crystallised debts are included since by application of section 36 of the Acts Interpretation Act 1901 (Cth), the restructuring period would be taken to include the whole of the day on which it commences. 
  5. It follows that the commencement of the restructuring may well push the company over the $1 million threshold when such cystallised debts are included.  The Law Council of Australia has recommended in a submission on the regulations that the threshold be calculated fromimmediately before the appointment (see item 1 here), which seems to me to be sensible.  It avoids the need for a review of company contracts to detect contingent debts which might not be disclosed in the accounts of the company. 

Issue:  it appears payments to referrers for appointments are allowed

  1. The regulations appear to permit a restructuring practitioner to pay a “broker”, being a person referring an appointment, for the referral – see reg 5.3B.16. 
  2. This has attracted criticism – it will feed perceptions of a lack of independence of the practitioner to say the least.

Issue:  What Transactions are in the ordinary course of business in the restructuring period?

  1. By s.453L of the Act there is a general prohibition on dealings outside the ordinary course of the company’s business, unless the restructuring practitioner has consented or the transaction was entered into under an order of the Court.
  2. The regulations provide a definition of “ordinary course of business” – see 5.3B.04. 
  3. A transaction that is for the purposes of paying a debt or claim arising prior to the commencement of the restructuring, relating to the transfer or sale of the whole or part of the business, or relating to the payment of a dividend are all outside the ordinary course of business.  Payments of company employee entitlements are not considered outside the ordinary course of business. 
  4. It seems the intent of the regulation is to give the practitioner a measure of control and require their supervision during the restructuring period.  The company will not be able to pay any essential debts arising before the appointment without consent:  for example, a payment to a key supplier might be necessary to continue trading. 
  5. Reg 5.3B.05, sets out a process for restructuring practitioners to follow when consenting to transactions outside the ordinary course of business.  Written consent is to be given by the practitioner and a record of the consent to be kept by the practitioner and given to the company within two business days of the consent being given.
  6. Practitioners should be aware of that requirement as it seems to me it will be a not uncommon occurrence.

Issue: when a restructuring ends

  1. How a restructuring is to end was left out of the Bill and is now provided for in the regulations.  Regulation 5.3B.02 deals with when a restructuring is to end.  In summary, a restructuring will end if the company:
    • fails to propose a restructuring plan in the restructuring period;
    • a proposal to make a restructuring plan lapses;
    • the restructuring practitioner terminates the restructuring;
    • the Court orders the restructuring to end;
    • an administrator of the company is appointed;
    • a liquidator or provisional liquidator is appointed;
    • or the company makes a restructuring plan (a successful ending).
  2. There are a couple of interesting points:
    • It appears to me that directors can still appoint a voluntary administrator even though the company is under restructuring;
    • Directors have a power under r5.3B.02(2) to unilaterally end a restructuring on giving notice to the practitioner and ASIC.  It seems odd to me that given that a company that enters into a restructuring is presumed to be insolvent and it would seem to be poor policy to allow the directors of the company to end the restructuring process without completing it and continuing to trade.
  3. If a restructuring is terminated by the restructuring practitioner, regulation 5.3B.02(6) requires the contents of the written notice required from the restructuring practitioner of the decision to terminate (see s.453J(3)(b) of the Act) are set out.  The notice must include the reasons for terminating the restructuring.

Issue: Proposing a restructuring plan and its contents

  1. Section 455B of the Act as amended provided for regulations to be made about the process of proposing a restructuring plan.
  2. Those regulations are included in Division 3 of the proposed regulations.  Practitioners will need to be familiar with these provisions and develop precedents that conform with them for draft plans to be used in practice.
  3. The plan must conform with that approved form and must also include various matters including regulation 5.3B.13.  They include matters such as:
    • how the company property is to be dealt with;
    • what property is to be the subject of the plan;
    • the remuneration of the practitioner;
    • the date on which the plan was executed.
  4. The plan may also:
    • authorise the practitioners to deal with identified property in a specified way (eg by sale);
    • providefor any matters relating to the company’s financial affairs;
    • be conditional upon the occurrence of events within a specified period no longer than 10 business days after the proposal is made and accepted (presumably, provision of finance, third party consents etc).
  5. Plans cannot provide for the transfer of property other than money to a creditor and plans can only have a life of 5 years beginning on the day that the plan is made in respect to payment.  In other words, payments under the plan have to be made within a maximum period of 5 years.
  6. By regulation 5.3B.14 a restructuring proposal statement must be prepared to accompany the plan which will include a schedule of debts and claims that are affected by it, and that statement must be in a prescribed form.
  7. The Act and regulations use the phrase “making a restructuring plan” and distinguish “proposing a plan”.  Making a plan is where a proposed restructuring plan is accepted by creditors and is accordingly binding.  Compare a deed proposal and a DOCA.

Issue:  the “proposal period” and extending it

  1. The default period of the restructuring process is 20 business days.  That period can be extended by another 10 business days if the restructuring practitioner is satisfied that requiring the company to give their plan within the 20 day period would not be reasonable in the circumstances.  Only one such extension can be given, that the Court can give further extensions on application.  See regulation 5.3B.15.
  2. This regulation mimics the practice in relation to voluntary administration of extensions made by the Court which, on the first request, are routinely given.  It seems to me to be a sensible regulation but one could expect the Court to be less accommodating than in VA on the first request to it for more time. 

Issue:  Certification of the restructuring plan by the restructuring practitioner

  1. Regulation 5.3B.16 provides detail of a certificate that restructuring practitioners have to provide in respect of each restructuring plan.  They should be of concern to restructuring practitioners as to the burden of certification, because of their broad scope, remembering that practitioner’s  freedom from liability in performance of their duties requires an absence of negligence.  The certificate must confirm the following matters:
    • the eligibility criteria for restructuring are met by the company;
    • the company is likely to be able to discharge the obligation created by the plan when they become due and payable;
    • the practitioner believes on reasonable grounds that all information required to be set out in the company restructuring proposal has been set out in the statement;
    • if the practitioner believes that is not the case, they must set out or identify the matters in relation to which a belief on reasonable grounds could not be formed; and
    • if a person referred the company to the restructuring practitioner it requires them to set out any details of that relationship and any payments made to the broker in connection with the referral.
  2. These obligations are serious and require a restructuring practitioner to satisfy themselves of the eligibility of the company for restructuring and the likelihood that the company imposing a plan will be able to satisfy the obligations that it is taking on.
  3. A restructuring practitioner commits an offence if they prepare a certificate under this regulation and do not make reasonable inquiries into the company’s business, property, affairs and financial circumstances or take reasonable steps to verify the company’s business, property, affairs and financial circumstances.  It is a 50 penalty unit penalty and an offence of strict liability.
  4. The prospect of civil liability for breach of these provisions (if such a breach is either because of a lack of good faith or because of the presence of negligence) and the fact that failure to make reasonable inquiries and take reasonable steps as noted above is an offence, should make practitioners cognisant of the important role in investigating the affairs of the company and certifying the proposed plan under these provisions.
  5. Further by Regulation 5.3B.17, a restructuring practitioner commits an offence if they fail to notify the company of incompleteness or inaccuracies in information in the plan or the restructuring proposal statement that accompanies it, where those flaws are likely to affect the company’s ability to meet its obligations under the plan.
  6. By regulation 5.3B.18 a restructuring practitioner can cancel a restructuring proposal under certain conditions, which include the restructuring practitioner discovering before the plan is made that the information in the plan is incomplete, affected creditors have not been disclosed, the proposal statement was deficient because it omitted a material particular or there has been a material change in the company’s circumstances not previously foreshadowed which is capable of affecting creditors’ decisions as to whether to accept the plan.
  7. That regulation provides the restructuring practitioner with a safety valve having regard to the onerous obligations that they are subject to.

Issue:  Acceptance of the plan

  1. Two interesting points regarding how a plan is accepted:
    • a plan is accepted if there is a majority in the value of the company’s affected creditors in favour who reply before the end of the acceptance period.  It would seem that if creditors choose not to vote, the plan can be accepted provided the majority of those voting are in favour by value.  Conceivably if one credited voted in favour and no other creditors voted, the plan would be approved.
    • if an affected creditor is entitled to vote because they have purchased another creditor’s claim, then the value of their vote is limited to the value that they paid for the debt.  In other words it’s the purchase price of the debt, not its face value that matters.
  2. The regulations make it an offence to give or agree or offer to give an affected creditor (simply a creditor who is bound by a plan or will be if the plan is made) any valuable consideration with the intention of securing an acceptance or non-acceptance of the plan.  Vote buying is out! 

Issue:  Appointment functions and powers of a restructuring practitioner under a plan

  1. The functions and powers of a restructuring practitioner under a plan, once made, are  provided in subdivision D, regs 5.3B.32 to 40.
  2. The functions include to receive and hold money for the company, pay money to creditors in accordance with the plan, realise property and distribute its proceeds if requested to do so by the directors,  do anything incidental to the performance or exercise of their functions and powers and to do anything else necessary or convenient for the purposes of administering a plan.
  3. By regulation 5.3B.34, there is a prohibition on a practitioner disposing of encumbered property, with exceptions.  The exceptions are if the property is PPSA retention of title property, disposals in the ordinary course of business, disposals with the consent of a secured party or with leave of the Court.
  4. By regulation 5.3B.35 the restructuring practitioner is the company’s agent when carrying out the company’s restructuring plan, and has qualified privilege in that respect and a right of indemnity with priority.  The priority is dealt with in reg 5.3B.39.  The right of indemnity prevails over all of the company’s unsecured debts, debts secured by a PPSA security interest that has vested, and debts secured by circulating security interest, except where a receiver has been appointed.
  5. By regulation 5.3B.40, the restructuring practitioner has a lien to secure the indemnity on the company’s property. 

Issue:  Information to be provided to the restructuring practitioner and reporting obligations

  1. Divisions 4 and 5 of the regulations deal with the company’s obligations to provide information to an incoming restructuring practitioner, declarations required to be made by the directors in relation to the appointment, notice of the restructuring plan and notices of contravention and termination of the plan. 
  2. A declaration by directors is required of the company’s eligibility to be under restructuring and other matters by regulation 5.3B.44.  The declaration must include whether any transactions that have been entered into by the company would be voidable under s.588FE if the company were wound up, other than transactions which would be an unfair preference.  This interesting obligation (one doubts it will be thoroughly observed) seems to require the directors to seek professional advice concerning the company’s transaction history to assess whether any voidable transactions may have occurred.  It seems to me that an unadvised company director would identify such transactions and the director/s will probably seek assistance from the restructuring practitioner before making of this declaration.

Issue:  Powers of the Court

  1. Much of the powers of the Court are left to be dealt with in the regulations and those regulations are contained in Division 6 in regulations 5.3B.50 to 55.
  2. Points of interest:
    1. The Court has a jurisdiction to deal with creditor disputes over claims and debts that are not resolved by agreement.  The jurisdiction only activates where a disagreement has arisen between the affected creditor and the restructuring practitioner; has refused to make a recommendation about it or has recommended that the dispute be referred to Court. 
    2. The Court also has a jurisdiction to vary restructuring plans on application of a company, an affected creditor, the restructuring practitioner or ASIC or on its own initiative. 
    3. The Court has a wide power to make orders to terminate, void or validate a restructuring plan. 

Issue:  Simplified liquidation

  1. The regulations also provide for circumstances in which a simplified liquidation process will end. 
  2. A problematic point is a deeming provision in reg 5.5.07.  If the company or a director of the company has been engaged in fraudulent or dishonest conduct that has had a material adverse effect on the interest of creditors as a whole or class of creditors as a whole, then the simplified liquidation process is taken to have ceased.  It is an interesting provision because the activating event is the formation by the liquidator of a that the dishonest or fraudulent conduct has occurred, where held on reasonable grounds. 

Date:  26 November 2020

Mark McKillop

Castan Chambers

Melbourne Victoria

Comments on the Exposure Draft of the Insolvency Reform Legislation – Corporations Amendment (Corporate Insolvency Reforms) Bill 2020

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Actual picture of the parliamentary drafting table

Laws are like sausages, it is better not to see them being made.

Otto von Bismarck

After announcing the introduction of streamlined Debtor in Possession reforms for small corporate business insolvencies just 2 weeks ago (see my thoughts at the time of release here) by 1 January 2021, the Commonwealth has now released an exposure draft of the amending legislation and an explanatory memorandum.   It really is a case of making  sausages.

In summary, the exposure draft leaves a lot of work to be done by the drafters to get the legislation finalised.  A lot of the meat (no pun intended) in terms of substantive changes to the existing law is left to regulation, probably sensibly the only way to get this process done with consultation within the industry in time.  It seems to me that the exposure draft has been rushed out by using this device and that a lot of the hard yards will be done in the process of sifting through submissions to be made,  due on Monday and in further consultation, hopefully with industry bodies and the legal profession.

My thoughts on the exposure draft:

  1. To be completed by regulations:  the draft is the ultimate “fixer upper” opportunity, being only about two thirds finished.  The unfinished parts are to be filled by regulations to be made later.  Presumably the idea is to permit more time for the Commonwealth to consult with the professions, industry and other SME stakeholders, which may be the only practical way to get the changes made so they can commence by 1 January 2021.  This approach, whilst unorthodox for insolvency reform, is welcome given that there was little or no consultation before the package was announced.
  2. A whole new insolvency office:  The term for the appointee used in the part is “restructuring practitioner”.  A new definition in s.9 of the Act is included to define that term.  The term is used for an appointee both during the restructuring period and after the restructuring plan is accepted: there is no term akin to “deed administrator”.
  3. A whole new part:  Rather than adapting the existing processes for voluntary administration, the drafters have inserted an entirely new part, Part 5.3B, dealing with restructuring of a company under the debtor and position model.   Again, this reflects the object of the reforms, which is a revolutionary, rather than an adaptive.
  4. #tag –  (Restructuring Practitioner Appointed):  Section 457B requires a company subject to the restructuring process must add the words “(restructuring practitioner appointed)” after its name.
  5. An act of insolvency:  like a part X proposal for an individual in bankruptcy, a company who proposes a restructuring plan is taken to be insolvent – s455A(2).
  6. Restructuring Practitioner’s power to end it all:   Interestingly, there is provision under subdivision C for the role of the restructuring practitioner to have the power to terminate a restructuring on certain grounds:  see s453J.  The grounds include at least if the company does not meet the eligibility criteria for restructuring,  if it would not be in the interests of creditors to make a restructuring plan, or continue with a plan, or it would be in the interests of creditors for the company to be wound up.  It will be interesting to see on what basis this power to terminate the restructuring of a company will be exercised in practice.  One would imagine the type of situations in which a VA might recommend liquidation would be a basis – where businesses are dead and buried with no potential of saving, so that the appointment is misconceived, or cases involving substantial fraud or criminality.
  7. Recycled nuts and bolts:   A lot of basic mechanics dealt with in the new Part 5.3B are copies of similar provisions from 5.3A.  An example: a person appointed as a restructuring practitioner must make a declaration of relevant relationships.  The DIRRI provision, section 60, has been amended accordingly.  Similarly, there are parallel restrictions on third party property and secured creditor action during the period of the restructuring process.  See generally subdivision D. 
  8. So much to be provided by regulation:  Some notable examples include:
    • The eligibility of a company to participate in a restructuring based on its liabilities, and the degree to which a director can have previously been involved in another restructuring – see 435C.  The whole question of what liabilities count toward the threshold debt ceiling for eligibility, and even what the ceiling is to be, are not yet in the legislation;
    • Surprisingly, nearly all of the functions, duties and powers of the restructuring practitioner.   There is a generic provision for basic functions like providing advice to the company on restructuring matters, assisting and preparing a restructuring plan, making a declaration to creditors “in accordance with the regulations” in relation to the plan and any other functions given to the practitioner under the Act.  Apart from that, the regulations are to provide…;
    • The form, content, making, implementation, varying, lapsing, voiding, contravention and termination of restructuring plans.    Regulations are also to provide for the role of the restructuring practitioner in relation to the plan.  There are all very important issues for the success of the reforms.  Whilst crossing the proverbial fingers, one would think that regulations are being used in order to allow consultation with the industry before the legislation is finalised, or perhaps allowing it to be easily tweaked after 1 January 2021.  It will be interesting to see whether substantive text is used in the final draft of Part 5.3B rather than in regulations. 
  9. The Role of The Court is a work in progress:  
    • There is a balancing act in any insolvency regime.  On one hand it is desirable to allow creditors or other stakeholders to go to court to protect themselves from abuse of process.  On the other hand, too much judicial oversight can make the process to expensive to use.  Cost is a key complaint that has led to the reform package.  The fact that the role of the Court is to be finalised in the Exposure Draft reflects, I think, a lot of thinking going on at government level and probably a desire to further consult on this issue with the profession.
    • The role of the Court is, in many respects, to be provided: there is division 6, which provides for the powers of the court in relation to restructuring plans to be subject to regulation.  Among more mechanical sections of the part copied over from part 5.3A, the role of the Court is defined, for example regarding permitting or penalising dealing with assets or shares during the restructure that would otherwise not be permitted (Part 1 Subdivision D), effects of an appointment on a winding up (which are akin to a VA appointment) and secured creditor assets and leave to proceed.
    • Section 458A does provide that the powers of the Court will include at least a power to vary or terminate a restructuring plan and to declare a restructuring plan void.
  10. Reporting Obligations to and from the Company and the Restructuring Practitioner are still to be finalised:  Division 5 deals with information, reports and documents, in relation to the company.  The draft provides for regulations to deal with these sorts of issues.  Section 457A deals with the things that the regulations can provide for, and they do include matters such as reporting to the restructuring practitioner by the company or others, reporting to ASIC, reporting to creditors, and reporting generally about a restructuring or restructuring plan to the public by publication. 
  11. Secured Creditors Decision Period:  there is an amendment to the dictionary in section 9 of the meaning of “decision period”.  The decision period for restructuring is the same as for voluntary administration – that is 13 days after the day of appointment.
  12. Relation Back Day:  There are amendments to section 91 to accommodate the restructuring process into the relation back day definition for a company that goes into a subsequent liquidation.  Basically, a restructuring appointment that is made after a winding up application starts preserves the relation back date of the application to wind up.  Likewise, for a winding up which commences as a consequence of an application made after the beginning of a restructuring period, the relation back day is the date on which the restructuring appointment is made, called the section 513CA day.
  13. Transition to VA and Liquidation:  There is provision for transition to a voluntary administration or liquidation in the event that a restructuring plan is rejected.  It is not clear to me exactly how this is to occur:  it is to be provided for in regulations (s453A(b)).  Amendments to the small business guide in Part 1.5 of the Act do provide that if creditors do not agree to the restructuring plan the company may be placed in voluntary administration or winding up.  It appears that the rejection of the restructuring plan will amount to a resolution by creditors that the company be wound up unless alternative arrangements are made to transition to a voluntary administration.  Logically it would be similar to the rejection of a DOCA proposal.
  14. Voidable Transactions – Protection for ordinary course transactions in restructuring period:  There is a significant change to voidable transactions for a liquidation which follows a restructuring.  The main change is that there is a carve out for transactions entered into by the company whilst it is in the restructuring phase, in the ordinary course of business or with the consent of the restructuring practitioner.  In voluntary administration there is a similar carve out for transactions entered into by a voluntary administrator or a deed administrator.  Since the new process is a debtor in possession model, it does make sense for transactions entered into by the company in the ordinary course of its business or with consent of the restructuring practitioner to be similarly exempt.  That is provided for in a new subsection 588FE(2C)(d) and (2D)(d).
  15. Another safe harbour:  There are amendments to the safe harbour provisions, and a new safe harbour for companies under restructuring in 588GAA(B).  There is a carve out for insolvent trading in relation to transactions entered into during the restructuring period which are in the ordinary course of the company’s business or with the consent of the restructuring practitioner.
  16. Liquidator Investigation:   In terms of subsequent supervision, there is provision for a liquidator appointed after a restructuring to examine the restructuring practitioner on a mandatory basis under amendments to 596A and further consequential amendments in the examination provisions.
  17. Insolvency Practice Rules A host of changes have been made to the insolvency practice rules, mainly to include restructuring practitioner where appropriate.  However there are carve outs which indicate the limited nature of the simplified liquidation process.  They include exempting completely from the simplified liquidation process any provision for committees of inspection.  They simply do not apply to the simplified liquidation process.
  18. Simplified Liquidation:  Once again, future regulation is to play a large part in defining how the simplified liquidation process is to be implemented.  The regulations are to provide in future for the eligibility criteria for the simplified liquidation process, simplified methods of dealing with proofs of debt and distribution of dividends, ASIC reporting, dealing with contributories, payment of dividends, and more limited basis of circumstances in which unfair preferences can be recovered.  See generally a new subdivision B to be added at the end of Division 3 of Part 5.5 of the Corporations Act.
  19. Virtually Done: As has been commented widely elsewhere, there are welcome changes that basically permit creditors meetings to be held virtually, notification and communication by electronic means and for “e signing” of documents electronically.

What a difference a day makes – When does the relation back period start?

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Re Weston Application; Employers Mutual Indemnity (Workers Compensation) Ltd v Omni Corporation Pty Ltd [2009] NSWSC 264

In insolvency law the calculation of precise periods of time is important.  Insolvency practitioners need to know exactly when limitation periods end in order to preserve potential claims.  The “relation back period” is one of the more important time periods relevant to calculating limitations, and yet there is surprisingly little authority on exactly when the relation back period starts.

The Relation Back period

Most practitioners are familiar with what is the last day of a relation back period. It is the “relation-back day” in corporate law, and in bankruptcy it is the date of the presentation of the petition against the bankrupt.

But what is the first day of the relation-back period?  If the relation back day is 12 December, is a 6 month relation-back period taken to begin on the 12 June?  Or 13 June?  The answer has obvious practical significance because it is not uncommon for a significant payment to fall on the 12th day.

The issue is whether one includes the relation back day or not in the 6 month period. Surprisingly, there is no appellate decision which makes the answer clear, however single judge authorities indicate one does count the relation-back day. So in the example, 12 June would not be included.

In Scott v The Commissioner of Taxation [2003] VSC 50 (link),  Justice Dodds-Streeton reached the same conclusion (at paragraphs 32 and 33).  However the decision does include reasoning on that point.

In Re Weston Application; Employers Mutual Indemnity (Workers Compensation) Ltd v Omni Corporation Pty Ltd[2009] NSWSC 264 (link), calculation of time going forward from the relation-back day was discussed in an application to strike out a voidable transaction claim on the basis it was out of time.  The time for making the application expires 3 years after the relation back day, or 12 months after the appointment of the liquidator, whichever is the later: s588FF(3)(a).

In Re Weston the liquidator commenced the application for relief under s588FF(1) exactly 3 years to the date after the relation back day:  the respective dates were 16 January 2009 and 16 January 2006.

Justice Barrett considered the issue relying on two statutory provisions (at paragraphs 6 to 16):

1.Section 105 of the Corporations Act. It provides:

Calculation of time

Without limiting subsection 36(1) of the Acts Interpretation Act 1901 , in calculating how many days a particular day, act or event is before or after another day, act or event, the first-mentioned day, or the day of the first-mentioned act or event, is to be counted but not the other day, or the day of the other act or event.

2.Section 36(1) of the Acts Interpretation Act 1901 (link).  It contains a useful table for calculating when a day should and should not be included in a time calculation.  The section states that:

A period of time referred to in an Act that is of a kind mentioned in [the table] is to be calculated according to the rule mentioned in [the table].

Based on those provisions, His Honour concluded:

  1. when a time period is expressed to end at, on or within a specified day, the period of time includes that day (item 4 of the table);
  2. when a time period is expressed to begin from a specified day, the period of time does not include that day (item 5 of the table).

The Start Date and the End Date

In Re Weston the result was that the liquidator had made his application in time, since the 16th of January 2006 was not included in calculating the 3 year limitation period after the relation-back day (applying item 5 from the table).

In calculating the start of the relation-back period, using the example above, 12 June would not be included, because 12 December would be included in the 6 month relation-back period (applying item 4 from the table).

Significance for Practitioners

The application of these principles is important:

  • for practitioners in diarising limitation periods;
  • identifying transactions at the extremes of the relation back periods under the voidable transaction provisions;
  • for third parties considering limitation defences;

for calculating the application of time periods generally where limits are strict. For an example, applied to determining whether an application was within time to set aside a statutory demand, see Autumn Solar Installations Pty Ltd v Solar Magic Australia Pty Ltd [2010] NSWSC 463.

Regards

Mark

Acknowledgement:  this post originally appeared on the Commercial Bar Association of Victoria blog, Commbar matters, at http://commbarmatters.com/2014/04/08/what-a-difference-a-day-makes-when-does-the-relation-back-period-start/

Liquidator’s or Receiver’s lien may be at risk under PPSA in some circumstances

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Most commentators, relying on s73 (link) of the Personal Property Securities Act 2009, state that liens are not affected under the PPSA.  Section 73 provides priority to liens and other security interests arising under general law or under statute (called “priority interests”) in some circumstances.

But there are some serious traps for creditors relying on liens under the new regime.

First, if a creditor is relying on a contractual lien to get paid,  that creditor is going to lose out in a priority battle with a secured party holding a security agreement in respect of all assets.  Section 73(1)(a) only provides for protection to an interest arising under general law or under statute, but not a lien arising by agreement.  A lien created by a contract is a security agreement that under the PPSA will require perfection (by registration or otherwise).

So where a logistical services company claimed a lien under its terms of trade over goods in its possession belonging to a customer, they lost out to a receiver appointed over the customer by a bank with a prior registered all assets security agreement:  see McKay v Toll Logistics (NZ) Limited (HC) [2010] 3 NZLR 700 (link); Toll Logistics (NZ) Limited v McKay (CA) [2011] NZCA 188 (link).  There is a good summary of McKay by Leigh Adams at (link).

Second, even if a creditor has a lien under statute or general law, it should be careful before taking a concurrent contractual lien.  It might be argued by a secured party holding a prior registered security agreement that section 73(1) doesn’t apply, because the contractual lien supplants the general law or statutory lien that would otherwise have arisen.  A solution for the lienee would be to ensure that the contractual lien on its terms specifically preserves any general law or statutory liens that may arise, and be created in addition to those liens.

Third, a liquidator or receiver who relies on a “salvage lien” arising under the principles in Re Universal Distributing Co Limited (in Liquidation) (1933) 48 CLR 171 should be careful to check that their lien is protected under s73(1).  It is possible that the terms of a prior registered security agreement could purport to prohibit the grantor “creating” a salvage lien.

A salvage lien does arise under general law, however it could be expected that a receiver or liquidator may well have actual knowledge of the terms of a prior registered security agreement held by a financier.

By s73(1)(e) a lien holder who has actual knowledge that creation of a subsequent priority interest will breach the terms of a secuity agreement does not receive protection of the section.   Further, the section only governs liens arising “in the ordinary course of business” – see s73(1)(b).

Now for many possessory liens arising in the ordinary course of business, the lien holder will be unaffected.  Think classically of a repairer.  A motor vehicle repairer engaged to fix a company vehicle might expect it to be under finance, but would not be likely to check the PPSR and obtain a copy of any prior security interests.

But for a salvage lien, the situation is more difficult.  A liquidator or receiver may well know the terms of a prior ranking secuirty agreement.  There could also be a tricky argument about whether a salvage lien arises “in relation to providing goods and services in the ordinary course of business”.  In my view it probably does not, given that it will arise only once the grantor is insolvent and continuing to trade under the control of an insolvency practitioner.  Until we know the answer by a decided case, the risk remains.

I note the same risk may confront solicitors and accountants holding a lien over a file for unpaid fees, for the same reasons.

These are potentially troubling results.   If one is in a position of having actual knowledge of prior security interests, then before relying on a lien of any complexion, care must be taken to avoid loss of priority to a registered security agreement.

Thanks to Nick Anson of Minter Ellison for comments on this post (link to Nick’s profile).

Regards

Mark

ATO beaten by trust liquidator in priority battle – twice!

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The Commissioner of Taxation is the most common unsecured creditor in insolvent estates and often the biggest.   That is not surprising since Federal tax revenues are currently about 21% of GDP.

In 1993 the Commissioner lost his priority over other unsecured creditors in bankruptcy or liquidation for outstanding group tax and PPS debts.

Since then,  the Commissioner has looked for other ways to gain de facto priority over unsecured creditors.  One method has been to recover tax from directors personally – the “directors penalty notice” provisions of the tax law was also introduced in 1993 partly to compensate the Commissioner for the loss of priority (an excellent paper explaining these provisions in clear terms can be found here, published by Worrells).

Another device given a try by the Commissioner was to garnishee debts owed by third parties to the insolvent company, by notice under section 260-5 of the Taxation Administration Act 1953 (TAA), after a company had gone into liquidation.   A notice under s 260-5 gives the Commissioner the right to recover from a third party an amount that the third party owes or may later owe to a taxpayer who is indebted to the Commonwealth for tax. The remedy given to the Commissioner by s 260-5 is available in respect of revenue obligations, which are given the character of “debts” by force of the TAA itself and without the need for a judicial determination.  The third party must pay the amount demanded in the notice; failure to comply with the notice is a criminal offence.  Upon payment the Commissioner has the right to give to the third party a valid receipt and discharge for money paid in compliance with the notice.   In these respects, a notice under s 260-5 operates in the same manner in which a garnishee order issued by a Court operating to attach a debt.

In effect the Commissioner was issuing notices to round-up debts owed to the insolvent company that would otherwise be collected by the liquidator, putting the proceeds of the debts exclusively to payment of the Commissioner’s debt.   If the debtor responded to the notice and its validity were upheld, then the Commissioner would then restore an effective position of priority, at least as far as proceeds of third party debtors recoveries are concerned.

The Commissioner’s efforts ended badly.

First, the use of garnishee notices in this way was held to be invalid by the High Court (Bruton Holdings Pty Ltd (in liquidation) v Commissioner of Taxation (2009) 239 CLR 346).   In a fairly extraordinary display of litigation muscle by the Commissioner (no doubt because of the potential precedent value of a favourable outcome), no less than six related proceedings were fought in the Federal Court and High Court, over about $470,000 held in a solicitor’s trust account, the debt in question.

Second, the outcome of the final Full Federal Court appeal – Bruton Holdings Pty Ltd (in liq) v Commissioner of Taxation (austlii link) (2011) 193 FCR 442 (FCFCA) (Bruton (no 2)) was that Bruton, the insolvent corporate trustee, was allowed its full indemnity costs of the entire sequence of litigation from the trust’s funds even though it was a bare trustee of the assets.   The Commissioner had argued, unsuccessfully, that a bare trustee is restricted to a “passive role” and that Bruton had no authority to conduct the litigation over the validity of the garnishee notice because, in effect, the ATO was the only unsecured creditor and would get the proceeds of the debt one way or other (no evidence to support this latter assertion was led).  The Full Court rejected that argument – first on the basis that there was some evidence suggesting the existence of other creditors, and secondly by reference to the general duties of any trustee to preserve and protect trust assets when threatened, by litigation.  See in particular paragraphs 19 to 27.

There has been no special leave application:  just an even half-dozen cases on this occasion then!

The introduction to the  joint judgment of Stone, Jacobson & Edmonds JJ in Bruton (no 2) sets out the extraordinary sequence of the litigation:

……….In 1997, by deed of trust, the appellant (Bruton) was appointed as trustee of the Bruton Educational Trust (educational trust). On 10 October 2005, Bruton applied to the respondent (Commissioner) for endorsement as a tax exempt entity as from 1 July 2006. The application was refused, as was Bruton’s objection to the Commissioner’s decision. An appeal from the Commissioner’s decision (objection appeal) was also dismissed.

Piper Alderman was the solicitor for Bruton in the objection appeal. Between October 2005 and February 2007 it was paid $470,000 by Bruton to be held in its trust account in respect of costs and disbursements of the proceedings including the endorsement application to the Commissioner. On 28 February 2007 administrators were appointed to Bruton and on 30 April 2007 the company’s creditors resolved that it should be wound up. By virtue of ss 513B(b) and 513C(b) of the Corporations Act 2001 (Cth) the winding up was taken to have commenced on 28 February 2007.

Clause 10.2(b) of the educational trust deed provided that the office of the trustee was “immediately terminated and vacated” if the trustee went into liquidation. Accordingly, from 28 February 2007 Bruton ceased to be the trustee of the educational trust and became the bare trustee of the assets comprising the trust fund (Fund). As a consequence Bruton was no longer entitled to exercise any power including the investment, management or payment of trust monies arising from the educational trust deed. Its powers were limited to those that under the general law or statute are the powers of a bare trustee.

On 26 March 2007, the Commissioner issued a notice of assessment directed to the trustee calling for payment in the amount of $7,715,873.73 in respect of tax and the Medicare levy for the 2004 income year. Furthermore, after Bruton was wound up, the Commissioner lodged a Proof of Debt with the liquidators of Bruton for the amount stated in the notice of assessment. On 8 May 2007, the Commissioner issued a notice to Piper Alderman pursuant to s 260-5 of Schedule 1 of the Taxation Administration Act 1953 (Cth) requiring the firm to pay $447,420.20 which it held in its trust account on account of the educational trust to the Commissioner.

On 30 May 2007 Bruton instituted proceedings in this Court (primary proceeding) seeking a declaration that the s 260-5 notice was void by virtue of s 500(1) of the Corporations Act. On 2 November 2007 Allsop J declared the notice was void (see Bruton Holdings Pty Ltd v Commissioner of Taxation (2007) 244 ALR 177). On 23 November 2007, his Honour made further orders including an order that Piper Alderman pay the $477,420.20 held in its trust account to the liquidators. The liquidators were to pay that money into an interest-bearing bank account and were restrained from spending that money except, inter alia, to pay expenses incurred by Bruton in respect of the primary proceeding and the appeal proceeding. His Honour ordered the Commissioner to pay Bruton’s costs as well as those of Piper Alderman.

An appeal from Allsop J’s judgment to the Full Court was allowed and Allsop J’s judgment was set aside (see Commissioner of Taxation v Bruton Holdings Pty Ltd (in liq) [2008] FCAFC 184; (2008) 173 FCR 472. Bruton was granted special leave to appeal to the High Court. The High Court allowed the appeal with costs (see Bruton v Commissioner of Taxation [2009] HCA 32. It set aside the orders of the Full Court and in their place ordered that the appeal to the Full Court be dismissed with costs.

A dispute followed between the Commissioner and the liquidators concerning whether the shortfall between the amount of Bruton’s solicitor and client costs and the amount of its party and party costs referable to the primary proceeding, the Full Court appeal, the application for special leave and the appeal in the High Court should be paid out of the Fund. This dispute over the payment of costs was the subject of the proceeding before Graham J (costs proceeding) and is the issue in the present appeal (emphasis added)

Regards

Mark

How to Cure an Invalid Voluntary Administrator Appointment

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I recently appeared in urgent proceedings for the voluntary administrators of  a company who may have been invalidly appointed.  The business run by the company had been the victim of obvious phoenix activity.   The administrators wanted to take action to confirm whether they were validly appointed, and were concerned that the company might revert to the control of the director with a real risk of the company’s business  being transferred to another entity.

What were the administrators to do?

The administrators had been appointed by a sole director (lets call her Ms Smith) of the company pursuant to s436A of the Corporations Act.  Ms Smith was essentially a nominal director who was appointed because the operator of the business was disqualified himself from acting as a director.  Ms Smith and the sole shareholder (lets call him Mr Jones) had fallen out with each other at about the time of the appointment.  It was allegedly the Jones camp who were seeking to “Phoenix” the company (for a third time as it turned out).

On the same day that they were appointed, the administrators made contact with Mr Jones and his lawyers.  Jones claimed the appointment was invalid.  The administrators immediately made an application to the Court for a declaration as to whether their appointment was valid, under s 447C.  They were concerned to act quickly in view of an impending first creditors meeting.

The administrators’ investigation in the days after their appointment made it clear that the appointment was invalid because Mr Jones had successfully removed Ms Smith as a director on the night before the purported appointment of the administrators.  This meant that the s447C application was no longer a solution, since that section does not allow the Court to validate an appointment which the Court determines is invalid.

Rather than withdraw,  the administrators did two things.

First, they expanded their application to seek an order validating their appointment relying on the very powerful Corporations Act provision, s447A (link).  Readers may recall that s447A allows the Court in its discretion to vary the operation of the Corporations Act as it applies to a particular company in Voluntary Administration.  In effect, the law as set out in Part 5.3A of the Corporations Act can be rewritten by the Court on application of a voluntary administrator and a range of other parties, including an “interested party”.

A line of cases has emerged over the past decade or more which makes clear that s447A can be used by a Court to validate an appointment of an administrator, even where the purported appointment was invalid and lacked power.  One of the most recent cases is National Australia Bank Ltd v Horne [2011] VSCA 380 (link).  In that case the Victorian Court of Appeal upheld a decision of Justice Sifris at first instance where his Honour used s447A to make an order validating the appointment of administrators who had been purportedly appointed by a chargeholder under s435C, which was found to be invalid because the chargeholder did not have security over substantially the whole of the company’s assets:  see Re Australian Property Custodian Holdings Limited (Administrators Appointed) (Receivers and Managers appointed) [2010] VSC 492 (link). The decision at paragraphs 31 to 35 reviews the authorities.

A question arose in our case as to whether the Court’s power under s447A should be used to validate an appointment which was in the interests of creditors (as in our case) but for which the purported appointor never had any authority to make the appointment at the time when it was made.   The basis for resisting the use of s447A in this way was a floodgates argument –  that any person could purport to be a person qualified to make an appointment, do so, and then have the appointees validate the appointment under s447A.  It is an interesting point and I will prepare a separate post about the issue.

Second, the administrators made a further application to wind the company up on the just and equitable ground, in view of the evidence of impending phoenix activity and the insolvency of the company.  The administrators had also been (validly) appointed as administrators of the second of the three companies that had been “Phoenixed” and that company had the necessary standing to seek an order under s461(1)(e).

Ultimately the proceeding settled before judgment, with Mr Smith agreeing to an order under s447A by consent, given the likely success of the winding up application.

Regards

Mark

(Thanks to Joanne Hardwick of Mills Oakley who was the instructor in the matter and provided input for this post)

Liquidators and Receivers – are you sure of your personal liability for CGT on asset sales??

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Readers

Recently a controversy has developed concerning whether insolvency practitioners selling CGT assets subject to mortgage security were required to remit CGT in priority to the secured creditor.  The controversy developed out of a reading of s254 of the Income Tax Assessment Act 1936 as it relates to trustees of incapacitated entities, including liquidators, VAs and receivers.

Late last year I co-authored a paper with Helen Symon SC concerning the liability of insolvency practitioners whilst in office to a range of taxes.  The paper concentrated on CGT, Income Tax and GST.   The main issues dealt with in the paper were whether sale of post CGT assets by an insolvency practitioner gave rise to an obligation to pay CGT on the sale in priority to a secured creditor (we formed the view this was probable), and the now recognised device of appointing an agent in possession to effect a post CGT asset sale, and the circumstances and period for which practitioners are required to file tax returns for the entities to which they are appointed.

A copy of the paper is available at this link – Taxation – Common Issues.

A decision handed down since the paper contains a similar analysis of s254 in obiter (non binding) comments of the Supreme Court of New South Wales.  The decision is Goldana Investments Pty Ltd (recs & mgrs apptd) v National Mutual Life Nominees Ltd & ors [2011] NSWSC 1134.  In that decision, an application was made by the debtor company to have receivers removed on the grounds that the secured debt had been paid after the sale of a shopping centre.  The receivers of Goldana successfully resisted the application to have them removed because their potential personal CGT liability arising because of s254 had not yet been resolved.   It was therefore appropriate to allow the receivers to stay in office and in control of surplus proceeds from the sale.   According to the judgment, the receivers are in the process of seeking a private ruling from the ATO on their personal liability.

Regards

Mark McKillop

Liability limited by a scheme approved under Professional Standards Legislation

(PS Welcome to this blog!)