Reshaping the Corporations Act to ensure business survival

Where are we at?

Just three months ago in Australia, anyone using the word ‘crisis’ would generally have been understood to be referring to the devastating summer bushfires.  Climate change risks had become the dominant public focus as businesses and the Commonwealth and state and territory governments faced renewed calls to action.

Now, the COVID-19 pandemic dominates just about every aspect of our lives – both professionally and personally. 

As the pandemic continues to have deep economic, financial and social impacts of a scale few could have imagined mere months ago, governments across the globe have introduced a range of emergency insolvency law reform measures – as well as broader fiscal stimulus and support packages – designed to calm the storm and help as many businesses as possible simply stay afloat until the current supply and demand shocks begin to subside.  

But outside of those legislative amendments, there is also the potential for existing provisions of the Corporations Act to be used to allow companies to adapt flexibly – and make the unpredictable a little more predictable – and thereby maximise the prospect of a successful workout and continued trade on the other side of COVID-19.  

In this post, we consider the nature of those provisions and what they mean for companies, their officers and advisors and insolvency practitioners.  

This post is the first in what will be an insolvency-specific ‘newswire’ series as the regulatory and policy measures continue to evolve globally and the courts also respond to what is expected to be an influx of insolvency cases in the next six months.  

Emergency insolvency reforms – the Commonwealth Treasurer’s intervention power

In Australia, apart from a six month moratorium on insolvent trading liability (applying from 25 March 2020), perhaps the most extraordinary insolvency law reform response – in a climate of itself so inherently extraordinary – is the Commonwealth Treasurer’s ability in new section 1362A of the Corporations Act to modify any provision of that legislation for certain classes of companies if, due to the impact of COVID-19, it is not reasonable to expect compliance or the modification is otherwise necessary to facilitate the continuation of business.

It has already been suggested that the Treasurer may use this power to ease the compliance burden for particular industries, such as health providers and hospitality and tourism operators.  The emergency power may also see a blanket ban on COVID-19 disclosure-related shareholder class actions against companies, an issue we will consider in a separate post in coming weeks. 

But what about flexibility for companies in their unique circumstances?

While wide-ranging and having the potential to alleviate significant financial pressure on companies and directors, the section 1362A power is designed to be used for classes of companies.  Yet the impact of COVID-19 on the specific operations of companies and their resources varies enormously.  

The question is then how existing insolvency laws could be adapted to accommodate for circumstances unique to individual companies.  

Apart from informal negotiations and relaxations with regulators, the two ‘hidden gems’ in the Corporations Act that distressed companies should consider are section 447A of the Corporations Act and section 90-15 of the Insolvency Practice Schedule (IPS) included in Schedule 2 of the legislation.  

Those provisions are broadly similar, but while both contemplate the court modifying how the express voluntary administration provisions in Part 5.3A of the Corporations Act apply to a particular company, section 90-15 of the IPS is cast in terms of the court making any order it sees fit ‘in relation to’ the external administration of a company.  

Potentially, this could allow the court to interfere with the substantive rights of secured creditors, owners, parent entities and other parties when those rights are not otherwise expressly mentioned in a specific provision of Part 5.3A (on the other hand, such express provision would be a mandatory precondition for the section 447A power to arise).  

The possibilities imagined – Re CBCH Group

We saw the first post COVID-19 application under those provisions in the Federal Court’s decision this month in Re CBCH Group Pty Ltd (No 2) [2020] FCA 472.   

In that case, administrators had been appointed to a group of mid-market bag, jewellery and accessories retailers in January before the COVID-19 crisis hit.  Up until 8 March, sales were exceeding targets and a successful restructure seemed likely.  However, with the onset of COVID-19, sales fell by more than 50% in just a week and all stores across the group were closed another week later.  

The administrators put evidence before the Court that they considered it would be in the best interests of creditors for the companies to engage in a two month period of ‘mothballing’, during which the companies would continue to have an online sale presence while scaling back all other operations, before a gradual reopening of stores and a resumption of trade while a sale process was conducted to keep the business intact. 

Markovic J made orders excluding the personal liability of the administrators that would ordinarily apply under section 443B(2) of the Corporations Act for post-appointment rental payments (beyond the indemnity available from the company’s assets) for an additional two week period.  The administrators were also excused from having to cause the company to itself meet the rental payments in that period, giving them comfort against a possible claim of unreasonable or improper conduct in future. 

In making the orders, the key factor for Markovic J was the overriding primary purpose of the voluntary administration process in Part 5.3A of the Corporations Act (as provided for in section 435A) to maximise the chance of an insolvent company, or as much as possible of its business, continuing in existence. 

Even though the orders had the effect of depriving the commercial landlords of the benefit of the rental payments, the orders enabled the administrators to explore the mothballing strategy while avoiding substantial depletion of cash reserves across the group (to the value of almost $650,000 in rental payments) and in any event it was unlikely the landlords would have been able to secure another tenant, and replacement rental income, for the two week period.  

Limiting the orders to two weeks was designed to give the administrators sufficient breathing room to continue their investigations while also allowing impending mandatory commercial tenancy reforms to come into effect (at the time of writing, eviction moratoria, mandatory negotiation procedures and land tax relief incentives to encourage landlords to waive and/or reduce rents for commercial tenants are currently being legislated by the states and territories).

Of particular note in Re CBCH Group, Markovic J emphasised that, in the difficult and unpredictable circumstances all businesses now face during the COVID-19 pandemic, it is necessary for administrators to have flexibility to assess and respond to ‘the ever-changing physical, legal and economic impacts’ of the pandemic.  COVID-19 was said to be truly ‘extraordinary’ and ‘brought about entirely by external factors’, not the fault of the administrators or reflective of the group’s underlying business in the case at hand.

While a mothballing strategy was not guaranteed to save the business, the administrators should at least have the chance to consider it because if successful, it would secure the best interests of all creditors, and indeed the landlords due to the prospect of a revived tenant continuing in occupation and resuming full rental payments in due course.  

Markovic J was clear that, during COVID-19, courts must respond to the reality that administrators ‘need to be agile and able to react to the interests of a number of stakeholders’. 

Just how far could section 447A and section 90-15 of the IPS extend in a COVID-19 world?

The decision in Re CBCH Group is significant in demonstrating the ability of these provisions to be used to impact on substantive ownership rights as part of the ‘trade off’ of trying to ensure businesses can survive in the interests of a much broader group of stakeholders deeply impacted by the COVID-19 pandemic – from employees to small suppliers and other creditors, customers and the broader community.  

That said, the two week period applying under the orders in Re CBCH Group is restrained and the decision should not be overblown.  

Whether the courts will be prepared to use section 447A and section 90-15 of the IPS to modify Part 5.3A of the Corporations Act in a more extensive manner – potentially through a mandatory moratorium and cram-down on the rights of all creditors, whether secured or not, and the adoption of other features of the debtor-in-possession model under Chapter 11 of the United States Bankruptcy Code, remains to be seen.  

But if the easing of social restrictions is delayed, and the economic and financial situation worsens, the courts may respond to a true crisis situation to give companies the flexibility needed to have at least some prospect of survival. 

The takeaway

This is a critical area for companies, directors, management, insolvency practitioners and professional advisors alike to continue to stay on top of in the months ahead.  Section 447A of the Corporations Act and section 90-15 of the IPS will continue to be tested by administrators and the prospect of large-scale structural modifications to the operation of Part 5.3A – which in turn will spark a renewed post COVID-19 push to adopt permanent legislative changes drawing on the Chapter 11 process – provide not just a mere hope or wish but rather a tangible legal option for businesses being able to emerge from the crisis and slowly recover their trade as supply and demand chains return to normal.