Legal Briefing No. 4

Number 4

23 July 1993

CORPORATE INSOLVENCY: PROTECTING
THE COMMONWEALTH

The Corporations Law deals with a number of different
types of insolvency administrations. The Commonwealth is
sometimes required to deal with a company which has entered
an insolvency administration of one form or another. On
other occasions, the Commonwealth may need to consider
whether to place a company into administration, and if
so, what form of administration is most appropriate. Client
Departments who are administering grant schemes may also
need to enforce security which has been provided as a condition
of the grant. In order to deal with these situations, it
is necessary to understand the implications of the different
types of corporate insolvency administration.

This Briefing:outlines provisions in the Corporations
Law (including the amendments recently introduced by the Corporate
Law Reform Act 1992) which need to be taken into account
where the Commonwealth has an interest in a company that
is, or is likely to become, insolvent. Some practical suggestions
for safeguarding the Commonwealth's interests in dealing
with companies that are in financial difficulties are also
provided.

Relevant Provisions In The Corporations
Law

The following types of external administration are addressed
in the Corporations Law (the most directly relevant parts
of the law are noted in brackets):

  • (official) liquidation (Part 5.4);
  • provisional liquidation (Part 5.4);
  • voluntary liquidation (Part 5.5);
  • receivers and receiver/managers (Part 5.2);
  • entry into possession by mortgagee or agent (Part
    5.2);
  • scheme of arrangement (Part 5.1); and
  • voluntary administration (new Part 5.3A)

Each type of external administration is designed to meet
a specific need. A decision to favour one form of administration
over another will depend on individual circumstances and
the commercial judgement of the creditors and members whose
interests are affected. The following paragraphs provide
some basic information about the three most important forms
of insolvency administration liquidation, receivership
and voluntary administration.

Liquidation

Where an insolvent company is placed into liquidation
(whether by way of a creditors' voluntary winding up, or
an official liquidation under the supervision of the court)
the liquidator will have wide investigatory powers, and
extensive powers to reverse transactions entered into or
recover debts incurred while the company was insolvent.
The main constraints are the time taken to initiate the
process and the limited power of the liquidator to carry
on the business of the company.

Receivership

Receivership is a remedy available to a major creditor
who holds a registered charge over the assets/undertaking
of the company. The main advantages of receivership to
a secured creditor are the wide and flexible powers commonly
conferred on the receiver under the loan instrument, particularly
powers in relation to the running of the business, and
the capacity for an appointment to be effected quickly
and relatively inexpensively after giving adequate notice
of demand.

The disadvantages of receivership are the limited investigatory
powers of the receiver and that the receiver has no power
to reverse relevant transactions entered into while the
company was insolvent.

Voluntary Administration

The major advantages of the new voluntary administration
scheme (which came into operation on 23 June 1993) are:

  • from the company's perspective, it provides a "breathing
    space" in the form of a moratorium from its creditors
    and protection from winding up without special Court
    consent; and
  • it provides creditors with the opportunity to put
    in place a deed of company arrangement at a significantly
    reduced cost and more quickly than a scheme of arrangement,
    principally because the arrangement is not subject to
    sanction by the Court.

These aspects should benefit all creditors by offering
a more flexible approach to solvency difficulties. Secured
creditors, however, have certain special rights under the
scheme which should be borne in mind by the Commonwealth
when it is assessing whether to seek security in respect
of a particular debt. In particular creditors with security
over all or most of the property of a company can opt out
of a deed of voluntary administration scheme and can enforce
their security (even during the moratorium period) if they
elect to do so within the statutory period.

Loan Interests

While there may be social policy reasons for the Commonwealth
not to require security over its loan interests, a secured
interest is the most effective way legally of protecting
Commonwealth loan funds. This is because:

  • the secured loan will be given priority over unsecured
    interests in any winding up of the company;
  • the loan agreement for a secured interest would normally
    provide for the appointment of a receiver or mortgagee
    in possession in the event that the company defaults
    in its loan repayments or fails to comply with other
    terms and conditions of the loan agreement this enables
    the Commonwealth to keep in control if problems develop;
  • the rights of unsecured creditors to take recovery
    action against the company are restricted from the time
    the company goes into liquidation unsecured creditors
    will have a right of claiming by proof of debt against
    a liquidated company but (except in limited circumstances
    with the approval of the liquidator) are not able to
    pursue individual actions against the company.

Where the Commonwealth has no shareholding interest in
a debtor company and is not represented on the board of
the company, client Departments will also need to consider
whether the Commonwealth should require the directors of
the company to which the loan is provided to give personal
guarantees as security for the loan.

Consideration should be given to whether the loan arrangement
ensures that the Commonwealth will be provided with sufficient
financial information to enable informed judgements to
be made about the financial viability of the company. These
judgements will in turn provide the basis on which proper
decisions can be made about the most appropriate courses
of action available to the Commonwealth.

Where the Commonwealth is the major creditor of a company
and is aware that the company is in financial difficulty,
one option available is to reach agreement with the company
for the appointment of an investigative accountant, usually
an insolvency specialist, to review the current financial
position of the company and its future commercial viability.
Such a review will often initially focus on key financial
indicators, such as cash flow, asset structure, and market
position, and then develop a rehabilitation plan, including
debt restructuring proposals, to preserve the business
and to improve its financial position.

One outcome of the appointment of an investigative accountant,
and an option which should be considered whenever the Commonwealth
is aware that a debtor company has financial problems,
is to renegotiate the loan agreement with the objectives
of either tightening the degree of Commonwealth supervision
of the debtor company and/or to increase the prospects
that the company will be able to trade out of its financial
difficulties.

Where the Commonwealth becomes aware that a company is
or could be in financial difficulties, great care needs
to be taken in accepting any payments from the company.
Knowledge of the difficulties could expose the Commonwealth
to an action by a subsequently appointed liquidator for
recovery of the payment on the basis that it was an undue
preference in favour of the Commonwealth over the creditors.
The Commonwealth should not enter into any transaction
with such a company without taking legal advice.

Where the Commonwealth forms the view that a debtor company
which has defaulted under the loan agreement is, or is
likely to become, insolvent three main options need to
be considered:

  • demand repayment of the debt subject to the comments
    in the previous paragraph;
  • initiate formal insolvency administration procedures;
    or
  • negotiate alternative arrangements (for example, debt
    restructuring).

The traditional forms of external administration (that
is, those available prior to commencement of the new voluntary
administration procedures in Part 5.3A) provide limited
opportunity for the restructuring of debts and for measures
to be put in place for the rehabilitation of the debtor
company. The new voluntary administration procedures offer
scope for rehabilitation plans to be put in place within
a formal administration process, although it will be necessary
for the Commonwealth to be secured over the whole or substantially
the whole of the company's assets before it will itself
be in a position to initiate the voluntary administration
procedures.

Shareholding Interests

The Commonwealth's capacity to protect its equity investment
will be limited by the extent of its representation on
the board of the company. Where the Commonwealth has complete
ownership and control of a company, the interests of the
Commonwealth and the interests of the company largely coincide.
Where, however, Commonwealth officers are appointed as
directors of a company in which the Commonwealth has less
than a 100% interest, the directors will be obliged to
safeguard the interests of the company as a whole, even
if there is a divergence between those interests and the
interests of the Commonwealth, and the Commonwealth will
therefore not have complete control over the funds that
it has invested in the company.

To comply with their duties and liabilities under the
Corporations Law, particularly in relation to insolvent
trading liability, Commonwealth officers who are representing
the Commonwealth on the board of a company should consider
whether the board of the company is supplied with relevant
accounting information ahead of regular board meetings
at which key financial decisions are to be made. Where
a significant borrowing is to be undertaken, it may be
appropriate for the management to supply the board with
a statement of the company's current financial position,
as well as particulars of the way in which the principal,
interest and other charges are to be serviced over the
anticipated term of the loan. Where the nature of the business
may expose the company to a high risk of sudden liquidity
restriction, or the company is known by the director to
be in financial difficulties, extra care and more rigorous
safeguards should be adopted.

Conclusion

In conclusion, the most important point to be emphasised
is the need for the Commonwealth to act commercially in
its dealings with companies and to make informed commercial
judgements within the legislative framework of the Corporations
Law.

It is essential that the Commonwealth put in place appropriate
loan arrangements, preferably those which give security
over the assets of the debtor company, and which ensure
that the Commonwealth receives relevant financial information
to allow it to make commercial judgements about the ongoing
financial position of the company. The Commonwealth also
needs to make such judgements in identifying problem loans,
renegotiating loan agreements and deciding whether to enforce
legal rights under the loan agreement or to negotiate alternative
arrangements with the company.

Similarly, Commonwealth representatives on the board of
government companies need to make commercial judgements
about the ongoing financial position of those companies
in order to comply with their duties and liabilities under
the Corporations Law, particularly in relation to insolvent
trading liability.

ISSN 1448-4803 (Print)
ISSN 2204-6283 (Online)

The material in this briefing is provided
for general information only and should not be relied
upon for the purpose of a particular matter. Please contact
the Legal Practice before any action or decision is taken
on the basis of any of the material in this briefing.

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