Are holding DOCAs the answer to COVID-19?

 

Thinking | 7 April 2020

By Katherine Payne, Wayne Kelcey and Emily So

The impact of COVID-19 on businesses will undoubtedly require directors to consider formal restructuring and insolvency options, including the appointment of administrators. Administrators are faced with the challenge of assessing a company’s options and forming a recommendation in an era of high market uncertainty. Both proposing a holding Deeds of Company Arrangement (DOCA) and extending the convening period are being discussed as options to provide administrators with more time to undertake these tasks. In this article we consider the scope and limitations of each strategy.

A changing landscape

There are a number of business factors which continue to develop rapidly as a result of the pandemic. These include:

  • restrictions on trading and lockdown measures (ie the extent to which consumers, suppliers and other stakeholders can practically continue engaging with the business);
  • government relief measures;
  • how long the effects of COVID-19 will continue to impact on business, which is uncertain at this stage; and
  • what market conditions will look like for the foreseeable future under threat of COVID-19, and in the aftermath.

What are the options?

Administrators have 20 to 25 days to convene the second meeting of creditors and form an opinion as to whether it is in creditors’ interests for the company to enter into a DOCA, for the administration to end, or for the company to be wound up. This timeframe can be extended by seeking creditors’ approval of a holding DOCA or seeking an extension of the convening period from the Court.

Holding DOCAs

The use of holding DOCAs was affirmed by the High Court in Mighty River International Ltd v Hughes[1] (‘Mighty River’). The DOCA proposed by the administrators in that case provided predominantly for a moratorium on creditor claims and did not provide for a distribution of the company’s assets. It effectively bought more time for the administrators to continue their investigations and assess restructuring options. The Court held that in that instance, it was permissible.

However Mighty River does not relax an administrator’s obligation to form an opinion at the second creditors’ meeting. The administrators in that case were able to substantiate their opinion that a holding DOCA was likely to result in a better outcome for creditors than an immediate winding up, and was therefore in their interests. It was accompanied by express statements in their report under section 439A of the Corporations Act (Act) that “it is not in the interests of creditors that the administration end … [and] it is not in the interests of creditors that the Company be wound up (emphasis in original)”.

Prior to the second meeting of creditors, the administrators were able to undertake a detailed assessment of the business (some 26 pages of ‘substantial reasoning’) and show that the sale of assets through the administration would provide a higher return than a sale in liquidation. A significant factor in this assessment was that there was inherent value in the company’s public listing, which would have been lost if the company were to be wound up (this was valued at between $400,000 - $900,000). Further, at the time that the DOCA was proposed, the administrators had commenced advertising for the sale of the company’s assets, and relied on the level of interest generated as a positive indicator of market response.

Given the uncertainty associated with the economic impact of COVID-19, an administrator appointed in the current market may have difficulty undertaking the same detailed assessment of the likely future value of company assets. The ability to demonstrate that the assets will be of more value as a result of an ongoing administration, or at least maintain their value such that the creditors are not worse off, will be important.

Most practitioners will hold a view as to the likely direction of the market. However, the statutory obligation on administrators to form an opinion as to what is in the best interests of the creditors requires more than speculation. With the current economic turmoil, it will, in many instances, be difficult to estimate the status of the future market with sufficient certainty to be able to provide a recommendation that the future sale value of company assets will be higher than their existing value. Likewise, it will be challenging to predict the viability of any alternatives, such as future recapitalisation or resumption of trading.

That Mighty River progressed to judgment is also a reminder that administrators cannot assume that creditors will support the DOCA. Creditors may not vote in favour of a holding DOCA in the first place or, as in Mighty River, seek to void a holding DOCA by challenging the validity of an administrator’s opinion in court. To challenge the DOCA, a creditor may allege that they voted for it on the basis of false or misleading material information given to the creditors. For example, information to the effect that the assets are likely to improve in value after the health crisis is resolved, or at least maintain their value during the administration period.

This risk is amplified in the current circumstances. Cashflow has become critical; creditor classes such as suppliers and employees will need to be persuaded that they are better off agreeing to a moratorium in the face of an uncertain economy and waiting for a future proposal than insisting upon what they may receive in an immediate winding up. If that persuasion is based on an assumption about the likely future of the market which is subsequently proven to be false, creditors may seek to set aside the DOCA.

It is also worth noting that while the majority of the High Court (Kiefel CJ and Edelman J, with Gageler J agreeing) held that a DOCA could be used as a device predominantly, or solely, for a moratorium, this was not a unanimous view. The minority (Nettle and Gordon JJ) held that the kinds of moratoria that will qualify as a DOCA are those which are calculated to enable a company to trade out of financial difficulties, or which include full or partial releases of debts. The minority rejected the arrangement in Mighty River on the basis that its only purpose was to enable the company to be kept, de facto, in administration to provide more time to seek proposals. It can therefore be assumed that the Courts will closely scrutinise whether any holding DOCAs proposed in the current market are actually in the best interests of the creditors.

We note the Treasury and the ATO have not specifically excluded companies in administration from being eligible for JobKeeper payments. However this is an opt-in, reimbursement scheme meaning administrators must elect to pay eligible employees $1500 per fortnight in advance. Where an administrator does not expect to pay employees, employees may reject an extension of the administration in favour of receiving FEG entitlements in liquidation.

Extension of the convening period

If an administrator does not have sufficient information to form an opinion as to whether the creditors will be better off under a holding DOCA, but where there is a genuine belief that the passing of time will assist in the restructuring of a company, it may be more prudent to apply to the Court to have the convening period extended.

Indeed, in Mighty River the High Court majority expressly contemplated this scenario:

“There may be circumstances in which there is simply insufficient information for an administrator to express an opinion, even where an alternative is a deed that imposes a moratorium on creditors’ claims to allow further time for investigation. In such a case, the only possibility is for the administrator to apply to the Court to extend the convening period under s 439A(6).”

This course of action similarly provides for a moratorium on creditor claims and gives administrators more time to assess the company’s options. However, unlike a holding DOCA, it does not require an administrator to form an opinion at this time under section 438A of the Act.

The application to extend the convening period ought be made before the convening period ends. In assessing whether to grant the application, the Courts will seek to balance the value of a speedy administration as against the need for flexibility to enable the administrator to maximise the return for creditors. In particular, the Court will consider whether there is any prejudice to creditors, including employees, in prolonging the administration. If there are limited prospects of a beneficial DOCA being proposed, the Court may be more reluctant to grant the extension.

While the Court application does necessitate some additional cost to the administration, when faced with the current magnitude of uncertainties, the Court’s approval provides a level of comfort to administrators who would otherwise be held to opinions that may be prematurely formed.

Considering creditors’ interests

Section 438A requires administrators to positively form an opinion that a holding DOCA is in the interests of creditors. Similarly, the Court will have regard to the interests of creditors when considering an application to extend the convening period. Is there a difference in the threshold to be met in each case?

As previously noted, holding DOCAs require that the administrator have sufficient information to recommend that an extension of the administration will be in the interests of creditors, whereas an immediate winding up will not. This requires a firm opinion to be reached, albeit that it is only an opinion and not a guarantee of the outcome.

In contrast, applications for extension have succeeded where the Court was satisfied that:

  • the administrator did not have sufficient information to provide a meaningful report to creditors that would enable them to make informed decisions about the various outcomes of administration, such that more time was needed;
  • the administrator did however have sufficient information to form a belief that there was potential for the continued administration to yield better results for creditors than a winding up; and
  • there was no material prejudice to creditors.

For example, applications have succeeded where there is a possibility of a DOCA being proposed in due course, the details of which were not yet available at the time of the application.[2]

In the current circumstances, an administrator may not be able to assess the merits of any future restructuring or arrangement with sufficient certainty to produce a meaningful comparison against the outcome of liquidation for creditors to consider. However there may be enough to satisfy a court that extending the administration will potentially benefit creditors without causing undue prejudice.

Key takeaways

  • In many instances, it will be difficult for administrators to properly assess a company’s options in the current economic climate.
  • A holding DOCA may not always be the answer. For example:
    • insolvency practitioners may be unable or unwilling to express an opinion that the creditors are likely to be better off under a future sale of assets, such that the holding DOCA is in the best interests of creditors; and/or
    • creditors may be unwilling to approve a holding DOCA in the circumstances, particularly if it delays recovery of their entitlements with minimal likely benefit.
  • Given the above, directors should be wary that the outcome of a second creditors’ meeting in the current climate may well be liquidation.
  • An application to the Court to extend the convening period effectively defers this decision making, while preserving the same benefits offered by holding DOCAs.
  • In either option, there must be the potential for a future DOCA which will be in the best interests of creditors. If there is no such potential, the company should proceed to liquidation.

[1] (2018) 359 ALR 181

[2] See for example: Federal Commissioner of Taxation v Malphus Pty Ltd [2019] FCA 471, Re Southern Riverina Dairy Group Pty Ltd [2017] VSC 4, Re Worrell; Storm Financial Ltd (recs and mgrs apptd) (2009) 69 ACSR 584

This article was written with the assistance of Emily So.

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