The situation where a creditor applies for a winding up of a company under the Corporations Act, and while that is pending, the directors appoint an administrator under Part 5.3A, has led to some odd law, under s 440A(2) of the Act.
Broadly, the one petitioning creditor’s intent to wind up the company will often prevail over all creditors’ opportunity to accept a deed of company arrangement, or to themselves put the company into winding up, after having had the advice of an administrator.
A winding up application may be made by a single creditor for a debt of at least $4000, and a winding up order made, with neither that creditor nor the court needing to be apprised of the financial circumstances of the company beyond its non-compliance with the winding up demand.
Winding up pending, and administrator appointed
Assume an application for winding up is filed on 19 May with a return date of 19 July.
As sometimes or even often happens the company’s directors delay or take time in negotiations and end up appointing a Part 5.3A administrator on 14 July, only a few days before the winding up hearing date. That appointment imposes at least three significant legal consequences.
- one is that the company immediately comes under the control of an administrator with the directors’ powers suspended;
- two is that the conduct of the directors comes under scrutiny and with potential reporting to ASIC; and
- three is that the creditors are given information about the company and given the opportunity to decide whether to wind up the company. They may well do so, but in circumstances more favourable than straight liquidation.
These consequences apply whatever time period is given to the administrator before the winding up hearing date to make any assessment of the company’s position.
On being confronted with this appointment, under s 440A(2), the court “is to adjourn” the winding up hearing if the court is “satisfied that it is in the interests of the company’s creditors for the company to continue under administration rather than be wound up”.
It is an odd section, premised on the court being given information to so satisfy itself. That information can only come from the administrator, who may not have funding to intervene; or whose recent appointment may limit their level of assistance. The court may then somewhat pre-emptively say to the administrator “no, you have not given us enough information on which to grant an adjournment therefore we will wind up the company”.
Apart from the cost and time, potential exposure to a costs order may prompt the administrator from taking any role.
That is in the context that, for the period of time the petitioning creditor waits from 19 May to 19 July for a hearing, there is no control over the company. When there is control imposed, on 14 July, the court is nevertheless often ready to wind up, pre-empting the creditors.
A further context is the feature of the voluntary administration regime that it does not require court approval or intervention unless necessary, unlike for example the US Chapter 11 process. Creditors are in effect in control, through the administrator.
In contrast, the present case law on s 440A(2) can give priority to the application of a single petitioning creditor with no necessary knowledge of the company’s position, a priority over the rights of all the creditors under the voluntary administration process. The right of a single creditor to seek a winding up, or bankruptcy, is long-standing. It has been questioned in bankruptcy as being inconsistent with policy, even absent an alternative proposal offered by the debtor.[1] Perhaps there is need to also reconsider the law in corporate insolvency, at least in this context.
Interests of creditors
The present law is based on the courts’ assessment under s 440A(2) of the “interests of creditors”, interests that the courts determine rather than the creditors. In assessing those interests, the court scrutinises proposed deeds of company arrangement, at whatever stage they might be. The court is only able to do so because the administrator gives the court, at some time and expense, a current update on the progress of the administration, greater or lesser depending on when appointed. Absent the administrator, the court would have no information to assess the collective creditors’ interests. In doing so, the court is perhaps taking on a role unnecessarily speculating and making assumptions about the motivations of each creditor – as to amount, timing, continued trading or other relationships.
The law is that the proposed outcome of the deed, or the administration, has to be balanced against the speculative rights of creditors in a liquidation. That is an assessment that must be made by the administrator in her or his report and may depend on recovery rights under voidable transaction provisions, or for insolvent trading. However, those rights of recovery are usually, on the statistics, illusory and distant in time, and may require creditor funding. Judges don’t usually inquire as to the actual dividend outcomes of recovery proceedings over which they preside.
Challenges to DOCAs
Also, the rather severe analysis of any proposed DOCA by the court under s 440A(2) contrasts with the views often taken when DOCAs are accepted by creditors but later are challenged, for example under s 445D. In O’Reilly v Precision Mining, the Court[2] was ready to dismiss a challenge to a deed based on the ‘interests of the creditors’ that, for example, offered ‘not much of a return to creditors’ but offer ‘better than’ the liquidation alternative.
The Court there emphasised that the creditors are the best placed to determine where their interests lie, such as, in that case, some (minimal) higher dividend return and the continuation of trading and of employment.
And creditors might have personal guarantee and other rights against the directors which might muddy their decisions about the company.
In the s 440A(2) context, in TCS Management v CTTI Solutions, the court noted that considerations beyond mere quantum of dividend return may be relevant and where there are advantages either way,
“in general terms it may well be the proper course to give such adjournment as will allow the creditors themselves to vote upon the proposal and determine which course they prefer”.[3]
As the Court said in First Netcom[4], “in a rather rough and ready fashion” creditors have to decide between some possible recovery in a liquidation
“for the usually relatively greater certainty of what is offered under the DCA … That is a decision open to the creditors to make and one which that they should be able to make rather than the court to pre-empt that possibility”.
Tweedledum and Tweedledee
At the same time, one can understand creditors being disengaged from any decision-making role when the options often are between not much of a return to creditors but better than liquidation, or between Tweedledum and Tweedledee, or whatever is enough to get a creditor out of bed to attend a Part 5.3A meeting: Just when we have some creditor activism in insolvencies … – Murrays Legal.
Law Reform
The scrutiny of the progress of an administration given by Australian courts when the circumstances of s 440A(2) arise bears some comparison with the role of US bankruptcy courts under Chapter 11. Like previous inquiries, the 2023 PJC Report on Corporate Insolvency considered a court driven and supervised Chapter 11 type process for Australia but rejected it. One important item of advice accepted by the PJC was that the US Chapter 11 system is
“not just a set of provisions providing another insolvency pathway. Instead, it is a legal system, with its own federal bankruptcy court and expert judges, premised on it being a court-driven system. Hence, there would be significant challenges to adding such a system to Australia’s insolvency system”.[5]
On the other hand, are creditors enough engaged and sophisticated?
The case law on s 440A(2) raises some important issues as to the balancing of competing interests among creditors, and the proper forum for those to be resolved, and what effort should be put into the process when outcomes are marginal. The subsection might be a useful mechanism to assess some fundamental issues about the purposes and mechanisms of insolvency law in any forthcoming review.
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[1] “Shock horror – insolvent people don’t have many assets” – Murrays Legal fn 3.
[2] DOCAs – should ‘not much of a return to creditors but better than the liquidation alternative’ be enough? – Murrays Legal discussing O’Reilly v Precision Mining and Drilling Pty Ltd (subject to DOCA) [2021] WASC 176.
[3] TCS Management Pty Ltd v CTTI Solutions Pty Ltd [2001] NSWSC 830
[4] Deputy Commissioner of Taxation: In the matter of First Netcom Pty Limited [2000] NSWSC 1045.
[5] At [7.82].
