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) (the “Corporations Act”) or their company constitution.
Whilst it is not unusual for financially distressed companies to grapple with matters of corporate governance, issues present where these matters permeate the ability of directors to appoint a voluntary administrator, or call into question the validity of such an appointment. Critically, directors of financially distressed companies may be unable to assemble the necessary quorum to pass a resolution to appoint a voluntary administrator. The risk of being stuck with an inquorate board is especially real for directors of distressed companies in Australia, given the tendency of directors to resign when a company becomes financially stressed, as well as the recent introduction to the Corporations Act of a provision that voids a director’s resignation if the company does not have at least one director at the end of the day.
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 composition 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 begins to materialise, boards of directors may consider whether their constitution contains emergency provisions or whether any amendments are needed to allow for greater flexibility in responding to distress.
How does a company ordinarily appoint a voluntary administrator?
Section 436A of the Corporations Act provides that a company may by a voluntary administrator if the board has resolved to the effect 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 own 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 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 also sets out its own requirements for the number and composition of directors: a proprietary company must have at least one director who is an Australian resident, while public companies must have at least three directors (excluding alternate directors), of whom two must be Australian residents.
What’s the risk of having too few directors?
A company may be unable to effectively appoint an administrator under section 436A of the Corporations Act (or their appointment may be vulnerable to challenge) in circumstances such as where:
- a quorum cannot be assembled due to the resignation or flight of a director;
- 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 due to the resignation of a director.
What is an emergency power provision?
Some company constitutions include provisions that alter the process and composition of the board of directors required for certain limited purposes. 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 falls below the minimum number fixed in the constitution.
An important advantage of emergency power provisions is that, even where the number of directors of a company falls below the minimum number of directors (or Australian resident directions) required by the Corporations Act, the appointment of a voluntary administrator may still be valid if it meets the requirements of the company constitution.
What constitutes an emergency?
It is established that where the level of financial distress of a company is expected to result in insolvency, it is an “emergency” for the purposes of an emergency powers provision in a company constitution. In Re HPI Australia Pty Ltd, 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?
Where the company constitution does not contain emergency powers provisions, hamstrung directors may need to approach the Court for assistance. Indeed, the Court may make an order under sections 447A or 1322(4) of the Corporations Act to cure the defects in the appointment of a voluntary administrator.
Section 447A empowers the Court to make such orders as it thinks appropriate about how Part 5.3A is to operate in relation to a particular company, while section 1322(4) 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 constitution.
The Courts have tended to prefer section 447A as the source of power to make such an order, due to the wide discretion it confers. In Hayes v Doran (No 2), Kenneth Martin J summarised the relevant principles in relation to the exercise of the power conferred by section 447A, including:
- whether the purposes of the Part 5.3A of the Corporations Act 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 of making the order 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), in which Gilbert + Tobin acted for Matthew Hutton and Rob Smith of McGrathNicol in their capacity as joint and several administrators of Big Village Australia Pty Ltd. In that case, the administrators sought orders under section 447A to dispel any uncertainty about whether they were validly appointed. In the months preceding their appointment, all but one of the company’s directors resigned. 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; and
- prior to passing the resolution to appoint administrators, the last remaining director resigned in accordance with the company’s constitution. Under the terms of the company’s constitution, this left the position of director vacant. However, the director later satisfied herself that her resignation was ineffective given the operation of s 203AB of the Corporations Act.
Justice Anderson of the Federal Court gave orders that the Corporations Act was to operate as though the administrators were validly appointed as joint and several administrators of the company. Relevantly, his Honour held in respect of the aforementioned issues:
- the better view appears to be that the fact a company has breached s 201A(1) does not affect the ability of the company to function (subject to the provisions of its constitution), and therefore does not affect its ability to appoint an administrator under s 436A of the Act; and
- [section 203AB] 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.