In this Part of the 2023 edition of R+I In Brief, we delve into significant judicial developments relating to insolvency law, including:
- how the Court can cure defects in the appointment of an administrator, if there are governance concerns including that a board is inquorate;
- the powers and duties of the last director left standing, in circumstances where all the other directors have resigned due to the company’s financial distress;
- how the Court can validate an administrator’s appointment, importantly securing their remuneration and disbursements;
- whether creditors are entitled to a right of set off against a liquidator’s claim to recover an unfair preference, and whether liquidators can apply the ‘peak indebtedness rule’ when assessing unfair preference claims;
- the Court’s attitude to late applications made by insolvency practitioners for routine matters; and
- a recent decision of the UK Supreme Court establishing the ‘creditors’ interest duty’ (or the West Mercia rule), which is likely to influence Australian courts going forward.
What you need to know:
When a company becomes financially distressed, directors are often required to act quickly and decisively. However, directors may at the same time find themselves held back by the requirements of the Corporations Act 2001 (Cth) (Corporations Act) or their company constitution.
While it is not unusual for financially distressed companies to grapple with matters of corporate governance, issues arise where these matters affect the ability of directors to appoint an administrator or call into question the validity of that appointment. Critically, directors of financially distressed companies may be unable to assemble the necessary quorum to pass a resolution to appoint an administrator. The risk of a board becoming inquorate is especially real for directors of distressed companies in Australia, given the tendency of directors to resign when a company becomes financially stressed.
How can emergency powers assist?
Emergency powers in a company’s constitution can assist directors to respond in situations of financial distress by temporarily relaxing the procedural and compositional requirements so that, for example, a board resolution will not be invalid because the usual quorum cannot be assembled.
As the long-forecasted economic downturn in Australia begins to materialise, boards should consider whether their constitution contains emergency power provisions or whether any amendments are required to allow for greater flexibility in responding to distress.
How does a company ordinarily appoint an administrator?
Section 436A of the Corporations Act provides that a company may appoint an administrator if the board has resolved that:
- in the opinion of the directors voting for the resolution, the company is insolvent, or is likely to become insolvent at some future time; and
- an administrator of the company should be appointed.
For the appointment to be valid and effective, the resolution under section 436A will need to satisfy the requirements of:
- the company’s constitution; or
- in the absence of a constitution, the Corporations Act.
A company’s constitution will usually set the “quorum” for a meeting of directors, being the minimum number of directors that must be present for a board meeting to take place (and for a resolution to be effective). Where a company has not adopted a constitution, or its constitution does not address a particular aspect of its governance, it will be governed by the ‘replaceable rules’ set out in the Corporations Act. The replaceable rules provide that, unless the directors determine otherwise, the quorum for a meeting of directors is two.
A company’s constitution will also usually fix the minimum number of directors the company must maintain. The Corporations Act requires that:
- a proprietary company must have at least one director who is an Australian resident; and
- a public company must have at least three directors (excluding alternate directors), of whom two must be Australian residents.
What’s the risk of insufficient directors?
A company may be unable to appoint an administrator under section 436A of the Corporations Act (or their appointment may be vulnerable to challenge) if, due to the resignation or flight of a director:
- a quorum cannot be gathered;
- a quorum can be formed, but only one (or in the case of a private company, none) of the directors are Australian residents; or
- in the case of a public company, the number of directors falls below three.
What is an emergency power provision?
Some company constitutions include provisions that alter the composition of the board of directors and its processes in certain limited circumstances. The purposes for which these provisions are enlivened often includes responding to a situation of “emergency”.
- a provision that allows a single director to act on behalf of the company; and
- a provision that allows the remaining directors to act even if the number of directors (or Australian resident directors) falls below the minimum number fixed in the constitution.
An important advantage of emergency power provisions is that the appointment of an administrator may still be valid if it meets the requirements of the company’s constitution, despite the number of directors of the company falling below the minimum number of directors (or Australian resident directors) required by the Corporations Act.
What constitutes an emergency?
It is well established that it is an “emergency” for the purposes of an emergency power provision in a company’s constitution if the level of financial distress of the company is expected to result in insolvency. In Re HPI Australia Pty Ltd  NSWSC 1106, Barrett J held:
“I am satisfied that a company faced with a need to take action to appoint administrators because of insolvency or expected insolvency should be regarded as facing a situation of “emergency”. Such a situation is one calling for immediate and decisive action in the interests of creditors in order that exposure to danger may be addressed. It is within the ordinarily accepted concept of “emergency”.”
What if a company constitution does not contain emergency power provisions?
If the company’s constitution does not contain emergency power provisions, administrators or hamstrung directors may need to seek an order from the Court under sections 447A or 1322(4) of the Corporations Act which cures the defects in the appointment of an administrator:
- Section 447A of the Corporations Act empowers the Court to make such orders as it thinks appropriate about the operation of Part 5.3A of the Corporations Act in relation to a particular company.
- Section 1322(4) of the Corporations Act provides that the Court may order that any act purporting to have been taken under the Corporations Act is not invalid by reason of a contravention of the Corporations Act or a provision of the company’s constitution.
The Courts have tended to prefer section 447A as the source of power for these orders, due to the wide discretion it confers. In Hayes v Doran (No 2)  WASC 486, Martin J summarised the relevant factors to be considered in relation to the exercise of the power conferred by section 447A, including:
- whether the purposes of Part 5.3A would be best served by the making of an order;
- whether substantial injustice would be caused by effectively validating an otherwise invalid appointment; and
- the position of the company at the time the order is made and what is best for the company in the future.
The utility of this provision was recently demonstrated in Hutton, in the matter of Big Village Australia Pty Ltd (Administrators Appointed)  FCA 48. In that case, the administrators sought orders under section 447A to dispel any uncertainty about the validity of their appointment given all but one of the company’s directors had resigned prior to their appointment. This case is further discussed in the next article.
Gilbert + Tobin acted for the administrators of Big Village Australia Pty Ltd in Hutton, in the matter of Big Village Australia Pty Ltd (Administrators Appointed)  FCA 48.
What you need to know:
Along with other reforms designed to prevent illegal phoenixing activity, the Federal Government passed the Treasury Laws Amendment (Combating Illegal Phoenixing) Act 2020 (Cth) in 2020. The amendment came into effect on 18 February 2021 and inserted section 203AB in the Corporations Act 2001 (Cth) (Corporations Act). Section 203AB prevents a company from being abandoned by its directors and left without a board by providing that the resignation does not take effect if, at the end of the day on which the resignation takes effect, the company does not have at least one director (unless the resignation is to take effect after the winding up of the company has begun).
Section 203AB had not been the subject of substantial judicial consideration until the February 2023 decision in Hutton, in the matter of Big Village Australia Pty Ltd (Administrators Appointed)  FCA 48 (Big Village Australia).
The Big Village Australia decision
In Big Village Australia, the administrators sought orders under section 447A of the Corporations Act to dispel any uncertainty about the validity of their appointment as joint and several voluntary administrators of the company. In the months prior to their appointment, all but one of the company’s directors had resigned and the administrators were appointed by resolution of the last remaining director. The uncertainty regarding the validity of their appointment arose from two issues:
- the last remaining director was a resident of New York, leaving the company in breach of section 201A of the Corporations Act, which requires a proprietary company to have at least one director that ordinarily resides in Australia; and
- prior to passing the resolution to appoint the administrators, the last remaining director resigned in accordance with the company’s constitution, leaving the position of director vacant. However, the director later satisfied herself that her resignation was ineffective under section 203AB of the Corporations Act. The director proceeded to pass the necessary resolutions to affect the appointment of the administrators.
Anderson J of the Federal Court applied section 203AB in a clear and common sense fashion. He gave orders that Part 5.3A of the Corporations Act must operate as though the administrators were validly appointed as joint and several administrators of the company. Relevantly, his Honour held:
“Section 203AB […] does not appear to have been the subject of judicial consideration. However, its terms are clear. It prevents a resignation taking effect if that resignation would leave the company without a director. In the present case, it operated to prevent Ms Kracht’s resignation taking effect on 13 January 2023. That meant that, notwithstanding cl 11.5(c) of the Company’s constitution, which provides that “the office of a Director becomes vacant if the Director … resigns as Director by giving written notice of resignation to the Company …”, she remained the director at the time she passed the Resolutions. Ms Kracht relied on the assumption that the legislation had that effect at the time she passed the Resolutions.”
Key takeaways for directors
The Court imparted some important lessons for directors, especially sole directors, of companies facing distress, including:
- section 203AB of the Corporations Act will apply notwithstanding any inconsistent provision in a company’s constitution;
- a director who has attempted to resign, but whose resignation has been rendered ineffective by section 203AB, can continue to exercise the powers of a director, including the power to pass resolutions in accordance with the company’s constitution; and
- having been prevented from resigning, the director will remain subject to the full suite of directors’ duties, including the duty to act in the best interests of the company.
Gilbert + Tobin acted for the administrators in Hutton, in the matter of Big Village Australia (Administrators Appointed)  FCA 48.
What you need to know:
As discussed throughout this Part, there is ample precedent where courts have made orders under sections 447A or 1322(4) of the Corporations Act 2001 (Cth) (Corporations Act) to cure defects in an appointment of an administrator. Circumstances warranting the exercise of this power include where:
- the resolution to appoint administrators was passed at an inquorate board meeting (Re Australian Art Investment Pty Ltd  VSC 18);
- notice requirements for the board meeting convened to appoint administrators were not met (Re Foodora Australia Pty Ltd  NSWSC 1426); and
- the last director of a company purported to resign prior to appointing administrators (Hutton, in the matter of Big Village Australia Pty Ltd (Administrators Appointed)  FCA 48).
The incentive for an administrator to seek validation orders is obvious. Aside from being dutybound to take reasonable steps to satisfy themselves of the validity of their appointment on the face of the appointment documents, the doubt cast over their right to recoup their remuneration and expenses, should their appointment be deemed invalid, is enough to send most administrators to court.
Specifically, an invalid appointment puts at risk an administrator’s right of indemnity under section 443D of the Corporations Act for remuneration and debts incurred, as well as the corresponding lien provided by section 443F of the Corporations Act over the assets of the company to secure that right of indemnity.
Given the potential exposure to administrators, the validity of an administrator’s appointment is an issue which is usually promptly resolved by the Court on application by an administrator.
However, what happens if the Court is unwilling or unable to grant validity orders when sought by an administrator? Aside from potentially jeopardising the administrator’s right to payment of their remuneration and expenses from the assets of the company, a subsequent finding of invalidity may also have wider-reaching effects, including calling into question the binding nature of steps taken by the administrator on behalf of the company during the appointment (including in respect of any transaction to which an administrator has sought to bind the company).
The administration of the Adaman Group
While the above circumstance may be rare, this was the situation the administrators of gold miner Adaman Resources and six of its subsidiaries (Adaman Group or the Group) found themselves in and which precipitated eight successive applications to the Federal Court of Australia.
Shortly after the appointment of administrators to the Adaman Group, questions were raised regarding the validity of their appointment, which stemmed from:
- the directors relying on an emergency power in the holding company’s constitution to affect the appointment of the administrators; and
- a consent requirement contained in a shareholders’ deed.
Banks-Smith J made orders validating the administrators’ appointment over five of the Adaman Group entities less than two weeks after the administrators were appointed. However, her Honour declined to validate the administrators’ appointment to the two remaining Group entities at that time. Her Honour’s reasoning was that a separate oppression proceeding had been commenced by an aggrieved shareholder in respect of these two companies which raised, amongst other things, the bona fides of the appointment of the administrators to those entities.
The unresolved question of validity created uncertainties for the administrators in continuing with the appointment over the two remaining Group entities, including whether:
- actions taken by them in the administration on behalf of the two remaining Group entities, including the entry into a Deed of Company Arrangement (DOCA), would be valid and binding on those companies; and
- the fees and disbursements incurred by the administrators would be recoverable, in circumstances where they would be relying on the right of indemnity and lien over the two remaining Group entities’ assets under sections 443D and 443F of the Corporations Act, respectively.
In light of the ongoing validity concerns, the administrators sought orders from the Court throughout the administration process to minimise their exposure and liability in continuing with the appointment over the two remaining Group entities.
Entry into the DOCA
The administrators applied for and received orders that they were justified and would be acting reasonably and properly by entering into and giving effect to the proposed DOCA. The administrators also received orders under section 447A of the Corporations Act that:
- Part 5.3A of the Corporations Act was to operate in relation to the two remaining Group entities as if the administrators did have the power to enter into the DOCA under sections 437A(1) and 442A(c); and
- entry into the DOCA would not be void for lack of authority.
Remuneration and disbursements
Prior to the Adaman Group administration, there was precedent for invalidly appointed administrators and liquidators receiving orders entitling them to their remuneration and expenses already incurred in an appointment after having their appointment deemed invalid by the Court (see for example Re Warwick Keneally as administrator of Australian Blue Mountain International Cultural & Tourist Group Pty Ltd (administrator appointed)  NSWSC 2037; Re Polat Enterprises Pty Ltd (in liq)  VSC 485). As recognised by Banks-Smith J, the foundational basis of this relief is restitution on a quantum meruit basis or that the work was of incontrovertible benefit.
However, the Adaman Group administration was the first time that a court granted prospective relief. In particular, the court , ordered that the administrators were entitled to their reasonable costs and remuneration, and a lien to secure the same, irrespective of and before any determination as to the validity of their appointment. This form of order provided the requisite comfort needed for the administrators to continue with the appointments.
As part of the application, the administrators proposed a regime that in effect applied Division 60 of Schedule 2 to the Corporations Act (being the Insolvency Practice Schedule (Corporations) (IPS)), requiring creditor or court approval for payment of their remuneration, and (departing from the usual course) also provided for the same approval process for costs and expenses.
Setting precedent, the Court granted orders giving prospective relief, citing the following factors in favour of the administrators:
- the administrators continued to carry out all relevant tasks relating to the administration of the Adaman Group and had reported to the Court on a number of occasions as to the work that was being undertaken;
- the Adaman Group continued to trade through the administrators' efforts. That work was being undertaken to maximise the possibility of a sale or restructure of the Group and the value of the assets for the benefit of creditors and to preserve employment prospects, in furtherance of the objects of Part 5.3A;
- it was appropriate that there be a measure of certainty in respect of the administrator’s personal exposure in undertaking that work; and
- the orders proposed by the administrators advanced the objects of Part 5.3A by giving the administrators a reasonable degree of certainty in the continued performance of their functions and duties, while leaving open the ability of interested parties to review their costs, expenses and remuneration in due course.
Voluntary administration – an out of court process?
Although the voluntary administration process is traditionally considered to primarily be an out of court process, with the Court taking a supervisory role, the broad powers conferred on the Court are a powerful tool which can be utilised by administrators to assist them in the performance of their duties, especially when undertaking higher-risk and more complex appointments.
While Banks-Smith J ultimately made orders validating the administrators’ appointment over the two remaining Group entities, those orders were only made some five months after the administrators’ initial appointment and only once the administration had effectively run its course, with the Adaman Group undergoing a restructure and recapitalisation through a DOCA. In the face of significant personal exposure, it was the ability to run the Adaman Group administration effectively under court supervision (consisting of eight successive court applications), which enabled the administrators to continue with and finalise the appointment.
The prospective relief received for the administrators’ remuneration and disbursements is just one example of the reach of section 447A of the Corporations Act and section 90-15 of the IPS. We will be keenly monitoring the development of case law in this area, as insolvency practitioners continue to turn to the Court for assistance, and the boundaries of the facilitative provisions in the Corporations Act are tested.
Gilbert + Tobin acted for the administrators of the Adaman Group. See Nipps (Administrator) v Remagen Lend ADA Pty Ltd, in the matter of Adaman Resources Pty Ltd (Administrators Appointed)  FCA 520 and the subsequent 7 decisions.
What you need to know:
The High Court of Australia began its judicial calendar in February 2023 with a “bang” for insolvency practitioners, handing down two landmark decisions that put to rest two long-held questions:
- whether creditors are entitled to a right of set off against a liquidator’s claim to recover an unfair preference; and
- whether liquidators are entitled to apply the ‘peak indebtedness rule’ when assessing unfair preference claims.
For some time, it has been unclear as to whether a defendant, faced with a liquidator’s claim to recover unfair preferences, is entitled to invoke a right to set-off under section 553C of the Corporations Act.
Pursuant to section 553C, a company’s creditors are entitled to a right of set-off where there have been mutual credits, debts or other dealings between an insolvent company that is being wound up and a creditor seeking to have a debt or claim admitted against that company.
The purpose of section 553C is to ascertain what funds are available for distribution to each of the company’s creditors. Where a right of set-off is applicable, only the balance of the account is admissible to proof against the company. Section 553C prevents a creditor of an insolvent company who is also a debtor of that company being required to pay the full amount of the debt owed to the company while being entitled to receive only a portion of the credit owed by the company.
The Courts have held that the following claims are capable of being set-off:
- liquidated damages;
- unliquidated damages;
- secured debts;
- contingent debts; and
- future debts
Section 553 creates a cut-off date for the determination of the debts and claims that can be proved in the winding up. In order for debts to be admissible to proof against the company, the rights of both the company and the creditor must arise out of circumstances that occurred before the “relevant date”, which is defined in section 9 of the Corporations Act as the day on which the winding up is taken to have commenced.
In order for the right of set-off to be available, the requisite mutuality must be established. In Gye v McIntyre  HCA 60, the High Court identified three key aspects of mutuality, being:
- the credits, debts or claims arising from other dealings must be between the same parties;
- the benefit or burden of the credits, debts or claims must lie in the same interests – this means that each party must hold the credit, debt or claim in the same capacity as that party is liable under the other claim; and
- the credits, debts or claims arising from other dealings must be commensurable for the purposes of set-off – that is, they must sound in money. However, they may also be contingent.
The Morton decision
In Metal Manufactures Pty Limited v Morton  HCA 1, the High Court has determined that a liquidator’s claim to recover an unfair preference is not subject to a right of set-off under section 553C of the Corporations Act.
Metal Manufactures Pty Ltd was paid $50,000 and $140,000 by MJ Woodman Electrical Contractors Pty Ltd (MJ Woodman), which was subsequently placed into liquidation. The payments were both made by MJ Woodman within the six-month, relation-back period prior to its winding up. MJ Woodman’s liquidator sought to recover both payments from Metal Manufactures pursuant to section 588FF(1)(a) of the Corporations Act on the basis that each was an unfair preference under section 588FA. However, Metal Manufactures contended that it had a right to set off its potential liability to repay the alleged unfair preferences against a separate debt owed to it pursuant to section 553C.
The issue was referred by the primary judge to the Full Federal Court. The Full Court unanimously held that set off under section 553C was not available to the appellant because mutuality was not met. In particular, the creditor’s debt arose from ‘historical events in the ordinary course of business’ while the creditor’s obligation to pay the unfair preference payments arose from a court order obtained by the liquidator in the exercise of their statutory duties after the ‘relevant date’.
Metal Manufactures appealed the decision to the High Court by special leave, which unanimously held that any liability arising from the Court making an order under section 588FF(1)(a) in relation to voidable transactions was not eligible to be set off against the debt owed to Metal Manufactures. The Court held that section 553C(1) requires that the ‘mutual credits, mutual debts or other mutual dealings” be credits, debts or dealings arising from circumstances that subsisted in some way or form before the commencement of the winding up’.
Immediately before the commencement of the winding up, there was nothing that could be set off as between the appellant and MJ Woodman. There was no mutuality of interest as required by section 553C(1). This was because the company owed money to the appellant, but the appellant owed nothing to the company immediately before the winding up commenced.
The Court relevantly held:
 It follows that the appellant could not identify a relevant mutual dealing. Contrary to its contentions, neither the trade transactions which were undischarged by MJ Woodman during the relation-back period nor, for the reasons already expressed, the discharged trade transactions (giving rise to the liabilities of $50,000 and $140,000), together with the liability which may arise under s 588FF(1)(a), were mutual dealings. Section 553C(1), correctly construed, does not address dealings which straddle the period before and after the commencement of the winding up.
 … under the statutory scheme of liquidation, any liability arising from the making of an order by a court under s 588FF(1)(a) cannot form part of the process for the identification of provable debts and claims for the purposes of s 553, and thus cannot be the subject of a valid set-off against pre-existing amounts owed by the company to the preferred creditor for the purposes of s 553C.
The Court concluded that there had been no dealing between the same persons because, while the liability created under section 588FF(1)(a) was owed to the company, it only arose on the application of the liquidator and not MJ Woodman itself. Further, there was no mutuality of interest because the amount the liquidator would recover from the unfair preference claim could not be seen as being for the benefit of the liquidator. Rather, it was to be made available, amongst other things, for the making of priority payments and for distribution to the company’s creditors in accordance with the pari passu principle.
What is the ‘peak indebtedness rule’?
Australian insolvency practitioners have previously applied the ‘peak indebtedness rule’ to calculate the value of unfair preference claims pursuant to section 588FA(3) of the Corporations Act. Liquidators, by applying the peak indebtedness rule, were able to maximise their assessment of the amount capable of recovery from a creditor by subtracting the debt owed to the creditor from the highest point of the indebtedness during the relevant period.
The peak indebtedness rule is based on the “running account” principle, being that the payments made from a company to a creditor are part of a “continuing business relationship” where the level of the company’s indebtedness to that creditor increases and decreases from time to time as a result of the existence of that relationship.
The Badenoch decision
In Bryan v Badenoch Integrated Logging Pty Ltd  HCA 2, the High Court unanimously settled the question of when the ‘peak indebtedness rule’ may be used. Previously, the Full Federal Court had held liquidators could not use the rule in assessing unfair preference claims. It found the peak indebtedness rule was not a rule that applied under the Corporations Act and that creditors ought to be provided with the benefit of earlier dealings within a continuing business relationship when considering whether creditors have received an unfair preference.
The High Court affirmed the view of the Full Federal Court. A key focus of the Court’s reasoning was the statutory context surrounding section 588FA(3). In short, the ‘peak indebtedness rule’ cannot be applied given its inconsistency with the broader clawback regime for insolvent companies contained in Part 5.7B of the Corporations Act, including:
- section 588FE(2) to (6B), which identify the circumstances when a transaction is voidable. Relevantly, the transaction must have been entered into during the time prescribed by the relevant subsection of the Corporations Act. That is, the transaction must have been entered into during the 6 months (or, if the transaction involves a related entity, the 4 years) ending on the “relation-back day” (the date the liquidation begins or is deemed to have begun) or after the relation-back day but before the day when the winding up actually began (section 588FE); and
- section 588FC, which provides that an insolvent transaction is only an unfair preference if, and only if, the transaction was entered into when the company was insolvent, or the transaction had the effect of causing the company to become insolvent.
The effect of the application of the ‘peak indebtedness rule’ would allow a liquidator to select a starting date for the “continuing business relationship” that was outside of the period prescribed by section 588FE(2) to (6B) or a start date that was prior to the insolvency date. It follows, the High Court found, that incorporating the ‘peak indebtedness rule’ is not possible.
While the High Court accepted that limiting the relevant period in this way might be arbitrary, the effect of which might prevent the liquidator from maximising the potential claw-back from creditors, it reflects a policy choice made by Parliament as to the operation of section 588FA(3) of the Corporations Act.
What you need to know:
Australian insolvency practitioners have long considered that the Court will take a liberal approach to granting an extension to the period in which the second meeting of creditors must be convened under section 439A(6) of the Corporations Act. Indeed, there is ample case law where courts have granted extensions to the convening period, with some extensions even being granted “on the papers”. Out of the 30 judgments published since the beginning of 2022 in respect of applications made to the Federal Court under section 439A(6), only one application has resulted in the Court declining to extend the convening period.
The decision in Frisken, in the matter of Xpress Transport Solutions Pty Ltd (Receivers and Managers Appointed) (Administrator Appointed)  FCA 448 (Frisken) provides insolvency practitioners with a timely reminder that the Court will not just “rubber stamp” an application to extend the convening period in all circumstances and will not exercise its powers under section 439A(6) lightly.
Extensions to convening period
The Courts have jurisdiction to make orders providing for an extension to the convening period under sections 439A(6) and 447A of the Corporations Act. When considering an extension application, the Courts have recognised the need to balance competing considerations that arise from:
- the expectation that an administration will be conducted in a relatively “speedy and summary” manner, typically between 25 and 30 business days (see for example Re Virgin Australia Holdings Ltd (Admins Apptd) (No 2)  FCA 717);
- fulfilling the overall object of Part 5.3A of the Corporations Act, as described in section 435A, to maximise the chances of the company, or as much as possible of its business, continuing in existence or achieving a better result for creditors and shareholders than in an immediate winding up.
Factors relevant to granting an extension
In Re Riviera Group Pty Ltd (admin apptd) (recs and mgrs apptd)  NSWSC 585, Austin J summarised the factors the Court will take into account when deciding an application to extend the convening period. These include:
- the size and scope of the business;
- whether there are substantial offshore activities;
- the complexity of the corporate group structure and intercompany loans;
- the time needed to execute an orderly process for disposal of assets;
- the time needed for thorough assessment of a proposal for a deed of company arrangement;
- whether the extension will allow the sale of the business as a going concern; and
- more generally, whether additional time is likely to enhance the return for unsecured creditors.
Section 439A(8) of the Corporations Act provides that, if the application for an extension is made after the convening period begins, the Court may only grant an extension if it is satisfied doing so would be in the best interests of the creditors.
The Frisken decision
In Frisken, an application was brought by the administrator of six related companies for a section 439A(6) order to extend the convening period for the second creditors’ meeting by around six months. Prior to the administrator’s appointment on 4 April 2023, receivers and managers had been appointed by the companies’ secured creditor. The administrator did not, however, apply to the Court for an extension until 9 May 2023. Without the extension, the time to convene the meeting would have expired on 11 May 2023.
Administrator’s application to extend convening period
Broadly, the administrator viewed that the extension was required and would be in the interests of the companies’ creditors where it would:
- allow for the administration to be conducted in a thorough and orderly fashion;
- permit the receivership to continue, with a clearer position likely to emerge as to the approach to be taken by the receivers;
- allow sufficient time for a DOCA to be proposed by the companies’ director or a third party; and
- allow for further investigations which were said to be required in order properly to provide a complete report to creditors on the future of the companies.
No extension granted
The Federal Court dismissed the application, citing the following:
- the director’s DOCA proposal was highly generalised and unsupported by documentary evidence;
- a six-month extension was a significant extension;
- while not opposed to the application, the receivers viewed that it was unclear whether the extension would benefit creditors in circumstances where the businesses conducted by the companies had been wound down and the DOCA proposal was highly speculative.
The Court was also critical of how the application had been brought, stating:
“To bring the application so late and on such short notice unnecessarily and unfairly undermines the opportunity afforded to stakeholders to seek to oppose the application when they choose to do so. It deprives the Court of the benefit of a properly prepared and instructed contradictor when approaching the balancing task it is required to undertake on an application such as this.”
Frisken is a timely reminder that routine applications by administrators are not simply ‘rubber-stamped’ by courts. The onus is on administrators to demonstrate an extension of time to the convening period is necessary in the circumstances and will not prejudice creditors.
The Court was particularly critical of the lateness of the application and the short notice given to creditors – two days before the convening period was set to expire. While extension applications are often lodged on an urgent basis, courts are not willing to forgo procedural fairness including adequate notice of the application to creditors. Practically speaking, administrators should leave some time between a court hearing an extension application and the end of the convening period so that, if the application is unsuccessful, there is time to write and finalise their report to creditors.
What you need to know:
In BTI 2014 LLC v Sequana SA  UKSC 25 (Sequana), the UK Supreme Court held that, in the context of insolvency, directors owe an obligation to consider the interests of the creditors of a company. This is known as the ‘creditors’ interest duty’, or the West Mercia rule.
Many of the underlying principles in Sequana have been accepted in Australian courts (and were, in fact, derived from those courts’ decisions), but no authority has recognised the duty in Australia. However, Australian courts generally regard company law decisions by superior UK courts as persuasive. The decision is therefore likely to influence future consideration of the existence and content of a ‘creditors’ interest duty’ affecting directors of Australian companies when the issue does come before an Australian court.
Summary of Sequana decision
The Court made several observations about the nature and content of the creditors’ interest duty:
- the duty is enlivened when a company is insolvent or nearing insolvency, or an insolvent liquidation or administration is probable; and
- the weight to be given to creditors’ interests is determined by reference to the extent of the company’s financial difficulties; and
- when the directors’ duty to act in good faith includes acting in the interests of creditors, shareholders are no longer able to authorise or ratify conduct which is in breach of that duty.
Background to Sequana decision
Sequana concerned a company called AWA. In May 2009, AWA’s directors caused AWA to distribute a lawful dividend to its only shareholder, Sequana SA. AWA was solvent at the time, both on a balance sheet and a cash flow basis. However, it had long-term pollution-related contingent liabilities of an uncertain amount which, together with uncertainty as to the value of its insurance portfolio, gave rise to a real risk (but not the probability) of AWA becoming insolvent at an uncertain but not imminent future date.
In October 2018, BTI 2014 LLC (BTI), who was assigned claims of AWA, sought to recover from AWA’s directors an amount equal to the dividend paid almost 10 years prior to Sequana SA. This was on the basis that the decision to make the distribution was in breach of the directors’ duty to AWA’s creditors. AWA’s largest creditor also applied to have the dividend set aside for being a transaction at an undervalue intended to prejudice creditors.
Both claims were heard together by the UK Supreme Court, which decided that:
- the dividend was a transaction at an undervalue intended to prejudice creditors; and
- the directors’ duty to creditors had not been enlivened at the time because AWA had not then been insolvent, nor was future insolvency imminent or probably (although there was a real risk of insolvency).
BTI appealed the second issue. It sought to establish that the common law imposes a duty on directors to considers creditors’ interests prior to insolvency, consistent with section 172(3) of the Companies Act 2006 (UK), which provides that a director’s duty to act in good faith to promote the success of the company is ‘subject to any enactment or rule of law, in certain circumstances, to consider or act in the interests of the creditors of the company’. BTI argued this duty arises in circumstances where the company is solvent and there is a real but not remote risk of it becoming insolvent at some future time.
The Supreme Court unanimously dismissed the appeal. It held the creditors’ interest duty is not enlivened prior to insolvency. Separate reasons were given by most of the judges from which the below principles may be gleaned.
Creditors’ interest duty: key principles
When is the duty enlivened?
Ordinarily, in considering the duty of a director to act in good faith in the interests of the company, the interests of the company are taken to be the interests of its members as a whole. Where a company is insolvent or nearing insolvency, the interests of the company are modified to include the interests of creditors as a whole. This is known as the West Mercia rule.
For the West Mercia rule to arise:
- It must no longer be appropriate to treat the interests of the company as being equivalent only to the interests of the company’s members, when considering economic interests and the distribution of risk.
- There must be some sense of imminence. This will be present where the company is insolvent or nearing insolvency, or if insolvent liquidation or administration is probable. It will not be present if there is only a real but not remote risk of insolvency, or if the company is likely to become insolvent at an undefined point in the future.
Once the duty is enlivened, shareholders no longer have the power to authorise or ratify conduct by the directors in breach of the duty.
Scope and content of the duty
The Supreme Court emphasised that the director’s fiduciary duty to the company is merely modified in an insolvency context where the directors are required to act with regard to the interests of the company’s creditors. It does not interfere with any statutory protections of creditors’ interests.
- The extent to which creditors’ interests are to be considered is based on the seriousness of the company’s financial problems. Initially, creditors’ interests should be considered alongside members’ interests but the weight given to creditors’ interests will increase as the company’s financial problems worsen. Where insolvent liquidation or administration is inevitable, the interests of members cease to bear any weight, and the company’s interests are to be treated as equivalent to the interests of its creditors as a whole.
- Creditors’ interests are to be considered as a whole class, not as a fixed group of individuals.
- Creditors’ interests should be understood by having regard to their prospective interests in the company’s assets and liabilities where a company is insolvent or nearing insolvency. Directors should take these prospective interests of the company, as well as those of its shareholders, into account and seek to prevent them.
Prior to liquidation becoming inevitable, the duty involves the consideration of creditors’ interests, giving them appropriate weight, and balancing them against shareholders’ interests where they may conflict. Determination of that balancing exercise is informed by ‘who risks the greatest damage if the proposed course of action does not succeed’.