9 August 2021
The Treasury has released a consultation paper on changes to improve creditors’ schemes of arrangement in Australia (the Consultation Paper).[1] The main proposal in the Consultation Paper is the consideration of a broad automatic moratorium, available to companies proposing a creditors’ scheme of arrangement.
In addition, the Consultation Paper briefly touches on a number of other topics for discussion, including scheme approval thresholds, cross-class cram downs, debtor-in-possession funding, cross border recognition issues, creditor protection and additional considerations for the improvement of the scheme process more generally.
These changes, if adopted, would have a major impact on Australia’s restructuring and insolvency environment.
Written submissions on the issues raised in the Consultation Paper (to be made to The Treasury) are due by 10 September 2021.
Background to the Consultation Paper
The Consultation Paper was signposted earlier in the year, by way of a media release by the Treasurer on 3 May 2021, promising a series of further insolvency reforms intended to complement the restructuring plan and simplified liquidation procedure introduced for small businesses last year.
In that media release, the Treasurer indicated that the Government would “consult on improving schemes of arrangement processes to better support businesses, including by introducing a moratorium on creditor enforcement while schemes are being negotiated.”
The proposals in the Consultation Paper appear to draw heavily from recommendations made by the Productivity Commission in its 2015 report.[2]
Automatic moratoriums for creditors’ schemes of arrangement
The main proposal addressed in the Consultation Paper is the consideration of an automatic moratorium to allow “a company and its creditors the breathing space to create a binding agreement to ensure that restructure of economically viable companies is not disrupted by a minority of creditors.”
The Treasury appears to envisage that the moratorium would be similar in scope to that available in a voluntary administration. On this basis it would therefore presumably stay both secured and unsecured creditor enforcement against the company (potentially subject to an exception for a creditor with security over the whole or substantially the whole of the assets of the company). The court would have the power to lift all or part of the moratorium in circumstances where its application would lead to unjust outcomes.
The scheme moratorium and scheme process more generally would continue to involve the directors retaining control of the company – a ‘debtor-in-possession’ process (as opposed to a voluntary administration where control passes to an external administration).
The Consultation Paper notes that the earlier an automatic moratorium is provided, the more effective it will be in providing ‘breathing space’ to the financially distressed company. However it also acknowledged that this needs to be balanced with any impact on creditor rights, the need for creditors to be appropriately informed, and the need for the moratorium to be to be targeted towards genuinely distressed companies seeking to make a scheme. It further provides that consideration needs to be given to the appropriate duration of any moratorium, particularly given the length of a scheme process (typically up to six months to implement).
Other issues
In addition to the automatic moratorium, the Consultation Paper also seeks feedback on a number of other possible changes to creditors’ schemes of arrangement, including:
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cross-class cram downs: whether to introduce of a ‘cross-class cram down’ mechanism, enabling a compromise or arrangement proposed via a creditors’ scheme of arrangement to be approved by the company’s creditors notwithstanding the opposition of one or more classes of the company’s creditors;
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debtor-in-possession financing: whether to introduce specific provisions for debtor-in-possession or rescue financing for distressed companies, which may involve granting priority treatment in a liquidation for such financing; or
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voting thresholds: whether to change the current voting thresholds to approve a scheme of arrangement.
The Consultation Paper also seeks more general feedback regarding the operation of creditors’ schemes of arrangement in Australia, including submissions on other issues that should be considered to improve creditors’ scheme processes, and whether there are potential impacts of the proposed reforms that need to be accounted for (such as cross border recognition issues, impact on particular parties or impact on programmes such as the Fair Entitlements Guarantee programme).[3]
Comment
The Consultation Paper does not contain an explanation as to what might be involved in introducing an automatic moratorium of this kind, or provide much discussion on the rationale for the proposed changes.
It does however reference the Productivity Commissions’ 2015 report, where the following benefits of an automatic moratorium were noted:[4]
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the lack of an automatic moratorium creates a risk that individual creditors can undermine the attempts to restructure a company via a scheme of arrangement;
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an automatic moratorium removes the need for costly, and potentially damaging concurrent appointments of administrators or liquidators while pursuing a scheme of arrangement in order to obtain a moratorium as occurred in the case of HIH Insurance; and
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an automatic moratorium allows time for reconstruction arrangements to be formulated.
However, it is notable that:
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there is an existing power under section 411(16) of the Corporations Act 2001 (Cth) for the court to stay actions by creditors, which in practice is rarely used; and
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the United Kingdom, which is the leading jurisdiction for corporate restructuring by way of creditors’ schemes of arrangement, did not see any need to introduce a scheme moratorium as part of its recent reforms (which included the introduction of the ‘restructuring plan’ – an enhanced form of creditors’ scheme of arrangement) under the Corporate Insolvency and Governance Act 2020 (UK) (CIGA).[5]
On its face, the proposal appears to contemplate something akin to the moratorium regime introduced in Singapore’s much publicised restructuring reforms initially introduced in the Companies Amendment Act 2017 (Singapore). These reforms have effectively created a ‘light touch’ debtor-in-possession regime which has fundamentally altered the Singapore restructuring landscape, and created a much more ‘debtor friendly’ environment. Careful thought is required as to whether this model is right for Australia, including an analysis of what has and hasn’t worked with the Singapore regime.
Debtor-in-possession restructuring regimes are becoming more popular around the world, given the potential to achieve a restructuring with less disruption and value destruction than a process involving an external administrator. A key issue in each such case is how to ensure an appropriate level of creditor protection and transparency. This will no doubt be an important consideration here too.
Whilst only briefly mentioned in the Consultation Paper, the cross-class cram down concept has recently been introduced in the United Kingdom through CIGA as part of the new restructuring plan procedure. The restructuring plan has had significant use since its introduction by companies impacted by the COVID-19 crisis, which are now more easily able to ‘cram down’ out of the money creditor classes. Such a mechanism, if properly implemented, could be a valuable addition to Australia’s legislative regime.
Priority treatment for rescue financing is another concept introduced recently in Singapore, which has drawn from the debtor-in-possession (DIP) financing concepts contained in Chapter 11 of the United States Bankruptcy Code. While such mechanics have the potential to unlock financing that can facilitate corporate rescue, they can also imperil the position of existing creditors. Establishing a workable regime that balances these competing interests is not straightforward.
Some initial questions on scheme moratoriums
The brevity of the Consultation Paper masks what is a complex set of issues. We set out below a number of initial questions on the proposed changes to creditors’ schemes of arrangement to assist parties to consider and assess the proposed reforms:
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Rationale: What is the problem that the automatic stay on creditor action is seeking to solve? How widespread is this problem in practice? Is an automatic moratorium the best way to solve this problem?
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Standalone vs scheme linked moratorium: If there is a concern that creditors’ schemes of arrangement (a valuable restructuring device) are only used sparingly in Australia, why is the moratorium tied to the scheme of arrangement process? Should an alternative approach of having a stand alone moratorium (such as the Part A1 Moratorium process adopted in the UK) be considered?
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Incentives: What behaviour (positive or negative) does the proposed regime incentivise? Does a “no questions asked” moratorium encourage companies to delay grappling with their issues (potentially leading to worse outcomes)? Could (and should) the moratorium be used as negotiating leverage to extract concessions from creditors?
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Lending: What impact will the moratorium have on Australian credit markets?
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Conditions of commencement: What conditions would need to be satisfied for a company to commence a moratorium? How developed would a scheme of arrangement need to be? Would the company need to demonstrate sufficient creditor support to pass the scheme (or insufficient creditor dissent to block the scheme)? Would the scheme need to be viable, and result in a better outcome for creditors than a voluntary administration or liquidation?
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Qualifying companies: Would the moratorium be available to all companies, or would certain types be excluded (eg banks or insurers)? Would it apply to just Australian incorporated or registered companies, or could it apply to foreign companies as well (eg with Australian COMI)?
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Excluded transactions: Would any types of security or transaction be excluded from the scope of the moratorium (eg financial market type transactions)?
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Related group companies: Would the moratorium just apply to the scheme company, or could it apply to related bodies corporate as well?
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Automatic vs court order: Would the moratorium be entirely automatic, or would the automatic moratorium only apply for a limited period during which the company would need to seek a court order for a moratorium of longer duration (eg like the Singapore approach)?
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Disclosure and transparency: What information would the company need to disclose about its financial position or activities? How would it be disclosed? Would the company need to disclose it was subject to a moratorium before incurring further credit?
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Oversight: Would there be any oversight of the company during the moratorium period (eg like the UK monitor concept)? What role would the court have, and who would have standing to apply to the court for orders?
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Restrictions on transactions: Would there be any restrictions on the company making payments, incurring debt, disposing assets, granting security or entering into transactions outside the ordinary course of business during the moratorium period? If so, who (if anyone) would give permission to the company to undertake such transactions? Would the court have a role in this?
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Priority of debt incurred: Would debt incurred by the company during the moratorium period have any priority treatment in a liquidation?
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Voidable transactions: Would payments to creditors and other transactions during the moratorium period be subject to the voidable transactions regime? When would the “relation back day” be if a moratorium was to precede a liquidation?
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Exit from moratorium: What would be the exit from the moratorium? If a scheme is approved then presumably the moratorium would cease, but what would happen if a scheme wasn’t approved – would the company go into administration or liquidation, and who would decide? Could there be other exits such as a DOCA if this was a more appropriate tool for restructuring the company than a scheme? Would it be possible to undertake a sale of the company or its business within the moratorium, and again what approvals would be needed?
Concluding remarks
Supporting businesses and directors whilst creditors’ schemes of arrangement are being negotiated is, of course, a worthwhile goal (noting, in particular, that complex schemes can take many months to formulate and negotiate). However, it is important that any such support is not abused and that creditors and other stakeholders are also protected through that process. Accordingly any change to the existing regime needs careful evaluation and a balancing of competing issues.
For further information, please contact:
Andrew Rich, Partner, Herbert Smith Freehills
andrew.rich@hsf.com
Endnotes
The views in this paper are the personal views of the authors.
[1] The Australian Government Treasury, Helping Companies Restructure by Improving Schemes of Arrangement (Consultation Paper, 2 August 2021).
[2] Productivity Commission, Business set-up, transfer and closure, (Inquiry Report, 7 December 2015).
[3] Consultation Paper (n 1) 7.
[4] Productivity Commission, Business set-up, transfer and closure, (Inquiry Report, 7 December 2015) 357, 398, 399. The Commission did not introduce any evidence indicating a causal relationship between these theories and the lack of widespread use of schemes of arrangement in Australia.
[5] The UK did introduce a standalone moratorium under CIGA, under the supervision of a ‘monitor’. In practice however the UK’s moratorium process has not to date been used by companies seeking to restructure by way of scheme of arrangement or restructuring plan.
