CORPORATE INSOLVENCY & DEBT RESTRUCTURING

CORPORATE INSOLVENCY & DEBT RESTRUCTURING Examining the value of Voluntary Administration Introduction Voluntary administration provides a moratorium period during which the future of a company can be assessed by an independent party. That independent party then makes recommendations to creditors as to whether that company has a future and recommends the form that future should take. The concept of Voluntary Administration has been embraced in the United Kingdom and in Australia. To make Voluntary Administration work, both jurisdictions have found it necessary to incorporate changes to other legislation and in particular to make changes to the ability of certain creditors to make preferential claims. Voluntary Administration has been mooted in New Zealand for a long time. For example in the 1970 s there was a bill drafted which was going to incorporate Voluntary Administration into the Companies Act 1955. The imperative demand for Voluntary Administration in New Zealand reduced when the Companies Act 1993 came into force. Until then time delays because of Court involvement meant that it was almost impossible to get a compromise between creditors approved. No-one would deal with the company in the period between the time when the compromise was first filed in Court and the date the Court eventually approved the compromise. The Companies Act 1993 changed compromises dramatically so that they now work effectively. From the time creditors receive notice of meeting until the meeting is held at which the compromise is to be approved, is usually a period of about six working days. There is no Court involvement so there are none of the subsequent delays which we suffered under the old regime. An alternative way of achieving the same result I have attached as an Appendix a discussion paper that was sent out to Insolvency Special Interest Groups in 1994. That discussion paper identified certain issues relating to

voluntary administration and included the thoughts of the Joint Insolvency Committee at that time. The thrust of the paper was that the main objectives of voluntary administration could be met by making suitable changes to Part XIV of the Act, rather than coming out with a completely new regime. The major recommendation was as follows- Recommendation: A separate regime for voluntary administration is not necessary. Part XIV of the Companies Act 1993 should be modified to accommodate the use of an Administrator, independent reports and moratorium. The Committee agreed that there should be available to distressed companies a procedure having one or more of the essential features of the voluntary administration regimes found abroad: Control of the company by an Administrator, An independent report on the state of the company and feasibility of administration, A moratorium on enforcement of proprietary rights, security rights (subject to certain overriding powers of secured creditors) and contractual claims, and The transfer of the company into liquidation in the event that a compromise proposal is not approved by the creditors. Accordingly, the Committee was of the view that use of an Administrator should not be mandatory. Under the existing Part XIV, the company can provide for an Administrator as part of the compromise proposal. Should it fail to do so, the creditors are free to insist upon modification of the proposal to provide for an Administrator. However, Part XIV should be amended to permit the company or, on the application of any creditor, or the Court to appoint an Administrator at the outset. As stated above, this would trigger the full moratorium. The object of Voluntary Administration The object of Voluntary Administration is outlined in the Australian Corporations Act as follows:

The Object is to provide for the business, property and affairs of an insolvent company to be administered in a way that: a) maximises the chances of the company, or as much as possible of its business, continuing in existence; or b) if it is not possible for the company or its business to continue in existence results in a better return for the company s creditors and members than would result from an immediate winding-up of the Company The mechanism of Voluntary Administration The Minister of Commerce, Lianne Dalziel, in an address to INSOL New Zealand on 12 March 2003 said that in order to achieve the real results of Voluntary Administration it is important that we stick closely to the Australian model. This minimises the potential for differences in the way that the schemes will operate, facilitating the way for simpler trans- Tasman administrations. The Minister recognised that specific features of the Australian law may not be appropriate for New Zealand. Assuming New Zealand follows the Australian model the basic steps will be as follows- Day 0 Appointment of an Administrator By a resolution of the board of a company or By a substantial chargeholder, or By a liquidator Day 1 Notification to any chargeholder whose charge relates to all or substantially all of the property of the company. Day 5 Meeting of creditors. The creditors determine at the meeting as to whether to appoint a committee of creditors. They also decide whether to replace the Administrator with their own appointee. Day 10 The last day for the debentureholder to appoint a Receiver. Day 21 The last day for the Administrator to convene the second meeting of creditors. The meeting must be held no later than 5 working days (or one week) after this date. When

notice of the meeting is circulated, the Administrator must also circulate a substantial report about the company s business, property, affairs and financial circumstances. The Administrator must also provide a statement setting out his or her opinion with reason on whether it would be in the creditors interest for- - The company to execute a deed of company arrangement - The administration to end; or The company to be placed into liquidation Day 28 Meeting of creditors to discuss the company s future. Day 28 Statutory moratorium staying the rights of unsecured creditors for an initial period comes to an end. Day 88 The statutory initial moratorium staying the rights of unsecured creditors may be extended for another 60 days by resolution of creditors or by court order. The content of the Administrator s Report The Administrator s Report contains very detailed Information with which creditors must be furnished. The report includes the following- History of the company and events leading up to and the need for the appointment of a Voluntary Administrator. Details of shareholders and officers and registered charges and changes in the preceding twelve months. An opinion as to whether books and records have been properly kept The date to which the company s financial statements were prepared prior to the appointment. Also a summary of the company s historical financial results and a preliminary analysis and commentary thereon. Disclosure of any prior involvement by the Administrator with the company, its officers or any related parties. The reasons for the company s difficulties. Winding up applications filed. Related entities and the value of their claims. Any offences committed. The quantum of any voidable transactions.

An opinion as to whether the company engaged in reckless trading. If so then an estimate of the loss incurred as a result and the financial position of the directors who could be made liable. Estimated value of assets and liabilities and the estimated return to creditors from a winding up of the company. Where a Deed of company arrangement is being proposed the report must disclose the key features of the proposed deed and a summary of the Administrator s reasoning as to why the Deed will provide creditors with a greater return than in a liquidation. Lastly the Administrator shall express an opinion and reasons for the opinion as to which option is in the interest of creditors. The advantages of voluntary administration. The advantages of voluntary administration (for the company and the creditors) are that: the directors are not in control of the company during the life of the administration; it provides for the transfer of the direction of the company to an independent insolvency practitioner and this is likely to appeal to creditors who may well have lost faith in the directors of the company the change of control can occur quickly and without inordinate cost; during the term of the administration the company is protected from attack from creditors (except where the courts specifically allow) while the insolvency practitioner formulates a proposal (concerning the future of the company) which he or she will put to the creditors; without the leave of the court winding up cannot occur during the period of the administration; the administration is not lengthy, and creditors are not pre-empted for a substantial period from taking action against the company if a resolution of the company s affairs is not viable; and the company can put a proposal to the creditors without the need for the sanction of the courts and this will, if accepted, bind all creditors.

The criticisms of Voluntary Administration Where directors appoint the Administrator there is the potential for those directors to orchestrate the administration for their benefit and that of shareholders, rather than creditors. In Australia there is evidence to suggest that some directors are utilising the voluntary administration process as a form of Phoenixism. They are either proposing a deed of arrangement where a modest return to creditors is promised out of future profits, or a deed which involves the sale of assets to a related party and a payment of a dividend to creditors. In both cases the prima facie return to creditors tends to be marginally better than the alternative of liquidating the company. The company finishes with an improved balance sheet, (although the underlying business fundamentals may not have greatly altered), and the directors are absolved from any action against them by creditors. Those seeking to promote Phoenix tend to push their proposal through creditor meetings via the use of the voting mechanism.. The outcomes of meetings can be influenced by related party debts and/or employee claims to enable either the passing of resolutions or the creation of a stalemate which requires the Administrators casting vote. As stated earlier, where the directors appoint the Administrator they may be capable of influencing the Administrator s position so as to ensure a favourable casting vote. Another criticism suggests that directors in Australia have favoured voluntary administration to avoid a thorough investigation of their conduct. The majority of creditors either attending the Administrator s second meeting or reading the Administrator s report are unaware of the work that needs to be performed to determine if: There has been insolvent trading; There are potential undue preferences; and There have been voidable transactions with related and other parties

Consequently the Administrator s opinion that there are no apparent grounds for instigating action on behalf of creditors against directors and/or related parties is often accepted at face value. The cost of Voluntary Administration There is obviously a cost to voluntary administration. At the end of 28 days the company will invariably be placed in liquidation or enter into a deed of company arrangement. The costs in respect of these will remain much the same as they have always been. The new cost is that of the Voluntary Administration itself. In Australia this requires two meetings of creditors and a detailed Administrators Report. Also there is the involvement in running the company for a period of 28 days. The very nature of the work means that costs will not be insignificant. The hope is that the new regime will encourage companies to act sooner while thee is still some substance in the company. If this is the case then creditors after costs should still be better off. Who should be involved in placing a company into Voluntary Administration? In Australia the party that places a company into Voluntary Administration is not the shareholders but the directors. The reasoning is that it is the directors who can become personally liable if they carry on the business of a company in a manner that is likely to cause substantial risk of serious loss to creditors. If they believe that there is such a risk they can place the company in Voluntary Administration and reduce that risk. In New Zealand the legislators will have to determine whether the shareholders should be directly involved. If they are not to be involved by legislation then it would appear likely that the constitution of companies will be changed so that directors must refer the matter to the shareholders. Directors after all do have a choice; they can place the company into Voluntary Administration or resign. Similarly the owners (the shareholders) of the company should have a choice as to whether they might want to appoint new directors or perhaps place the company into liquidation.

Changes required to legislation I am firmly of the belief that Voluntary Administration has a place in business rehabilitation. However I am also of the belief that it cannot be brought in without considering whether it will work in New Zealand without changes to other legislation. The Minister has quoted the Australian model. The Australian model works because other legislation is also different. To bring Voluntary Administration into New Zealand by itself without making changes in other direction could well be counterproductive. To keep in line with the Australian model the following other changes to existing New Zealand legislation will have to be considered- Companies Act 1993-Reckless Trading In Australia it is a breach of the Australian Corporations Legislation to trade a company whilst it is insolvent. The closest equivalent in New Zealand is the law regarding reckless trading. The Insolvent Trading Laws in Australia are far more robust and it is much easier to make directors personally liable. A list of overdue creditors-bank statements-informal and/or formal demands gets one well on the way for proving a case. Consequently there is a very large incentive for directors to appoint Administrators early on. New Zealand Insolvency Practitioners have always said that if they were approached early enough there would be many companies they could save. More robust reckless trading provisions would certainly be a step in the right direction. Companies Act 1993-Preferential Creditors In Australia the Inland Revenue has no preference for GST and PAYE. The position in the UK is similar. The lack of preference means there is a very real chance of creditors getting a worthwhile distribution if through the Voluntary Administration regime the company enters into a deed of arrangement. I comment that one Australian insolvency practitioner has said to me that while the Inland Revenue Department still has preference Voluntary Administration will be a waste of time.

Taxation Law In Australia it is possible to transfer under a deed of arrangement the company rather than the business of a company. This means a purchaser automatically gets the benefit of any contracts the company might have. Also, unlike New Zealand, the purchaser gets the benefit of tax losses. This enhances the value of the company as a whole to the purchaser and consequently increases the return to creditors. Registration of Administrators In Australia and in the UK insolvency practitioners/administrators are registered. This must give the creditors confidence in the appointee. In Australia, the instance of directors appointing tame Administrators is not common. Complaints have been made by creditors and other insolvency practitioners to the Australian regulatory body. These complaints have resulted in many Administrators (who had been in the business of offering the Directors a gentle touch ) having had their licence removed and these Administrators are no longer able to practice. In New Zealand where insolvency practitioners are not registered there has been a suggestion that there not even be the five day meeting at which the Administrator can be changed. Such a suggestion without registration is demonstrably unrealistic. Conclusions Voluntary Administration is likely to be a very useful regime if New Zealand gets it right. If Voluntary Administration is linked with other law changes it could have a real impact in preserving businesses and jobs. The proposed legislation will need close scrutiny and interested parties will have to be made aware that without legislative changes in other areas it would be totally misleading to quote Australian statistics in support of its implementation. My sincere hope is that we will get sufficient time to study and make submissions on the draft legislation. Date:17/11/03 Author: John Vague MacDonald Vague & Partners Conference: Corporate Insovency & Debt Restructuring