True pre-pack transactions are rare in Australia. Although the benefits of insolvency practitioners acting early to preserve value are widely recognised, a relatively conservative interpretation of the law has operated to increase the perceived risk profile of pre-pack transactions and has, therefore, hindered their use. In particular, creditor-friendly insolvency regimes, duties on insolvency practitioners exercising their power of sale, and perceived and actual independence requirements are seen to be at odds with the traditional pre-pack model, which is in essence a business sale (with no formal creditor involvement or court approval) effected immediately upon the appointment of an insolvency practitioner. This paper suggests that a less conservative interpretation of the current law would allow for an increased use of the pre-pack, particularly in circumstances where the transaction has the support of stakeholders that are ‘in the money’. Although recent legislative reform should, in theory, allow directors of debtor companies to explore more creative solutions to corporate rescue, further and significant reform is needed to encourage the adoption of pre-pack transactions on a wider scale.
Overview of key restructuring tools
The primary pre-insolvency restructuring tool available in Australia is the scheme of arrangement. Like that in the United Kingdom, a scheme is a restructuring proposal put forward with input from management, the company and its financial creditors and is effected by compromising the rights of any, or all, stakeholders. The process is overseen by the courts and requires approval by all classes of financial creditors.
A scheme must be approved by at least 50 per cent in number and 75 per cent in value of creditors in each class of creditors and by the court at two separate stages. Creditor classes are determined by pooling creditors whose rights are not so dissimilar as to make it impossible for them to consult one another with a view to a ‘common interest’, although recent case law suggests that the boundaries of what may constitute a class may be stretched.
The outcome of a scheme depends on the terms of the compromise reached with creditors; however, most commonly, the company is returned to its normal state as a going concern with the relevant compromises having taken effect.
Schemes sit at the opposite end of the restructuring spectrum to pre-pack transactions in terms of timing and cost. Schemes are complex, time consuming (given they are subject to the court timetable, which cannot be expedited) and subject to the overall approval of the court (even if the scheme is approved by creditors, the court may still take the view that the scheme is not fair). Accordingly, schemes are generally used to implement large corporate restructures and in situations where time is not necessarily of the essence.
The Corporations Act 2001 (Cth) (the Corporations Act) is the primary piece of legislation governing the administration, reorganisation and insolvency of companies incorporated in Australia. While there is no formal process around implementing a pre-pack transaction, the receivership and administration regimes described below are capable of being used to effect a pre-pack transaction.
Unlike many other jurisdictions, receivership is alive and well in Australia. The central role of a receiver is to take control of the assets of a company and realise those assets for the benefit of the secured creditor. A receiver may be appointed by application to the court or, more commonly, pursuant to a security document in favour of the secured creditor in circumstances where the debtor company has defaulted and the security has become enforceable.
Once appointed, the receiver will usually be the agent of the debtor company (not the appointor) and will have wide-ranging powers, including the ability to operate the debtor’s business, realise assets and borrow against the secured assets. Those powers are set out in the underlying security document and are supplemented by the receiver’s statutory powers set out in Section 420 of the Corporations Act.
On appointment, a receiver will immediately take possession of the assets subject to the security and then may elect to run the business if he or she is appointed to oversee the whole or substantially the whole of the assets of the debtor company.
Depending on the circumstances, a receiver may effect a sale process. In doing so, the receiver is required to fulfil his or her duty under Section 420A of the Corporations Act to take all reasonable care to sell the property for not less than market value (where the relevant property has a market value) or otherwise obtain the best price that is reasonably attainable, having regard to the circumstances existing when the property is sold. Traditionally, satisfying this duty has presented one of the biggest perceived barriers to the adoption of pre-pack transactions by receivers as a restructuring tool.
Once a receiver has realised the secured assets and distributed any net proceeds to the secured creditor (returning any surplus to the company or later-ranking creditors), he or she will retire in the ordinary course.
Administration, unlike receivership, is entirely a creature of statute. Its key object, as set out in Section 435A of the Corporations Act, is to maximise the chances of the company, or as much as possible of its business, to remain in existence, or if this option is not possible, achieve a better return for the company’s creditors and members than would result from an immediate winding up of the company.
An administrator (often referred to as a voluntary administrator) may be appointed to a debtor company:
- by resolution of the board of directors who consider the company is or is likely to become insolvent;
- by a liquidator (or provisional liquidator) if he or she considers that the company is, or is likely to become, insolvent; or
- by a secured creditor entitled to enforce security over the whole or substantially the whole of the company’s property in circumstances where the security interest is enforceable.
Administration is not a debtor-friendly process. Rather, the administrator and creditors control the final outcome of the administration to the exclusion of the existing board of directors.
A significant feature of administration is the implementation of a statutory moratorium upon appointment, which restricts the exercise of rights by third parties under leases and security interests and in respect of litigation claims. The moratorium provides the administrator the opportunity to investigate the affairs of the company and either implement change or realise value while having protection against potential claims.
Administrators are required to call two meetings of creditors during the course of the administration. The first meeting must be convened within eight business days of the administrator’s appointment and its purpose is to confirm the identity of the administrator, approve their initial remuneration and establish a creditors’ committee (if the creditors resolve to do so). The second meeting is usually convened 20 business days after the date of appointment of the administrator (or as extended by application to the court). At the second meeting, the administrator reports to creditors on the affairs of the company and presents their view on the best option to maximise return to creditors. Importantly, an administrator is able to sell the business and assets of a company without the approval of creditors at the second meeting of creditors.
There are three possible outcomes that can be put to the creditors at the second meeting: entry into a deed of company arrangement (DOCA) with creditors (see below), wind up the company or terminate the administration by returning the business to the control of its directors.
A DOCA is in essence an agreement between the company and its creditors as to how the company’s business and its assets are to be reconstructed or wound down. DOCAs are flexible arrangements that can contain any combination of terms but typically include a moratorium on debt repayments for a specified period, a compromise of creditors’ claims, a rescheduling of the company’s debts by creditors agreeing to accept payments in instalments or by other means (such as via a debt-for-equity swap) or forgiveness of outstanding debt.
For a debtor company to enter into a DOCA, a bare majority of creditors by both value and number voting at the second creditors’ meeting must vote in favour of the company executing a DOCA. Once executed, the DOCA binds the debtor company, its shareholders, directors and unsecured creditors. Secured creditors can, but do not need to, vote at the second creditors’ meeting, and usually only those who voted in favour of the DOCA at the second creditors’ meeting are bound by its terms.
Upon execution of a DOCA, the voluntary administration that preceded it terminates. The outcome of a DOCA is generally dictated by the terms of the DOCA itself. Usually, once a DOCA has achieved its stated aims, it will terminate. If a DOCA does not achieve its objectives, or is challenged by creditors, it may be terminated by the court or in accordance with its terms.
Implementation of a restructuring on a pre-packaged basis
The receivership, administration and (to some extent) the DOCA regimes outlined above are the principal means by which insolvency practitioners may implement a pre-pack transaction in Australia. However, as will be explained further below, these regimes have presented a number of perceived legal and practical difficulties, which have led to a general unwillingness of insolvency practitioners to adopt the pre-pack as a restructuring tool. This is in contrast to other jurisdictions, such as the United Kingdom, where we understand pre-pack transactions are a central feature of the restructuring landscape.
Receivers have the power under Section 420(2)(b) of the Corporations Act to implement a pre-pack transaction immediately upon or shortly after their appointment to the debtor company. The Section provides that, in addition to any other powers granted by the security document or a court order, a receiver has the power to dispose of property of the company in the manner it sees fit.
Perhaps the single largest impediment to receivers exercising their power of sale to implement a pre-pack transaction is the fear of contravening the duty under Section 420A of the Corporations Act to take all reasonable care to (1) sell the property for not less than market value (where the relevant property has a market value) or (2) otherwise obtain the best price that is reasonably attainable, having regard to the circumstances existing when the property is sold. ‘Market value’ has been held to mean ‘the estimated amount for which an asset should be exchanged on the date of valuation between a willing buyer and a willing seller in an arm’s-length transaction after proper marketing wherein the parties had each acted knowledgeably, prudently and without compulsion’.
The prevailing view is that Section 420A requires receivers to exercise their power of sale in good faith. This presents a much higher bar than in other jurisdictions, such as the United Kingdom, where receivers are only required to show they were not negligent in exercising their power of sale.
The question of whether the receivers have breached their duty under Section 420A by exercising their power of sale to implement a pre-pack has focused primarily on the process undertaken by the receiver to sell the relevant property. Judicial consideration has typically focused on whether the receivers were properly informed (i.e., did they seek independent advice regarding the proposed sale and did they follow it?) and what steps were taken to market the property. The court in Florgale Uniforms Pty Ltd v. Orders (2004) 51 ACSR 699 summarised the courts’ approach in determining whether a receiver has breached Section 420A as follows:
the process of evaluating and balancing the competing costs and benefits and the associated risks of various methods of sale will not, in every case, require a formal comparative analysis or documented calculations. All will depend on the circumstances of the individual case, including the scale of the receivership, the value and nature of the property involved, the receiver’s expertise in relation to the type of property, relevant expert advice, the advice or input of proprietors and staff, the trading history and marketing of the company, including during the receivership, and other relevant variables in a realistic commercial context.
The very nature of a pre-pack transaction – being the quick sale of a company or its assets upon or soon after the appointment of the insolvency practitioner (and where the desired outcome is known prior to their appointment) – has, in the minds of insolvency practitioners, raised two key difficulties with respect to the ability of receivers to satisfy the duty under Section 420A.
The first relates to the amount of time required to implement the pre-pack. Any pre-appointment work performed by the receiver (as investigating accountant or consultant, for example) should be considered in the receiver’s assessment of compliance with Section 420A. However, where a receiver has had no pre-appointment involvement and the pre-pack sale is effected upon or shortly after their appointment, it might be difficult for the receiver to demonstrate that they have complied with the duty – given they would not have had the time to complete a thorough review. Having said that, a receiver might be able to rely on work done by others pre-appointment, such as running an earlier sale process.
The second difficulty concerns the requirement under Section 420A to achieve market value. This conflicts with the principal aim of a pre-pack transaction to preserve value by minimising the impact of the sale on the business. A sale to a particular purchaser may in fact produce a better outcome for the business and its stakeholders than any marketing campaign aimed at achieving the requirements of Section 420A. Additionally, in circumstances where value breaks in the debt and the secured creditor supports the proposed pre-pack transaction, whether the receiver has satisfied the duty in Section 420A is arguably irrelevant given the ‘out of the money’ creditors (including subordinated creditors and equity holders) would be unlikely to suffer any loss as a result of the transaction.
Case law in Australia has been interpreted to suggest that to fulfil this duty, a sale process should be conducted. However, it is suggested that a receiver reaching an informed view as to market value would be sufficient. We consider there to be scope for receivers that have had pre-appointment involvement in the debtor company (or who can rely on others’ work in that regard) to implement a pre-pack transaction in circumstances where the decision not to pursue the transaction would result in value dilution in the business, value breaks in the debt and the receiver’s view on market value has the support of the ‘in the money’ stakeholders. In these cases, it would be difficult to argue that the receivers had not discharged their duty under Section 420A.
Administrators have the power under Section 437A(1) of the Corporations Act to effect a pre-pack transaction provided it meets the objectives of Part 5.3A – i.e., that the sale allows the company to continue or results in a better return for creditors and members than a liquidation. This approach was confirmed in Carter v. Global Food Equipment Pty Ltd (2007) 25 ACLC 1173, where White J held at  that:
Administrators are entitled to sell all or part of a company’s assets and business before a second meeting of creditors with a view to maximising the returns to creditors (s 437A(1)). The matter for decision at the second meeting of creditors under s 439A is not whether the assets or business of the company should be sold and if so, at what price. It is not the creditors’ direct function to approve or disapprove of a proposed sale. The creditors must decide whether the company should remain in administration, whether it should be wound up, or whether any deed of company arrangement which is proposed should be entered into.
There is at least one example of administrators implementing a pre-pack transaction before the second meeting of creditors (which usually occurs 20 business days after appointment of the administrator). In Re Eisa Ltd; Application of Love (2000) 35 ACSR 394, the court held that the sale by the administrator of all the shares in the company to one of the company’s secured creditors without convening a general meeting of members was a legitimate use of the administrator’s power of sale under Section 437A(1) of the Corporations Act and met the objects of Part 5.3A.
There appears to be a prevailing fear among insolvency practitioners in Australia that implementing a pre-pack transaction quickly (and without properly exploring other options) may fail to meet the requirements of Part 5.3A, thereby exposing the transaction (and the administrators’ conduct) to challenge. However, in our view, in circumstances where a pre-pack transaction has the support of ‘in the money’ stakeholders, such a transaction would not be exposed.
Independence requirements for insolvency practitioners
Another significant perceived impediment to the implementation of pre-pack transactions in Australia is the strict independence requirements for insolvency practitioners. Until the Ten Group decision (see ‘Case study: Ten Group’), the general law position has been that administrators are not permitted to have any substantial prior involvement with a company to which they are appointed as this can be seen to detract from their ability to act fairly and impartially during the course of the administration. In addition, the Australian Restructuring Insolvency & Turnaround Association’s (ARITA) Code of Professional Practice for Insolvency Practitioners provides that an insolvency practitioner must not accept an appointment, or continue to act under an existing appointment, if the practitioner is not in fact independent or is not seen or perceived to be independent.
The recent Ten Group decision has arguably broadened the scope for insolvency practitioners to accept an appointment in circumstances where they have performed pre-appointment work provided they put certain safeguards in place to avoid the existence or appearance of conflict should a subsequent appointment occur. These safeguards include (1) ensuring that the potential administrator has made it clear to the board of directors that he or she may become the actual administrator if the other measures to fix the company are unsuccessful, (2) having in place a clearly defined retainer and (3) maintaining a sufficient record of the nature of tasks performed. In that case, the court held that pre-appointment work does not necessarily lead to a reasonable apprehension of bias and that insolvency practitioners are permitted to consider the benefits to the company and its creditors of their pre-appointment involvement.
Notwithstanding the statements in Ten Group, the Australian position on practitioner independence remains in stark contrast to that in the United Kingdom, where we understand it is the view of the courts, professionals and stakeholders that perceived conflicts are capable of being managed and the replacement of an insolvency practitioner is an option of last resort.
Case study: Ten Group
Although there are no examples of traditional pre-pack transactions in Australia, the 2017 decision in Korda, in the matter of Ten Network Holdings Ltd (Administrators Appointed) (Receivers and Managers Appointed)  FCA 914 has arguably paved the way for the use of planned insolvency (or pre-positioned) processes in the Australian restructuring market.
The distinction between a pre-pack and a planned insolvency process is important. A traditional pre-pack typically involves the conclusion of a consensual restructure (usually the sale of all or part of the distressed company’s business or assets), which is then completed immediately or shortly after the appointment of a voluntary administrator. In contrast, a planned insolvency process is where the parties use a formal insolvency regime to implement a broader restructuring in circumstances where a fully consensual restructuring may not be achievable. The distressed company engages insolvency practitioners or appropriately qualified advisers to develop a contingent restructuring plan should a later appointment prove necessary. The formal insolvency process is then used to cramdown dissenting creditors with a view to implementing the contingent restructure.
The Ten Group of Companies (Ten Group) operated a free-to-air Australian TV network. In the lead up to its insolvency and entry into voluntary administration on 14 June 2017, the Ten Group had experienced significant financial difficulty. For the half-year ending February 2017, it reported accumulated losses of AU$1.5 billion, owed AU$73.7 million to its financiers and AU$215 million to its other creditors. The case involved the engagement of insolvency practitioners, partners from KordaMentha, by the Ten Group’s legal advisers, as potential administrators, the subsequent appointment of those partners as voluntary administrators of the Ten Group and the ultimate takeover by CBS of the Ten Group by way of a DOCA.
Rather than a formal pre-pack arrangement, partners of KordaMentha were involved pre-appointment to prepare a contingency administration plan that they would carry out should the informal restructuring negotiations not succeed. The case explored the ‘boundaries of pre-administration’ work in considering whether the administrators could continue to act as administrators in circumstances where they had performed pre-appointment work in connection with the Ten Group. The judgment considered at great length the treatment and status of pre-pack transactions in Australia and concluded that the boundary of pre-administration work that is acceptable in Australia does not extend to advising or assisting with pre-pack transactions.
In his judgment, Justice O’Callaghan cited the views of various authors on the impediments to adopting pre-packs in Australia. These included various ethical issues that may arise where the proposed administrator, driven by its desire to secure the appointment, uses a pre-pack that is heavily influenced by certain stakeholders, rather than pursuing a transaction that benefits creditors as a whole.
Although Justice O’Callaghan did not go so far as to endorse the proposition that involvement in a pre-pack proposal would ‘ipso facto disqualify an Australian insolvency practitioner from taking an appointment as a voluntary administrator’, his Honour agreed that it would be difficult to imagine a situation where an insolvency practitioner would be permitted to take an appointment in the circumstances described above. Relevantly, the position would be different if the insolvency practitioners took on a role as receivers (as opposed to administrators), where the importance of independence is not as acute.
The Ten Group judgment demonstrates that the courts are not yet prepared to relax the administrators’ duty of independence and impartiality. However, as will be discussed below, the recent safe harbour and ipso facto legislative reforms may overcome some of the barriers to implementing traditional pre-pack transactions in Australia.
In 2015, the Australian Government Productivity Commission conducted an independent review into barriers to business entries and exits in Australia, including an assessment of how Australia’s corporate restructuring regimes could be improved. The ensuing Productivity Commission Inquiry Report (the Report) found that Australia’s insolvency framework focuses too strongly on penalising and stigmatising corporate failure and recommended a number of reforms to improve the efficacy and success of restructuring and insolvency regimes.
In particular, the Report recommended that, where no related parties are involved, the Corporations Act could provide for ‘pre-positioned sales’ (as distinct from pre-pack sales (see ‘Case study: Ten Group’)), whereby administrators could overturn sales only if they can prove that the sale was not for reasonable market value or if it would unduly impinge on the performance of the administrators’ duties. The Report notes that a number of stakeholders, including ARITA, had submitted that legislating for pre-pack transactions in the traditional sense would not be suitable, given the actual and perceived independence concerns to which they give rise (see ‘Independence requirements for insolvency practitioners’).
Following the recommendations made in the Report, in 2017, the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act 2017 (the TLA Act) brought into operation the following key changes to Australia’s insolvency laws.
The first change introduced by the TLA Act was a new safe harbour from civil liability for insolvent trading under Section 588G of the Corporations Act for directors if they appoint a restructuring adviser to develop a restructuring plan for the company. Under Section 588GA of the Corporations Act, a director will not be liable for debts incurred by a company while it is insolvent if at a particular time after the director starts to suspect the company may become or be insolvent, the director starts developing one or more courses of action that are reasonably likely to lead to a better outcome for the company than the immediate appointment of an administrator or liquidator to the company. The relevant director bears the evidential burden if he or she seeks to rely on this defence.
Given the essence of a pre-pack transaction is that its terms are negotiated to near completion prior to the appointment of an insolvency practitioner and that the company may be operating in an insolvency context while the sale is being negotiated, certain boards may see the introduction of safe harbour as the protection to allow a pre-pack to be formulated during insolvency. However, many commentators do not see safe harbour as providing sufficient protection for directors with no appetite for risk, i.e., who do not want to entertain the prospect of having to justify why their plan is ‘reasonably likely’ to lead to a better outcome than an administration or liquidation.
The recent high-profile Arrium administration is an example of circumstances where a plan developed by directors (offering lenders around 50 cents in the dollar) proved to provide a worse outcome than that eventually received by lenders in the subsequent administration, i.e., in excess of 70 cents in the dollar.
Ipso facto stay
The second change introduced by the TLA Act was the implementation of an automatic stay on the enforcement of certain ipso facto rights, which came into effect from 1 July 2018. The stay precludes a party from enforcing certain rights (including terminating a contract) simply because the company has entered into certain formal insolvency processes. Relevantly, the automatic stay will not apply in certain circumstances, including where (1) a receiver or controller is not appointed over the whole or substantially the whole of the company’s assets or (2) the company has entered into a DOCA.
The recent Ten Group decision and safe harbour and ipso facto reforms demonstrate an increased openness of the courts, legislature and insolvency practitioners in Australia to the use of pre-pack transactions to facilitate the more creative and effective restructuring of financially distressed or insolvent companies. While we view these developments as a positive step forward, further reform needs to be achieved if we are to see pre-packs adopted on the scale seen in other jurisdictions.
On that basis, potential suggested areas of reform to facilitate the use of pre-pack transactions in Australia could include:
- shortening the legislative time frames (see ‘Insolvency processes: Administration’) for conducting an administration so as to accommodate a rapid sale or restructure through a DOCA;
- allowing pre-pack transactions to proceed in circumstances where the administrators or receivers are able to satisfy themselves as to where value breaks in the debt and that there is no evidence of real loss of value to the business should the proposed transaction be implemented; and
- addressing the independence requirements for insolvency practitioners so as to permit pre-appointment work and subsequent appointments. One possible way to manage this could be to implement an independent review panel for pre-pack transactions such as that proposed in the UK Graham Review, whereby a second practitioner appointed by an independent body (such as ARITA) reviews the proposal and, if approved, either the first or second practitioner carries the plan forward.
1 Dominic Emmett is a partner and Hannah Cooper is an associate at Gilbert + Tobin.
2 A scheme of arrangement can also be used where the debtor company is insolvent.
3 The courts may agree to put creditors in classes even where such creditors appear to have objectively distinct interests: First Pacific Advisors LLC v. Boart Longyear Ltd  NSWCA 116.
4 Corporations Act 2001 (Cth), s 436A.
5 ibid. s 436B.
6 ibid. s 436C.
7 However, there is an exception to the moratorium on the exercise of rights under security interests in the case of a secured creditor that has security over the whole or substantially the whole of the assets of the company and such rights are exercised within the ‘decision period’ (being 13 business days after the appointment of the administrator).
8 There are two recent cases challenging the validity of the widely held view that secured creditors are not ‘bound’ by a DOCA unless they vote in favour of it. In Australian Gypsum Industries Pty Ltd v. Dalesun Holdings Pty Ltd  WASCA 95 and Re Bluenergy Group Limited  NSWSC 977, it was held that a DOCA can (if so expressed) have the effect of extinguishing the debt of a secured creditor that did not vote in favour of the DOCA pursuant to Section 444D(1) of the Corporations Act. However, this extinguishment is subject to the preservation of the secured creditor’s ability (by virtue of Section 444D(2)) to realise or deal with its security in respect of its proprietary interest in the secured property and to the extent that its debt was provable, and secured assets were available at the date that debt would otherwise be released under the DOCA, without requiring that the debt be preserved into the future or for other purposes.
9 Fortson Pty Ltd v. Commonwealth Bank of Australia (2008) 100 SASR 162 .
10 Pendlebury v. Colonial Mutual Life Assurance Society Ltd (1912) 13 CLR 676.
11 Cuckmere Brick Co Ltd v. Mutual Finance Co Ltd  Ch 949.
12 Florgale Uniforms Pty Ltd v. Orders (2004) 51 ACSR 699 .
13 Commonwealth v. Irving (1996) 144 ALR 172.
14 Korda, in the matter of Ten Network Holdings Ltd (Administrators Appointed) (Receivers and Managers Appointed) (2017) 252 FCR 519 at 528.
15 M N Wellard and P Walton, ‘A Comparative Analysis of Anglo-Australian Pre-Packs: can the means be made to justify the ends?’ (2012) 21(3) International Insolvency Review 143.
16 Rowarth, Jade ‘A change in the Australian restructuring landscape’ 2017.
17 Ten Network Holdings (n14) 526.
18 Veronica Finch, Corporate Insolvency Law: Perspectives and Principles (2nd ed, Cambridge University Press, 2009) 460; Wellard and Walton (n15) 162–163.
19 Wellard and Walton (n15) 162–163.
20 Ten Network Holdings (n14) 526.
21 Australian Government, Productivity Commission Inquiry Report: Business Set-up, Transfer and Closure, Report No. 75 (2015) 23–24.
22 ibid. 392.
23 E Poulos and A McCunn, ‘Pre-pack Transactions in Australia’ (2011) 19 Insolvency Law Journal 255.
24 Alicia Salvo, The UK’s Graham Review into pre-packs – is Australia missing out? 15(9) Insolvency Law Bulletin 140, 143.