Creditors' trusts: weighing up risk and reward for creditors (and insolvency practitioners)

There has been much debate of late as to the suitability of pre-packaged insolvencies in an Australian context and the need for amendments to the Corporations Act (Act) to cater for such arrangements. Those in favour of such an approach point to the perceived benefits to creditors and employees of an insolvent company.  

Presently though, practitioners are left with the Act as it currently stands.  However, there is still room for ingenuity.  A recent reminder is the decision of Bevillesta Pty Limited (In Voluntary Administration) [2011] NSW SC 417, which examined the use of creditors’ trusts as a means of swiftly returning a company in administration to its directors and allowing creditors’ claims to be met by the establishment of a separate trust.

It is an arrangement that does not sit well with ASIC. However, such trusts are arguably consonant with the guiding principles of Part 5.3A of the Act, which, as is known, are to provide for an insolvent company to be administered in a way that “maximises the chances of the Company, or as much as possible, its business continuing in existence, or if this is not possible provides the best return for Creditors and a return that is better than would result from an immediate winding up of the Company.”

What is a creditors’ trust?

In May 2005 ASIC issued Regulatory Guide 82 (Guide) entitled “External administration: Deeds of company arrangement involving a creditors’ trust”.

It states that:

“A creditors’ trust is a mechanism used to accelerate a company’s exit from external administration.  To date, it has been used most commonly (but not exclusively) in connection with the rehabilitation of public companies listed on Australian Stock Exchange Ltd (ASX).  In some cases, this leads to a “backdoor” listing.

Typically, under the terms of the DCA and one or more interconnected deeds, a trust entity is created and the company’s obligations to some or all of the creditors bound by the DCA are compromised and transferred to the trust.  Those creditors become beneficiaries of the trust.  Occasionally, there may be separate creditors’ trusts for employee and non-employee creditors, or for secured and unsecured creditors.”  

Differences between the statutory and trust regime

It is immediately apparent that a creditors’ trust differs from - and takes the rights of creditors outside of - the regime mandated by Part 5.3A of the Act as it applies to deeds of company arrangement. The major differences are:

·       The funds available to creditors are paid into a trust account, to be administered by the insolvency practitioner as trustee, and not as deed administrator

·       Whilst the trustee still adjudicates on proofs of debt, the mechanism to contest rulings is not governed by the Corporations Act

·       The statutory role of the insolvency practitioner is automatically terminated when the deed is effectuated by the creation of the trust fund and execution of the DCA and the trust Deed

·       Accordingly, none of the statutory protections afforded to creditors and enshrined in Part 5.3A are available to creditors.  For example, creditors could not later resolve to wind up the company.  As above, the company is returned to the control of the directors.

The Guide contains some sobering warnings for insolvency practitioners. ASIC notes that the use of creditors’ trusts is usually not appropriate for most insolvency administrations, that practitioners are required to closely follow the requirements of the Guide, that in certain circumstances practitioners should apply to the court for directions in relation to any proposed use of a creditors’ trust and that, alarmingly, “if we consider that the administrator has not adequately and properly performed their duties or functions as a registered liquidator (or is otherwise not fit and proper to remain a registered liquidator), we may make an application to the Companies Auditors and Liquidators Disciplinary Board (CALDB) under S1292(2) for cancellation or suspension of the administrator’s status as a registered liquidator.”

The decision

In Bevillesta, the administrators applied to the Court for directions and a declaration that they would be justified in putting to a meeting of creditors a proposed DCA and associated creditors’ trust deed. The administrators had determined that there were likely to be no “clawback” proceedings worth issuing if the company was placed into liquidation, that the trust deed offered the prospect of a 100c in the dollar return to unsecured creditors, and that if the company were otherwise to be placed into liquidation then the unsecured creditors would receive nothing.

The more pertinent aspects of the proposal were as follows:

·       An initial amount of $2.5M was to be paid into the Deed Fund to be held on trust for the benefit of creditors

·       The insolvency practitioners as trustees would adjudicate upon all unsecured claims upon the Fund (which were required to be made within 30 days), though the Funder retained a discretion to appeal any decision made by the trustee

·       Further "top-up" amounts were to be paid into the Deed Fund to ensure that all creditors received 100c in the dollar if, for example, known contingent claims were established and accepted by the trustee (though the Funder had only a paid up capital of only $5 so, "top up" payments could not be assured and no security was offered)

·       The Funder was to be refunded the initial payment if the trust deed was later terminated or the company later placed into external administration 

·       As is standard for a creditors’ trust, upon the execution of both it and the DCA, the DCA would be effectuated and terminated immediately

·       Thereafter Part 5.3A of the Act would cease to have application and control of the company would return to the directors.

Issues

Given the dramatic language used in the Guide, the administrators were concerned to ensure that they were not subject to later criticism by either creditors or ASIC in proposing that creditors vote in favour of the proposed creditors’ trust deed. The Court accepted that the report to creditors met the requirements of the Guide, was therefore incredibly detailed and properly warned the creditors of the risk of the proposed trust arrangement. A matter which was of obvious concern to the administrators, however, was the wording of section 1.14 of the Guide, which provides relevantly as follows:

1.14     In our view, s435A does not justify in a DCA every kind of mechanism that would produce one of the outcomes referred to in that section.  We consider that any mechanism intended to achieve one of those outcomes should only be included in a DCA if it is:

             (a)       in the interest of creditors as a whole;

             (b)       in accordance with the purpose and policy of Part 5.3A; and

             (c)        consistent with the public interest.

                         Note 1: We consider, for example, that it is likely to be an abuse of Part 5.3A or otherwise contrary to the public interest for a DCA to involve a creditors’ trust where:

                         (a)       there is no proper and compelling legal or commercial reason why the continued existence of the company or its business could not be achieved under a DCA that does not involve a creditors’ trust.

What was apparent from the evidence provided to the Court was that the Funder had not, despite request, provided to the administrator any “compelling legal or commercial reason” why the continued existence of the Company could not be achieved within the statutory framework regulating deeds of company arrangement. ASIC submitted, for example, that absent such an explanation that there was no compelling legal or commercial reason for the proposed trust. Conversely, the Funder argued that as the decision to recommend the proposal to creditors was a commercial decision by the administrators, the issues were not apt to permit directions by the Court.

Findings

Firstly, the Court observed that it was appropriate for the administrators to seek directions from the court given the quite dramatic language used in the Guide (ie the “unveiled threat” by ASIC to seek the cancellation or suspension of practitioners if there is a failure to follow the Guide) and also the explicit reference in section 1.12 of the Guide that it may be necessary for administrators to seek directions from the court in proposing a creditors’ trust.

What will be of most interest to practitioners though is comments made by the Court that the requirement to demonstrate “compelling” commercial reasons for the use of a creditors’ trust was an unnecessary impediment which hampered an administrator's ability to make commercial decisions without requiring the intervention of the Court. The Court stated that:

“…if there is a “sound”, but not “compelling”, commercial reason that persuades the administrators that in all the circumstances, it is in the best interests of the creditors to adopt a DCA with a creditors’ trust deed to obtain a better return than from an immediate winding up of the company, the administrators should be able to recommend such a proposal to the creditors without having to seek the Court’s imprimatur.  Such ability is subject to the “heavy burden of explaining to creditors the implications” of adopting such a proposal”.

The Court also gave weight to the fact that under the proposed creditors’ trust, creditors stood a chance of receiving “something”, whereas in a liquidation scenario they would most certainly receive nothing. The Court stated that:

“where creditors stand a chance of receiving something under a structure that is somewhat controversial and prima facie unsafe (the DCA and Trust Deed) but nothing under a structure which is conventional (liquidation under the Act) there seems to me to be a commercial reason that may present as “compelling” and if not certainly “sound”.”

For those reasons the Court considered that the administrators were justified in putting the proposed creditors’ trust to a meeting of creditors, despite the risks inherent in the proposal.

Conclusion and comment

Any administrator proposing a creditors’ trust would be well advised to closely read the Guide and ensure that its report to creditors conforms closely with its requirements. Naturally, each case will turn on its own facts, but practitioners would do well to ensure that any such proposal is incredibly detailed, offers a modicum of security vis a vis the availability of funds to pay creditors and that there are, at a bare minimum, sound commercial reasons for recommending a creditors’ trust to creditors. ASIC's intervention in this case, and the dramatic language contained within the Guide, are testament to ASIC's overarching concern that such trusts have a tendency to undermine the statutory protections afforded to creditors under Part 5.3A of the Act.

The closing comments of the Court, however, suggest a degree of acceptance with the adoption of an unconventional approach which results in a better deal for creditors. A similar approach by legislators might one day create the appropriate regulatory environment for the use of  pre-packaged insolvencies.