The Russell Kennedy Insolvency and Restructuring
2021 Wind Up
With 2021 coming to an end, our Insolvency and Restructuring team round-up some of the key issues faced this year including:
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In Badenoch Integrated Logging Pty Ltd v Bryant, in the matter of Gunns Limited (In Liquidation) (Receivers and Managers Appointed) [2021] FCAFC 64 (Badenoch), the Full Federal Court of Australia held that what has been known as the ‘Peak Indebtedness Rule’, is abolished in Australia with the introduction of s588FA of the Corporations Act 2001 (Cth) (the Act).
In circumstances where a preference payment is claimed pursuant to s588FA(3) of the Act in relation to a creditor that has a ‘Running Account’ with another entity, the supply of goods by that creditor to a debtor is required to be taken into consideration. The result of this is that the entirety of the transaction, including the credits and debits, determine the amount of the preference which is the net result at the end of the Running Account.
Background
Gunns Limited (Gunns), a major Australian forestry company located in Tasmania, conducted a Managed Investment Scheme with operations in forestry management and veneer production. The company entered into liquidation in March 2013.
Subsequently, the liquidators, commenced recovery proceedings against creditors claiming payments had been made to them after Gunns became insolvent which resulted in unfair preference payments being made to the creditors by Gunns.
Key points
- The liquidators claimed unfair preferences against three entities, Badenoch Integrated Logging Pty Ltd, Edenborn Pty Ltd (Edenborn) and Bluewood Industries Pty Ltd (Bluewood)
- The three companies were involved in the Gunns operation and in the preceding six months of the appointment of the liquidators in September 2012 (the "Relation Back Period") it was alleged that Gunns made payments to each of these companies of around $3.5 million, $2.5 million and 1.5 million respectively
- In a previous ruling, Gunns was found to be trading in an insolvent position from 30 March 2012. Given this, the question for determination by the Full Federal Court was, were the payments made to Badenoch, Edenborn and Bluewood, unfair preference payments?
Federal Court decision at first instance
Badenoch’s arguments at first instance included that a liquidator should not be entitled to elect the commencement date of the running account and that the entirety of the commercial relationship referred to in section 588FA(3) of the Act should be used to calculate the factors that are taken into account in respect of s588FA(3).
Notwithstanding, the liquidators pressed and succeeded on the argument that the Peak Indebtedness Rule should be applied to determine the quantum of the preference payment. The Peak Indebtedness Rule provides that a liquidator can calculate the value of a preference claim by subtracting the debt on the relation back. This is calculated at the highest point of the indebtedness within the relation-back period. The Peak Indebtedness Rule may be applied where a business was conducted between the creditor and the insolvent company on the basis of a running account.
Full Federal Court decision on appeal
On appeal, the Full Federal Court held that the Act does not permit a liquidator to nominate the point of Peak Indebtedness and that the entirety of an ongoing business relationship must be considered in relation to the application of s588FA(3).
This decision is consistent with the New Zealand Court of Appeal’s decision in Timberworld Ltd v Levin (2015) 3 NZLR 365 which considered a similar provision to s588FA(3) of the Act and determined that the continuing business relationship is required to be taken into account in the strict interpretation of the words in the New Zealand equivalent legislation.
Key takeaways
- The Peak Indebtedness Rule has now been abolished following the decision in Badenoch by the Full Federal Court of Australia
- For transactions in relation to a continuing business relationship where s588FA(3) applies, the amount of a preference claim is determined by calculating the remainder payable to the creditor at the later of the commencement of the relation-back period and in consideration of the entirety of the continuing business relationship. This is minus the amount owed to the creditor at the earlier date of the relation back period and the end date of the continuing business relationship. On review, the Court held that an unduly restrictive approach should not be taken when identifying a continuous business relationship but rather one should take into consideration the establishment of substance over form, the duration of a ‘stop supply’ and the presence of a repayment plan negotiation for overdue invoices.
- This is a positive outcome for creditors who may otherwise have faced claims for unfair preferences as part of a continuing business relationship. Following this case, any claims made by a liquidator against a creditor for an unfair preference payment may well be the subject of a reduction in comparison to the original claim that offered no option of a reduction.
Combating Illegal Phoenix Activity
In times of uncertainty and instability, company directors may look at different ways to ensure the continuation of their business but may not realise that their activity, and the advice they may receive from trusted business advisors, could fall foul of a new form of voidable transaction known as a ‘Creditor Defeating Disposition’.
On 18 February 2020, the Treasury Laws Amendment (Combatting Illegal Phoenixing) Act 2020 (Cth) came into operation and introduced significant changes to improve the accountability of resigning directors and combat phoenixing activities by introducing new rules relating to property transfers seeking to defeat creditors.
Creditor Defeating Dispositions
The reforms introduced a new form of voidable transaction, a “Creditor Defeating Disposition” which is defined in section 588FDB of the Corporations Act 2001 (Cth) (Act) as a disposition of property where:
- The consideration payable to the company was less than the lesser of:
- The market value of the property;
- The best price that was reasonably obtainable for the property, having regard to the circumstances existing at that time; and
- The disposition has the effect of:
- Preventing the property from becoming available for the benefit of creditors in the winding up of the company; or
- Hindering, or significantly delaying, the process of making the property available for the benefit of the company’s creditors in the winding up of the company.
Interestingly, creditor defeating dispositions also cover instances where:
- by reason of the company’s conduct, another person becomes the owner of property that did not previously exist; and
- a company makes a disposition of property to another person and the other person gives all or some of the consideration to a person other than the company (i.e. a third party), the company is taken to have made a creditor defeating disposition of property relative to the amount of consideration given to the third party.
Period Prior to Relation-Back Day
Section 588FE(6B) of the Act states that a creditor defeating disposition is a voidable transaction if:
- the transaction was entered into or an act was done giving effect to it, when the company was insolvent and occurred twelve (12) months before the winding up; or
- the company enters into external administration within 12 months of the transaction occurring and the disposition, whether directly or indirectly, resulted in the company entering into external administration.
Additional Powers
The reforms also give power to ASIC, pursuant to section 588FGAA of the Act, to order the person in receipt of the consideration or the company property to:
- transfer the property back to the company; or
- pay to the company an amount that in ASIC’s opinion, fairly represents some or all of the benefit that the person has received.
Importantly, ASIC may make these orders on its own initiative or on the liquidator’s application to ASIC and non-compliance of an ASIC order is an offence. However, such orders can be set aside by the Court provided the interested party makes an application within 60 days of being given or becoming aware of ASIC’s order.
Duties and Consequences
The new reforms have introduced civil penalties as well as criminal offences for officers and other persons who engage in conduct that results in the company making a creditor defeating disposition. More specifically, section 588GAC of the Act states that a “person” (therefore, not necessarily an officer of the company) must not engage in conduct of procuring, inciting, inducing or encouraging the making by a company of a creditor defeating disposition.
Why the changes?
It has been acknowledged that companies in financial distress may need to dispose of property quickly to help with cash flow issues and the like. In those circumstances, it is not uncommon for dispositions to be less than market value, so long as they are the best price reasonably obtainable at the time.
These changes give companies flexibility in the way they can approach and deal with any financial issues in the most stressful of times.
Further, giving ASIC power to essentially undo the effect of a creditor defeating disposition should help reduce liquidators, costs for recovery where there are insufficient funds to commence court action to recover the property. However, we are yet to see the practical effect of this power particularly in circumstances where ASIC may become inundated with applications from liquidators across all of Australia.
What to remember if you are considering or need to dispose of company property
To ensure you comply with these new reforms, we recommend you:
- Keep good records of the steps taken prior to disposing of the property to prove reasonableness and obtain an independent valuation wherever possible.
- Take note that in the absence of adequate records, the disposition may be presumed to be less than market value or less than the best price reasonably obtainable.
- Seek proper legal and financial advice from a suitably qualified and reputable advisor, before you enter into an agreement to dispose of the property especially if the company is in financial distress.
- Contact us should you require any further advice.
Update to Creditor's Statutory Demands & Bankruptcy Regulations
The Federal Government announced that from 1 July 2021 the statutory minimum debt amount in order to serve a creditor’s statutory demand increased from $2,000 to $4,000.
The time limit for a debtor to respond to service of a statutory demand remains at 21 days and the existing personal liability on directors for insolvent trading remains unchanged.
Some companies, albeit very few, were still eligible for “Temporary Restructuring Relief” and were afforded the maximum extension debt amount of $20,000 and six months to comply, and this remained unchanged into the month of July. But those companies will now be required to face the new statutory minimum of $4,000 and 21 days to comply, from 1 August 2021.
Update to the Bankruptcy Regulations
On 1 April 2021 the Bankruptcy Regulations 1996 were phased out and have now been replaced by the Bankruptcy Regulations 2021.
Key amendments include the following:
- In March 2020, the Bankruptcy Regulations were amended by Coronavirus Economic Response Package Ombnibus Act 2020 to prescribe a temporary bankruptcy threshold of $20,000 in response to the pandemic however this threshold ceased on 31 December 2020. A minimum bankruptcy threshold of $10,000 commenced in January 2021 allowing this threshold to be applied to bankruptcy notices issues or creditors petitions after this date.
- On the transfer of funds into the Consolidated Revenue Fund, the previous Regulation 12.01 statement has been replaced by an approved form outlined in section 72 of the Bankruptcy Regulations
- Schedule 8 of the 1996 Bankruptcy Regulations has been divided into separate provisions, found in sections 75 to 78
- A new section 24 deals with the treatment of proofs of debt specifically in relation to foreign currency
- The introduction of new tables outlining the indexed amounts for previous financial years in relation to the priority amounts for employee dividends in section 26, protected tools of trade in section 29 and vehicles used primarily for transport in section 30.
A further measure designed and implemented to assist bankruptcy practitioners navigate the new Bankruptcy Regulations 2021, includes a comparative table between the old and new regulations has been published on AFSA's website.
Also new on AFSA’s website are the practice statements and practice directions of AFSA’s Inspector-General, the Official Receiver and the Official Trustee which have been updated and also became effective on 1 April 2021.
Small Business Restructuring Process
In 2020, the Russell Kennedy insolvency team covered the changes to the Australian insolvency framework introduced by the Federal Government in response to the COVID -19 pandemic. This included temporary relief measures to support small businesses restructure debt.
As indicated in our updates last year, these temporary measures expired on 31 December 2020, and were replaced by changes introduced by the Corporations Amendment (Corporate Insolvency Reforms) Act 2020 (Cth) (Act) on 1 January 2021.
The Corporations Act 2001 includes a Small Business Restructuring Process (SBRP) which is intended to permit eligible companies to:
- retain control of their business, property and affairs while developing a plan to restructure with the assistance of a small business restructuring practitioner; and
- enter into a restructuring plan with creditors.
In order to access the SBRP, a company must be able to demonstrate that it has liabilities of less than $1 million on the day the restructuring begins, excluding employee entitlements (including superannuation), in the Corporations Regulations 2001.
The company must undertake this eligibility assessment on the day on which a restructuring practitioner for the company is appointed.
How does the SBRP work?
Under the SBRP, all unsecured and some secured creditors are prohibited from enforcing any rights against the company whilst a proposal is developed.
The process commences following a resolution of the board that:
- in the option of the directors voting for the resolution, the company is insolvent, or is likely to become insolvent at some future time; and
- a restructuring practitioner for the company should be appointed.
A restructuring practitioner must be a registered liquidator. Their role is to provide advice to the company on matters relating to the restructure, including preparation of a restructuring plan. Directors of the company are required to give the restructuring practitioner information about the company’s business, property, affairs and financial circumstances.
The Corporations Regulations 2001 stipulates that within 20 days of appointment of the restructuring practitioner, a restructuring plan is developed by the company directors with the support of the practitioner. The plan must identify and specify how the company’s property is to be dealt with, and be accompanied by a restructuring proposal statement that includes a schedule of debts and claims.
The restructuring practitioner must declare that if the restructuring plan is made, the company is likely to be able to discharge the obligations created by the plan as and when they become due and payable.
The restructuring practitioner will then provide the proposed plan to the company creditors, who must vote on whether the plan should be accepted within 15 days of receipt. A majority of creditors by value must endorse the plan for it to be approved.
If approved, the plan binds the company and is administered by the restructuring practitioner.
Key takeaways
As discussed in our previous updates, these reforms were designed to address the expected increase in the number of companies being put into external administration following the expiration of temporary relief measures in December. However, as the wave of expected insolvencies has not eventuated, we are yet to understand the effectiveness of the SBRP and whether any amendments to the process will be required.
It will be interesting to see whether companies who have weathered the storm during Victoria’s seventh lockdown by relying on Government grants will soon need to utilise the SBRP in order to obtain some sort of relief. Although Victoria is slowly opening up, the full effect of the extended lockdowns to small businesses may not be felt for quite some time and we may see an uptake of the SBRP in the next six to twelve months.
If you require assistance with the SBRP, please contact a member of our Dispute Resolution team or Corporate and Commercial teams.
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