LECTURE 10: Financial Difficulties Part 1. Winding up or Liquidation, and Deregistration Introduction Source: https://www.abc.net.au/news/2020-03-06/coronavirus-shuts-vodafone-shops-workplaces-send-employees-home/12033132 So far in the lecture series, we have witnessed the birth of the company, which usually involves registration with ASIC, as well as various encounters of the members, directors and other players in the life of the company. Now we move onto what happens when the company is in financial difficulty, including its death or termination. Of course, many big companies in particular seem to keep going indefinitely and have become ingrained in our culture. They are institutions. But even big companies can fall, as the tabloids reveal. Indeed, in our competitive and cyclical economy, it is a matter of survival of the fittest, and no company is guaranteed immortality. The coronavirus pandemic has shown just how vulnerable many companies are, particularly those at the lower end of the scale. So, the law has responded. It has developed elaborate ways of handling collapsing companies, including methods to prevent their ultimate demise, as well as ways of dealing with the impact of company closure on stakeholders. This lecture explains the law and provides some illustrations with reference to companies in the Illawarra region and beyond. Deregistration without a Liquidator Source: https://www.smsfadviser.com/news/18818-tax-agent-deregistered-for-false-smsf-declarations Now, although this lecture focuses on what happens to companies in financial difficulty, it may be that a business owner or set of owners wants to shut down their company that is financially viable. Perhaps they do not see a future for it or a market to buy it, and so it has reached its logical limit. Perhaps its trading has ground to a halt and it has no debt or assets left and the owners are ready to call it a day. In which case, the business could simply enter into a process called ‘voluntary deregistration’, whereby a form is filled out and a nominal fee is paid to ASIC. To be able to terminate a company in this fashion, there are a few requirements: all the members need to agree to deregister the company, the company needs to have stopped conducting business, there must be no outstanding liabilities such as unpaid employee entitlements, the company’s assets must be worth under $1,000, the company must not be involved in any legal proceedings, and it needs to have paid all fees and penalties owing to ASIC.1 Deregistration with a Liquidator Source: https://stonegatelegal.com.au/winding-up-applications/ But the world of business is not always so simple. What if a company is solvent and the great majority of members want to close it, but the other criteria are not met for a simple deregistration process? What if the members want to end the company, but it is insolvent (so, unable to pay its debts when due and payable)? What if an administrator, which I will come to, recommends ending a company, or a court or ASIC decide to terminate it? With all of these scenarios, liquidation comes into the picture, involving a process in which the affairs of the company are put in order and wrapped up, before its life is ultimately ended by deregistration. It is a process that is also called winding up. Source: Wiley And who takes care of liquidation? Well, it is undertaken by liquidators, who are registered with ASIC. They are deemed by ASIC to have the requisite qualifications and to be fit and proper to undertake such a procedure that can impact the lives of many people. They are independent and external to the company. And they are part of a profession of insolvency practitioners. So, what happens when a liquidator is appointed? Well, they are put in control of the company, and generally the company stops trading and paying its bills, and members cannot trade their shares without the liquidator’s permission. And what does the liquidator actually do? Well, the liquidator gathers up all the assets of the company, values them, and sells them at auction or by private agreement, which produces a pool of money to divvy up. Source: https://www.cartoonstock.com/directory/l/liquidation_sales.asp They also investigate the affairs of the company, in an effort to procure more money and enlarge the pool. They might find hidden assets, transactions of the company that can be reversed, and breaches of duties by directors and officers that can be pursued by suing them and reporting them to ASIC, which could yield income for the company where the wrongdoers are made to compensate it. Source: https://www.123rf.com/photo_45616531_businessman-hands-passing-money-australian-dollar-aud-banknotes-on-gray-background.html Next, the liquidator distributes all the proceeds. To do this, it compiles a list of creditors and puts the creditors in an order prescribed by law. It then pays out the creditors in such order, to the extent that there is enough to pay them, and if any money is left, which is rare, the liquidator gives it to the shareholders. The process of liquidation can be a long and complex, sometimes lasting years before creditors are recompensed. In some cases – involving HIH Insurance, Ansett Airlines, and the companies of corrupt businessman Alan Bond – liquidation has taken decades. At the end of the process, ASIC is able to deregister the company so that the company is removed from the official register and no longer exists as a legal entity. In which case, any property that the company may still have (other than trust property) usually vests in ASIC and any legal proceedings to which the company is a party cannot be continued. Source: Wiley Now, just to backtrack a little, how do we get to the stage of liquidation? Well, there is usually financial distress to the point that the company is hopelessly insolvent. The company simply cannot be revived financially. Source: https://www.cartoonstock.com/directory/c/creditors.asp Perhaps it cannot secure a loan or investment to cover its debt and has no potential to attract the necessary business income. There is also a series of steps that the law requires before liquidation commences. And there are different steps depending on the circumstances, as this diagram suggests, including whether winding up is voluntary, which is the most common, or compulsorily ordered by a court. In terms of the voluntary option, liquidation can be initiated by members or creditors. With members’ voluntary winding up, the company must be solvent, and has usually finished serving its purpose. The directors need to declare in writing that it is solvent and will remain so for at least 12 months following the commencement of winding up, and 75% of the members need to agree by special resolution to end the company, before a liquidator is appointed to realise the company’s assets and pay out the creditors. If the liquidator determines that the company is in fact insolvent, the process converts to creditors’ voluntary winding up, as insolvency means that there are creditors, and so their permission for liquidation needs to be sought because their assets are at stake. With this form of winding up, a meeting of the company’s creditors needs to pass an ordinary resolution to wind the company up and they may use a liquidator of their choice. Creditors’ voluntary winding also occurs after members of a company elect liquidation on the basis of insolvency in the first place, or if creditors elect liquidation when under voluntary administration, discussed shortly. Moreover, creditors can be called on to agree to liquidation in the event that ASIC orders winding up. ASIC can do this if, for example, the company has not paid its fees or responded to ASIC and ASIC believes it has ceased trading. Source: https://publishednotices.asic.gov.au/browsesearch-notices/notice-details/WOLLONGONG-CONSULTING-SERVICES-PTY-LTD-620197837/084a0b59-ac70-492f-acab-f47477c739c6 By the way, when ASIC initiates deregistration, it will publish a notice on its website, as with this one published in relation to a company called Wollongong Consulting Services Pty Ltd. Source: https://www.illawarramercury.com.au/story/6564522/warrawong-dvd-pop-culture-store-closes-after-company-goes-into-liquidation/ An example of a company that recently went into creditors’ voluntary liquidation is JRT Entertainment Pty Ltd, trading as DVD World, which you might have come across at Warrawong Plaza in Wollongong or online. Apparently, it was half a million dollars in debt, perhaps as DVDs are now an almost superseded technology. Source: https://publishednotices.asic.gov.au/browsesearch-notices/notice-details/JRT-Entertainment-Pty-Ltd-136987589/839f17b7-28ef-40a3-a474-c02744ed3eaa So, faced with this debt, a general meeting of the members decided to wind up the company and appoint a particular liquidator. The following day, the company closed its doors to the public. Shortly after, the Illawarra Mercury reported that a spokesperson for the liquidator said that any customers with a claim should contact the liquidator.2 And presumably a creditors’ meeting took place. Source: https://anz.msiglobal.org/what-a-statutory-demand-means-for-your-company/ So, what might happen in the event that the members or creditors do not voluntarily agree to the company being wound up? Well, a creditor could issue a statutory demand. A statutory demand is where a creditor demands in writing that the company pay its debt (which needs to be a minimum of $2000) within 21 days, and accompanies this demand with an affidavit verifying the debt. If the company disputes the debt, it needs to apply to the court within 21 days to have the demand set aside. If the company has not paid the debt, or not challenged it, or not reached an agreement with the creditor within this period, the company is presumed insolvent and the creditor can apply for a court order that the company be wound up and a liquidator be appointed – so, compulsory winding up. Interestingly, for most of 2020, the law on statutory demands was actually relaxed by the federal government, in line with its relaxation of various laws relating to business, due to the coronavirus. Under the now-repealed Coronavirus Economic Response Package Omnibus Act 2020 (Cth), the minimum debt for issuing a statutory demand was increased from $2,000 to $20,000, and the compliance period was extended from 21 days to 6 months. So, quite a generous temporary change for companies, which allowed them more debt and more time to repay it before the court could consider liquidation. And that brings us to the end of the topic of winding up. I will see you in the next part. Part 2. Receivership Introduction Source: Wiley So, we are looking at what happens to companies in financial difficulty. So far, we have considered liquidation as an option if there is a particularly dire financial situation. But it does not have to come to such bleak end for a company. There are other options: options that may enable the company to deal with its debt that do not necessarily spell the end; options that can even help to resuscitate the company. These include receivership, voluntary administration, and arrangements or reconstructions such as scheme of arrangement. I will look at receivership in this part of the lecture, before moving onto the other forms in the next part. Concept of Receivership Source: https://www.cartoonstock.com/directory/r/receivership.asp Like liquidation and voluntary administration, receivership is a type of external administration. This is where an independent insolvency practitioner, like a liquidator or administrator, from outside the company intervenes where the company is in financial distress. However, receivership is a little more one-sided than the other forms of external administration. It is usually initiated by a big creditor of a company. The creditor has decided that if it is ever going to recover from, say, its loan to a company that the company has defaulted on, someone will have to be appointed to work within the company to help. And that person is a receiver. In doing its job, the receiver might be able to leave the company intact and still operating. Though, the outcome is not so often a positive one. The main aim is to return property to the creditor in question, regardless of what the outcome is for other creditors or the company as a whole. To achieve this aim, the receiver takes possession of the company’s secured assets, which have served as security for the loan, and manages or sells these assets in an effort to recover the debt that is owed to the creditor and therefore meet its obligations to the creditor. The receiver is also able to take control of and manage the business more generally where the business of the company itself is secured property, and not simply particular assets of the company. In this common situation, the receiver is called a ‘receiver and manager’ and is empowered to manage the affairs of the company. If the company does not want a receiver that is entitled to come in and deal with the company’s assets and business in this way, there is little it can do, in contrast with voluntary administration, which, as the name suggests, is a voluntary form of external administration that is commenced at the company’s own initiative. And just to note, receivership also applies to partnerships and trusts, though corporate receiverships are the most common. Appointment of Receiver Source: Wiley As this diagram shows, there are different ways in which a receiver can be appointed. One is by the judiciary on application of the corporate regulator, which is often with the purpose of safeguarding the company’s assets. But by far the most common way is at the behest of the secured creditors themselves. Source: https://www.picpedia.org/keyboard/s/secured-creditors.html So, what are secured creditors, and how are they different from unsecured creditors? Well, secured creditors are often banks or finance companies that loan money and use some asset(s) of the borrower as security or collateral, like a company car, so that if the borrower defaults on the loan, the creditor can take control of the secured asset(s). In contrast, a creditor such as a supplier that incurs a debt between supplying goods and being paid but has no such formal arrangement, will be an unsecured creditor. Source: https://www.cartoonstock.com/directory/c/creditors.asp Now, in their private security instruments or loan agreements entered into with companies, banks and other secured creditors often have clauses stipulating that they are entitled to appoint a receiver if the company defaults. The agreements also set out the secured property and the circumstances in which the creditor is to receive it. Moreover, where there is a conflict between the powers of the receiver listed in such agreements and the powers of receivers listed in the legislation, the agreement takes precedence. This could help explain why creditors, with private agreements worded to their satisfaction, might take a keen interest in initiating receivership, not to mention that they do not need to obtain court approval. Indeed, having the option of a private appointment of a receiver is a powerful legal basis from which banks and other secured creditors can take action. This option gives them significant leverage in their dealings with failing companies. Role and Duties of Receiver Source: Wiley Let us now look more closely at the role of the receiver. So, the receiver has an interest in the secured property. It can sell the secured property, lease it out, or even borrow money on it. As suggested, depending on the loan agreement, it can also manage the company’s business, which could include hiring and firing employees, dealing with any contracts and matters on behalf of the company, and even winding up the company – hence the receiver is also a registered liquidator. The receiver will then use the proceeds to repay the creditor and discharge the debt – which terminates the receivership, as the receiver has achieved its objective – and will give any surplus to the company. So, on the face of it, the receiver has an exclusive duty to the creditor that has appointed the receiver. And yes, the receiver does have contractual, tortious, fiduciary, and statutory duties to the creditor, and can be liable to it if anything goes wrong, such as the sale of the secured property for less than its market value. In this way, the receiver acts on behalf of the creditor, in contradistinction to the liquidator and administrator, who act on behalf of the company and do not owe duties to individual creditors. However, let us not forget that the definition of an officer of a company in section 9 of the Corporations Act 2001 (Cth) includes a receiver, just as it includes a liquidator and administrator. Hence, the receiver also has duties to the company as an officer of the company – the same duties in sections 180-184 that we studied under the topic of directors’ and officers’ duties. If it does not act with care and incurs debts on behalf of the company, for instance, it can be liable to the company. The privately appointed – as opposed to court appointed – receiver is also technically an agent of the company, as with liquidators and administrators, which is how it can enter into contracts under the company’s name, and so has obligations in its capacity as agent. Moreover, if we again consider the scenario of a receiver underselling the secured property, it is clear that not only would this underselling put more financial pressure on the company, it could additionally disadvantage other creditors who might also have an interest in the company’s assets. Therefore, the receiver owes duties to other creditors, too. Though, its paramount duty belongs to the creditor that has appointed the receiver. Consequences for the Company Source: https://theregister.co.nz/2016/04/26/how-not-make-dick-smith-yourself/ So, what happens to the company during receivership? Does it keep trading or does it stop trading, like with liquidation? Well, it just depends, both on how much of the company’s property and functions the receiver has control over, and on the method it wants to use to recoup the creditor’s losses. Technically, the directors remain in office and still have their duties, but they can lose their authority over the property to the receivers, subject to the nature of the appointment, such that the identity of the agents acting on behalf of the company switches from the directors to the receivers. So, the so-called ‘receivers and managers’ can be the ones operating the company and making decisions about whether to close stores, rationalise staff, and so on. It is not surprising, then, that some companies remain in receivership for years. And what happens to the company after receivership? Well, in the best-case scenario, the directors can resume managing the company’s affairs. On the other hand, there may not be a company if the receivership has ended in liquidation. However, as the privately-appointed receiver is an agent of the company, it may be less likely than a court-appointed receiver to take steps to liquidate the company and more likely to try to restore the company’s financial health by restructuring it and disposing of its unproductive assets or activity. Source: https://en.wikipedia.org/wiki/Dick_Smith_(retailer) It might find a new owner for the company or even for the company’s intellectual property. In this regard, we may recall the formerly listed company Dick Smith. This iconic Australian company and its subsidiaries went into receivership in 2016. The receivers and managers were unable to find a buyer for the company, as the offers were apparently ‘significantly below liquidation values or highly conditional or both’.3 And so they had to close the business down – it entered liquidation and 3,000 people lost their jobs – which the eponymous founder and original owner Dick Smith famously blamed on its over-expansion and the ‘utter greed of modern capitalism’.4 Source: https://theregister.co.nz/2016/04/26/how-not-make-dick-smith-yourself/ But, in selling off the assets of the company, the receivers were able to find a buyer for the intellectual property of the company – that is, the Dick Smith brand, trademark, online business, customer databases, websites, and domain names. And that buyer was Kogan, the big retailer. So, Dick Smith was able to continue operating in a sense – just in name and concept only, not as a registered business and separate legal entity. And in this image, you can see Dick Smith’s intellectual property being advertised by the receivers and managers Ferrier Hodgson. Source: https://www.dicksmith.com.au/da/contact-us/ Also, in this image from Dick Smith’s website, you can see that the only registered business is Kogan. There is no Australian Business Number (ABN) or Company Registration Number (CRN) for Dick Smith, but rather there is an ABN and CRN for Kogan, which is listed on the website as ‘trading as’ Dick Smith. Local Examples Source: https://www.urban.com.au/expert-insights/investing/17227-thirroul-motel-where-brett-whiteley-overdosed-set-for-receivership-sale As for local examples of receivership, about a decade ago, the Thirroul Beach Motel where the famous artist Brett Whitely died from heroin overdose, went into receivership. An insolvency firm took over and sold the motel under a receivership sale. Source: https://www.accomnews.com.au/2012/02/illawarra-hotel-in-receivership/ A similar fate befell Gilmore’s Hotel at Coniston, near our university, at one stage. Source: https://www.illawarramercury.com.au/story/6672647/illawarra-stores-in-limbo-as-stationery-retailer-kikki-k-collapses-into-receivership/ And more recently, the chains Kikki K and Harris Scarfe, with stores at Wollongong and Shellharbour, also experienced financial woe. They went into receivership, but only after the companies placed themselves in voluntary administration, which can often happen this way. And on that note, stay tuned for the next part of the lecture, where I will explain the concept of voluntary administration. Part 3. Voluntary Administration and Scheme of Arrangement Introduction Source: https://moneymorning.com/2019/09/18/one-of-our-options-strategies-just-made-you-200/ In this part of the lecture, we look to see what further, and perhaps more promising, avenues there are for companies in financial difficulty and for their range of creditors. Voluntary Administration Source: https://www.lynnandbrown.com.au/network-ten-goes-into-voluntary-administration/ One prominent avenue on the scene of insolvency law is voluntary administration. When a company is either insolvent or at risk of becoming insolvent soon, it can put itself into voluntary administration. This is yet another form of external administration, this time involving a voluntary administrator – again, registered as a liquidator. The administrator is appointed to work towards bringing the company back to financial health – so the opposite job of a liquidator who is tasked with winding up the company. And if the administrator cannot save the company, then it is at least expected to chart a course of action that would result in a better return for creditors than if the company was wound up. Voluntary administration is relatively convenient, in that it can be initiated simply by a resolution of the board of directors, without requiring shareholder approval, and as it allows the directors to avoid insolvent trading. Though, the directors cannot decide to take this route when the company is already in liquidation. And companies may also enter into voluntary administration, albeit less commonly, by way of a liquidator, if the liquidator thinks the business can be saved, or a secured creditor, though the secured creditor’s interests are not given the same priority as under receivership. Indeed, voluntary administration is designed to resolve the matter to suit everyone’s interests, rather than just the interests of the big banks, as well as to be quick and efficient. So, voluntary administration is a more modern approach to dealing with companies in financial distress, that tries to manage the situation more ethically. In fact, it has only been around in Australia since 1993, following recommendations in the late 1980s of the Australian Law Reform Commission to adopt a corporate rescue model based on an American bankruptcy procedure. Source: https://www.heraldsun.com.au/business/arrium-administrators-hold-nerve-in-bid-to-keep-steelmaker-operating/news-story/ac1e6c3eb7d39b17442f396a59fc7e25 Now, how does voluntary administration work? Well, it begins once an administrator has been appointed – usually, as suggested, by a majority of directors. The administrator proceeds to investigate the company’s affairs and to report on this to the creditors and present them with options for the way forward. To assist with this investigation, the directors provide the administrator with a report on the company’s affairs within 5 business days, and hand over any company books. The administrator then holds an initial creditors’ meeting within 8 business days of his/her appointment, unless the court gives an extension. At this first meeting, for which the creditors have been given at least 5 business days’ notice, the creditors can vote to replace the administrator. They can also create a ‘committee of inspection’, which is a small group of creditors that represents the creditors’ interests in administration or liquidation and can liaise with the administrator and request and approve certain things. Then, only 20 business days from the commencement of administration (or 25 business days over Christmas and Easter) – give or take 5 business days or with an extension by order of the court, which can be relatively generous – there needs to be a final meeting of the creditors, after which the administration ends. The 20-25 day period is called the convening period. And within this period, the administrator needs to have prepared advice on the following three options that creditors must choose from, with the administrator having the casting vote in the event of a deadlock. Source: https://www.stoddartgroup.com/blog/2020/3/30/business-as-usual One option is that the administration is terminated. So, the situation is safe enough for the company to return to the control of the directors and to continue to trade as normal. Source: http://acronymsandslang.com/definition/459785/DOCA-meaning.html Another option is for a deed of company arrangement (or DOCA) to be entered into between the company and its creditors, with the aim of recapitalising or selling the business to a solvent buyer. So, this is the rehabilitative option under voluntary administration. The DOCA may or may not be a deed that the administrator has proposed. The company would need to execute it (that is, sign it) within 15 business days of the meeting, unless the court has granted an extension, otherwise creditors’ voluntary liquidation will ensue. And if the deed is accepted, the company enters into a second stage of voluntary administration, in which it is under a deed of arrangement managed by a deed administrator whose powers are determined by the deed. Are DOCAs a good idea? Well, they have the advantage that they can be flexible and include concessions for the company to help it meet its liabilities and return to solvency, such as the extinguishment of part of the debt, while providing benefits for creditors in exchange. Moreover, they can potentially offer a better return for creditors than under liquidation. However, in practice, secured creditors rarely vote for them. And even if a deed is adopted, creditors can ask a court to have it set aside. Source: https://www.whatisliquidation.com.au/blogs/126-how-long-does-a-voluntary-administration-go-for.html And the third option is that the company enters into liquidation and the administrator becomes the liquidator, which is actually the fate of most voluntary administrations. Source: https://www.abc.net.au/news/2020-05-11/illawarra-hawks-face-liquidation-administrator-says/12234880 It seems to have almost been the fate of the Illawarra Hawks basketball club, which plays its home games at the ‘Sandpit’ in Wollongong. The club is registered as a proprietary limited company that is part of the NBL franchise. It fell into administration in 2020. And the administrator recommended, given outstanding debts of more than $770,000, that the company liquidate its assets. However, it looks as though the NBL has found new owners for the club, so watch this space. Source: https://marketbusinessnews.com/financial-glossary/administrator-definition-meaning/ Now, getting back to technicalities. During administration, the administrator takes control of the company. It becomes an independent agent and officer of the company and needs to adhere to the officers’ duties in the Corporations Act. Consequently, the directors are suspended from managing the business and controlling the company’s assets, unless they receive permission from the administrator. And how does the administer know how to run the business? Well, this could be a problem, so commonly the day-to-day operations will continue under the usual management, albeit supervised by the administrator. Source: https://newstodaynet.com/index.php/2020/09/10/sc-extends-loan-moratorium-gives-last-chance-to-centre/ Along with the suspension of directors’ control is a general moratorium on the creditors’ claims against the company, which gives companies precious time to restructure their affairs and is considered one of the real advantages of voluntary administration. This moratorium includes the freezing of personal guarantees of directors and their relatives. Personal guarantees are where personal property has been used as security for a loan; the directors have put their own assets on the line, which is common among small- to medium-sized businesses. So, the suspension of these can be of great relief. A partial exception to the moratorium on claims is where secured creditors have commenced enforcement proceedings or appointed a receiver before the commencement of voluntary administration. Such creditors will only be bound by the moratorium 13 business days after the voluntary administration has begun. However, as they tend to be banks with significant bargaining power, they will often be able to negotiate an arrangement with the administrator, such as the continuation of privileges after the 13-day period. Also, for employees there is a moratorium on their claims to entitlements in the event that the administrator terminates their employment, and for shareholders there is a moratorium on the trading of their shares. So, that is voluntary administration. Scheme of Arrangement Source: https://www.dreamstime.com/illustration/scheme-arrangement.html A similar option for companies in financial difficulty, but which can also be applied to companies not in financial difficulty, is scheme of arrangement. A scheme of arrangement can be either a creditors’ scheme, affecting the rights of creditors, which is most relevant to companies in financial difficulty, or a members’ scheme, affecting the rights of members, which applies usually in relation to take-overs. As with a DOCA, a creditors’ scheme involves a plan by the company to restructure the company’s debt owed to creditors. It essentially varies the terms of the repayment of the debt. The debt might be extended; or assigned to a third party, with refinancing from external sources; or capitalised by issuing shares to the creditors, which is called a ‘debt for equity’ swap. But the process of attaining a scheme of arrangement is quite different from that of a DOCA. It is more complex. The company needs to draft a scheme and explanatory statement, it needs to apply for a court order to convene a meeting of creditors or affected classes of creditors, and it needs to give ASIC notice of the application. Then the creditors at the meeting need to vote in favour of the scheme (with higher voting thresholds than with a DOCA), and finally the court must approve the scheme after hearing any arguments from dissenters. Needless to say, with the court’s approval required not once but twice, a scheme of arrangement is a significantly cumbersome and costly process, which is why it has not been used much since the introduction of the more efficient system of voluntary administration. However, some believe that the mechanism has experienced a modest a revival. And certainly, there appear to be some advantages. One is that a scheme of arrangement can be more stable and less likely to be legally challenged, because it has already gone through rigorous creditor, court, and ASIC processes. In contrast, a DOCA is more likely to be subsequently set aside by a court, such as where minority creditors have sought protection from oppression. Hence, a scheme of arrangement can sometimes be the preferred option for companies proposing a major debt restructure and that are large and suitably resourced. Source: https://www.gtlaw.com.au/insights/deal-report-wollongong-coal-schemes-arrangement One such company is Wollongong Coal Limited. We can see a picture of its mining operations on the screen. It is not a small company; it was listed on the ASX until 2020 when its debts exceeded $1 billon.5 And its method of dealing with its financial difficulty so far has been via some creditors’ schemes of arrangement. Conclusion Source: https://www.openbusinesscouncil.org/1-in-10-businesses-face-collapse-as-the-economic-crisis-deepens/ So, that is an introduction to a range of options for companies in financial distress – liquidation, receivership, voluntary administration, and scheme of arrangement. Now, liquidation is frequently the first course of action that is chosen. And even with receivership and voluntary administration, liquidation is very commonly a final outcome. So, let us look in the next video at how creditors and other stakeholders fare legally in the process of company failure. Part 4. Effect of Financial Distress and Liquidation on Stakeholders Introduction Source: https://uxdesign.cc/hierarchy-of-information-work-e40eaf973ae0 I would like to begin by asking: if a company goes into financial distress and if it collapses, does the legal system give equal consideration to the interests of everyone affected – the institutions financing the company, the workers, the shareholders, etc? The answer is: generally, no. It may try to balance the various interests in some ways. But ultimately, it chooses between them and places a select few on a higher plane. Hence, the image of a pyramid. So, in this final part of the lecture, I will consider what choices the legal system makes. From Shareholders to Creditors Source: https://www.lifeplanresource.com/protect-estate-assets-from-creditors-with-a-dapt-trust/ We may say that the legal system changes its perspective somewhat when companies find themselves in financial trouble. In the beginning, when companies are trying to attract capital and build their business, the law emphasises the members or shareholders, in line with the doctrine of ‘shareholder primacy’. It says to companies: you must disclose and be accountable to shareholders. You must involve shareholders in the decision-making to an extent. You must value their rights and remedies. Even if large owners benefit most in the corporate world, there is symbolic celebration of the role of the shareholder. But when things start to go wrong financially – when there is corporate failure – the emphasis on the ordinary shareholder is reduced. Instead, we see an effort to accommodate the company’s creditors. So with liquidation, I pointed out that it only constitutes a member’s winding up, in which the members have the last say, when the company is solvent. But when the company is insolvent, it becomes a creditor’s winding up, where the creditors have the final say. There is a switch. And even more so with receivership – it is driven usually by the company’s largest creditor, which tends to be a bank. And the ‘independent’ receiver, in adverted commas, has an important duty to the single creditor and not simply the company or the creditors more generally. Which is one reason why it has been abolished in the United Kingdom since 2002.6 Though, it is certainly still part of the Australian corporate landscape. Also, with voluntary administration, the voluntary administrator is accountable only to the creditors and takes his or her cue from the creditors. And with scheme of arrangement, the company needs to obtain approval from the creditors, as well as the court and ASIC who have heard from and liaised with any concerned creditors. So, once a company becomes insolvent or approaches insolvency, it is managed for the benefit of the creditors rather than the shareholders, which is confirmed in statute and the case law.7 Hierarchy of Creditors Source: https://www.cartoonstock.com/directory/c/creditors.asp But even if the law wants to satisfy creditors’ interests, it knows that there will not usually be enough funds to satisfy all of the creditors at the end of an insolvent company’s life. So, it ranks the creditors, following a priority regime set out in the Corporations Act (2001). At the top of the pecking order are secured creditors. When the liquidator has pooled all of the company’s remaining assets, and is ready to distribute them, the secured creditors get the first go at recovering their money. And remember, the secured creditors, like banks, are the ones with collateral or security over the assets of the company. So, the outcome of liquidation in fact ends up being similar to that of receivership. Source: https://www.greenfieldslawyers.com.au/articles/preparing-for-revised-fees-and-costs-information-in-periodic-statements The next in line in liquidation are preferential creditors, who are technically a higher tier of unsecured creditors. The first preferential creditor is the liquidator, with funds distributed to pay for the costs and expenses of winding up. The ASIC website says, however (and I quote): ‘If there are no – or only limited assets – the liquidator is sometimes not paid (or only partially paid) for the work they do. The liquidator may arrange for a third party to contribute to their fees.’8 The next category of preferential creditors are employees. Any funds available are distributed to pay first for their wages and superannuation, then leave entitlements, and then retrenchment. However, if directors or their relatives are employees, their pay is capped to $2,000 for wages and superannuation and $1,500 for leave entitlements. Source: https://www.cartoonstock.com/directory/g/global_financial_crisis.asp Next down the list to receive payment, if there are still funds left, are the general unsecured creditors. This category includes independent contractors, such as tradespeople and professionals who have done jobs for the company, and people who have received gift vouchers to spend at the company, among others. According to the ‘pari passu’ rule, unsecured creditors rank equally. So, where funds are insufficient to pay them all in full, the creditors share proportionately in the proceeds, with each creditor receiving the same number of cents in the dollar of the debt owed to them. And at the very bottom of the pecking order are members, who are unlikely to receive anything. But, in any case, with limited shares, they do not lose more than their investment. The State Source: https://www.ancap.com.au/media-and-gallery/releases/vehicle-safety-a-continuing-priority-for-the-federal-government-59ba40 So where does the state lie in the order of priority? Say the company under liquidation owed the government money from fines and penalties or from a tax debt that it had accrued. Would the government get paid what it was owed as a matter of priority, or would it be at the bottom of the list or not even on the list? Well, it seems that the government gets very little priority, if any. The Corporations Act says that ‘penalties or fines imposed by a court [on a company] in respect of an offence against a law are not admissible to proof against an insolvent company’, with the exception of a specific type of penalty order (s553B), meaning that the government cannot generally stand in line as a creditor when it comes to fines. One company law textbook writer says that (and I quote): ‘This is because it would be inappropriate to penalise creditors for a wrong committed by an insolvent company.’9 But what are your thoughts on the matter? Should companies effectively be exempt from the rule of law? On the question of unpaid tax, however, the government is allowed to be a creditor, albeit an unsecured creditor, meaning that it will often have little chance of getting paid from the pool of assets. This was not always the case. Before 1993, tax liabilities received priority.10 Employees Source: https://www.smh.com.au/politics/federal/cut-dole-to-40-a-day-except-for-long-term-jobless-employer-group-20210201-p56ye9.html What about employees? Well, we know they are significantly disadvantaged by liquidation because liquidation terminates the workforce and of course does not redistribute employees into other employment, though the liquidator can permit temporary employment at the company for the purposes of winding up. The law does give employees priority status in being paid, but only after secured creditors and the administrative costs of winding up are dealt with. There could be nothing left by the time the liquidator comes to employees. Fortunately, employees can access money from the government’s Fair Entitlements Guarantee scheme, though only up to a limit, and independent contractors and sub-contractors are not eligible. The scheme may be of some relief for employees who bear the brunt of liquidation. But another way of looking at the scheme is that it takes responsibility from companies and gives it to the public to provide for the victims of corporate failure. Source: https://www.cpa.org.au/guardian/2020/1910/13-waterfront.html Now, some questions that unions have asked are: Do companies sometimes feign or exaggerate financial distress in order to lay off workers? Might companies even put themselves in a position of insolvency or voluntary administration to give them more leverage over workers? And, if so, does the law properly respond to this? Such questions were asked in relation to the famous Australian waterfront dispute of 1998. The company at the centre of the dispute, the Patrick group, was said to have deliberately created a corporate structure of Patrick Stevedores subsidiaries that it gave contracts of work to, so that it could then cut the contracts and thereby make the subsidiaries insolvent, which would mean that it could then place the subsidiaries under voluntary administration and dismiss the unionised workforce and replace it with a cheaper, non-unionised workforce. Unfortunately for Patrick Stevedores, the Maritime Union of Australia (MUA) cottoned on to this plan and successfully won an injunction that prevented 1,400 workers from losing their jobs.11 The outcome was positive for the workers in that particular case. However, it may be said that the structure of the legal system which enabled the company to engage in such behaviour in the first place has not fundamentally changed. So, on the one hand we may see insolvency law as having some inbuilt protections for employees, such as requiring their consent to vary their entitlements in a deed of company arrangement (DOCA). But on another, broader level, companies might be using laws on insolvency and corporate structure against unionised employees and perceived inefficiencies in the cost of labour. Other Stakeholders Source: https://www.cartoonstock.com/directory/s/stakeholder.asp Finally, it is useful to consider one other stakeholder affected by corporate collapse: the economy. In expressing concern for the economy, some argue that we need to have a legal system that gives companies maximal support to see them through financial hardship. They believe that, otherwise, if companies all too readily fail, there will be a range of negative economic ramifications: less investment, less tax revenue for the state from both companies and workers, more unemployment and poverty, upheaval in the lives of small business people, more monopolies, less competition which can lead to price increases for consumers and lack of innovation, the prevalence of assets that are no longer usefully employed, etc. And there is supposedly a flow-on effect, with a range of people and communities indirectly absorbing the losses. Source: https://www.cartoonstock.com/directory/c/creditors.asp Others argue that, on the contrary, as one company falls, another rises, and that the rise and fall of companies is a natural process of a vibrant economy continually looking to weed out business that is unproductive, in driving the private sector forward and creating more opportunity for jobs and development. Capital and assets of less productive companies, they say, can be restructured and reused more effectively among other companies that are more profitable. It appears, then, that the economy is one of the more difficult stakeholders to please. Maybe, in this case, the larger problem to figure out is not simply the challenges of the law on insolvency, but of a seemingly contradictory economic backdrop. On this note, I will leave you to ponder the question of what direction this area of law should be taking in Australia. © 2021 Dorothea Anthony 1 ASIC also recommends that other measures be taken, such as closing bank accounts, cancelling licences and ensuring no property is registered in the company’s name, and appointing a new trustee if the company was a trustee. 2 . 3 Thuy Ong, ‘Dick Smith Stores to Close After Receivers Fail to Find Buyer; Almost 3,000 Jobs Lost’, ABC News (25 February 2016) < https://mobile.abc.net.au/news/2016-02-25/dick-smith-stores-to-close-after-receivers-unable-to-find-buyer/7200006?pfmredir=sm>. 4 Ibid; Julia Talevski, ‘Dick Smith Enters Liquidation’, ARN (26 July 2016) . 5 Timothy Fernandez, ‘Shareholders Left Frustrated as Mining Company in More than $1b Debt Delists from ASX’ ABC News (19 August 2020) < https://www.abc.net.au/news/2020-08-19/wollongong-coal-delists-from-asx/12575396 >. 6 Jason Harris, Anil Hargovan and Michael Adams, Australian Corporate Law (LexisNexis Butterworths, 6th ed, 2017/2018) 694. 7 Ibid 672. 8 Australian Securities and Investments Commission, ‘Liquidation: A Guide for Creditors’ (August 2020) . 9 Phillip Lipton, Abe Herzberg and Michelle Welsh, Understanding Company Law (Thomson Reuters, 20th ed, 2020) 1012. 10 Insolvency (Tax Priorities) Legislation Amendment Act 1993 (Cth). 11 Maritime Union of Australia & Others v Patrick Stevedores No. 1 Pty Ltd (under administration) (ACN 003 621 645) & Others  FCA378.
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