The continued role of the Australian judiciary in shaping voluntary administration processes during the COVID 19 pandemic

This article is the second in a series of articles reflecting upon the evolving judicial role in Australian voluntary administrations during the COVID-19 pandemic.¹ Legislative responses globally to the COVID-19 pandemic in the context of voluntary administrations have been well documented. However, in Australia the judiciary has also played a significant role in shaping voluntary administration processes to ensure those processes take into account the unique circumstances and remain a viable option for companies during the COVID-19 pandemic. This article explores some of the most significant developments in this respect, and compares the responses of Australian courts with those in the United States.

Introduction

Voluntary administration is the most common form of corporate reorganisation in Australia. Part 5.3A of the Corporations Act 2001 (Cth) (Act) contains the main provisions dealing with voluntary administrations. Voluntary administration is intended to provide a fast, flexible and relatively inexpensive procedure designed to be able to reach a variety of outcomes that align with its primary purpose—maximising the chances of the company or its business continuing in existence or, if that is not possible, to obtain a better return for the company's creditors and members than would be achieved by an immediate winding up of the company.

When a company enters voluntary administration, an administrator (being an insolvency professional) takes control of the company and its business. The administrator also becomes personally liable for the debts the company incurs during the voluntary administration period. As a result, where the assets of the company are (or may become) insufficient to meet future debts, the likelihood of the company continuing to trade and operate as a going concern is greatly diminished.

Australian Courts do not play a direct role in the commencement of, or decision making process during, a voluntary administration. Rather, the Courts typically play a benign supervisory role in the process. Nevertheless, in this supervisory role the Courts do have wide ranging powers under section 447A of the Act and section 90-15 of the Insolvency Practice Schedule (Corporations) being Schedule 2 to the Act (IPSC) to shape the operation of Part 5.3A and to give effect to its objectives. Under these provisions, a voluntary administrator is permitted to seek orders from the Court limiting or excluding their liability for debts incurred or any other obligations that may apply during a voluntary administration.

Historically, and reflective of their supervisory role, Australian Courts have taken a cautious approach in relieving voluntary administrators of their obligations under Part 5.3A - ensuring the legislative framework is not altered in a fundamental way. However, the COVID-19 pandemic has imposed unprecedented challenges on legislators, businesses and the economy on a global scale. Accordingly, it is unsurprising that the Courts have demonstrated a willingness to respond to those challenges in a more proactive manner.

The Q2/Q3 2020 Newswire article "Voluntary administration and the evolving judicial approach to the reallocation of financial risk in the face of COVID-19" explored the approaches taken by Australian Courts in relieving administrators of personal liability for payment of rent and the deferral of rent. This article explores the broader role the Australian judiciary has played in shaping the voluntary administration process throughout the COVID-19 pandemic and compares this approach to that taken by some companies that commence a voluntary petition under Chapter 11 of the United States Bankruptcy Code.

Relief against personal liability: The Virgin Group administration

One of the features of Australian administrations is that the administrators are personally liable for post-administration operating costs and debts to the extent not paid by the estate. This obviously has an impact on the extent to which an administrator will operate the debtor's business.

Section 447A of the Act, however, gives the Courts the power to make any such orders as it thinks appropriate about how Part 5.3A is to operate in relation to a particular company. Similarly, s 90-15 of the IPSC affords the Court powers to make any such orders as it thinks fit in relation to the voluntary administration of a company. In making orders under these provisions, the Courts' main considerations are the overall objectives of Part 5.3A and, in particular, what is in the best interest of creditors.

One of the first, and arguably the most complex, matters to come before the Australian Courts so far in the COVID-19 pandemic was a series of applications made by the voluntary administrators of the Virgin Australia Airlines Group (Virgin Group). The Virgin Group administration provides an example of the way the Courts are flexible in applying the legislative provisions governing the voluntary administration process during the pandemic.

The Virgin Group is one of two national airlines that operates a domestic and international passenger and cargo airline business and, at the time of its administration, employed approximately 10,000 personnel nationally and operated 114 aircraft.

The voluntary administrators advised the Court that the COVID-19 pandemic had, and was continuing to have, considerable adverse effects on the Virgin Group's revenue. Although the voluntary administrators desired to continue to trade on a 'business as usual' basis in an effort to sell the business or recapitalise it, it was likely that the Virgin Group would continue to generate losses throughout the administration period while state and federal restrictions introduced in response to COVID-19 remained in place.

At the date of the voluntary administrators' appointment, the Virgin Group had entered into more than 1,330 contracts with approximately 500 unique suppliers, which triggered the administrators' personal liability under the Act. In order to insulate themselves from personal liability while pursuing a course of action that, in their view, was in the best interest of creditors, the voluntary administrators sought orders, described by the Court as "extraordinary", to limit their personal liability for debts incurred in respect of the following arrangements:

1. an agreement entered into with an individual customer regarding specific charter flights to be provided to that customer;
2. intercompany loans between various entities within the Virgin Group;
3. the Commonwealth government's wage subsidy program (known as "Jobkeeper"); and
4. future arrangements entered into/adopted by the voluntary administrators in connection with the maintenance of the operation of the Virgin Group's business (Future Arrangements).²

The granting of the orders in relation to categories 1 to 3 above was largely uncontroversial given:

• that the relevant individual customer had agreed to the voluntary administrators' proposal;
• the administrators agreed to ensure proper accounting and reconciliation of the financial records of the applicable Virgin Group entities; and
• the Court recognised that in the absence of the ongoing wage subsidies being on paid to employees, those employee creditors would suffer considerable hardship.

However, the orders sought in respect of the Future Arrangements tested the boundaries of the Court's willingness to intervene. Here, the voluntary administrators gave the following reasons supporting their position that the orders ought to be granted:

• the voluntary administrators wished to enter into/adopt the Future Arrangements to facilitate the ongoing trading of the business (and its possible expansion);
• the entry into such arrangements was consistent with the objective of selling or recapitalising the business as a going concern in the best interests of all creditors;
• a counterparty's entry in any arrangement would be entirely voluntary;
• if the voluntary administrators were exposed to personal liability under the Future Arrangements, then it was unlikely they would adopt them; and
• if operating the business was not possible, the practicalities, costs and time associated with a new owner sourcing new counterparties and negotiating agreements with them at a future date would make a sale of the Virgin Group's business as a going concern impractical.

Notably in the first application brought before the Court by the Virgin Group's voluntary administrators, the Court made the following statement:

"The COVID-19 pandemic is causing great disruption to the whole Australian community and the economy. Nevertheless, existing laws that are made or authorised by Federal or State Parliaments must be adhered to and enforced by the courts. However, the COVID-19 pandemic, and the consequent restrictions on the movement and behaviour of people, is a reason to apply flexibility in the application (and perhaps adaptation) of existing laws, and to exercise any discretion residing in a court to ensure that the Australian community and economy are supported during this time of crisis."³

It was against this background that the Court granted the orders sought by the Virgin Group's voluntary administrators. In reaching its decision the Court noted that its main concern was to consider the best interest of creditors. However, the Court also took into account the following factors:

• the particular circumstances confronting the voluntary administrators and the uncertainty that arose from the COVID-19 pandemic;
• the national interest, since the Virgin Group was one of two national airlines and employed thousands of people whose lives had been dramatically impacted by the Virgin Group entering into voluntary administration; and
• the ability of the Virgin Group's suppliers to continue to receive revenue if arrangements were adopted by the voluntary administrators (thereby further supporting those businesses and the Australian economy generally).

Given the AU$3.5b sale of the Virgin Group (described by its administrators as being "like no other in Australian corporate history"⁴) completed in November 2020, it is difficult to argue that the Court erred in limiting the voluntary administrators' personal liability which, in turn, facilitated the sale. Rather, in the novel circumstances faced by the voluntary administrators, the orders fell squarely within the flexible nature, and overall objective, of the voluntary administration process.

Practical assistance during COVID-19

The voluntary administrators of the Virgin Group also relied upon the Court to provide practical assistance with fulfilling their obligations under part 5.3A of the Act throughout the pandemic.

For example, prior to COVID-19, creditor meetings under Part 5.3A required in person attendance, and the Court had not considered the validity of virtual meetings. During the Virgin Group administration, however, Virgin Group's voluntary administrators sought orders to enable all creditors' meetings to be conducted solely by video-link or telephone (rather than in person). The Court found that there was no practical impediment to creditors' meetings being held by electronic means and it was appropriate (if not necessary) that this occur in the current environment.

Shortly thereafter, various temporary measures were introduced by the federal government to enable voluntary administrators to conduct meetings of creditors electronically. However, the decision in Re Grocon Pty Ltd (admins apptd) (No 1)⁵ (Grocon) highlighted that there remained a number of legislative requirements relating to creditors' meetings that had not been modified by these temporary measures. These requirements related to the conduct of virtual meetings, communications to and from creditors, participation in virtual meetings and the provision of notices. As occurred in the Virgin administration, the Court in Grocon relieved the voluntary administrators of their obligation to strictly adhere to these legislative requirements instead adopting the alternative processes put forward by Grocon's administrators.

Following the Courts' decisions in the Virgin Group administration and in Grocon, the Act has recently been amended to embrace the use of technology by external administrators previously supported by the Courts. These amendments permanently:

• expand the situations in which documents relating to the voluntary administration of a company may be given electronically;
• permit persons to sign documents relating to the voluntary administration of a company electronically; and
• allow meetings to be held virtually (or a hybrid virtual/in person model).

Comparison with the United States

The Court's decisions in relation to the Virgin Group administration, as well as other subsequent cases, demonstrate that Australian Courts are willing to embrace the flexibility of the voluntary administration process and support innovative measures proposed by voluntary administrators as long as they are in the best interest of creditors. Further, the decisions reinforced the Courts' longstanding view that there is a public interest in not permitting voluntary administration to continue for lengthy periods of time and, as such, there ought to be an efficient and timely progression of the voluntary administration as far as circumstances permit.

Various companies in Chapter 11, such as Modell's Sporting Goods, Inc., Pier 1 Imports, Inc. and CraftWorks Parent, LLC, requested Bankruptcy Courts to temporarily suspend their Chapter 11 proceedings, to accommodate the suspension or "mothballing" of their business operations during COVID-19.

Following the introduction of COVID-19 restrictions such as the shutdown of non-essential businesses and the impact of local and global supply chain disruptions, companies in Chapter 11 faced the risk of expenses continuing to accrue at the same time as a drastic reduction in revenue and, consequently, the potential elimination of hope for a successful reorganisation under Chapter 11.

Accordingly, some companies relied on a previously seldom used provision of the Bankruptcy Code, being section 305(a), which affords US Bankruptcy Courts powers to suspend all proceedings if it is in the interests of creditors and the debtor.

The granting of these "mothballing" orders restricts the ability of creditors to seek disruptive relief against the debtor company and its assets and otherwise suspends payment of noncritical expenses for a period of time set down by the Court. The objective of these orders is to preserve value in the business for all stakeholders. In making these orders, the Courts acknowledge creditors' arguments that such orders frustrate the purpose of Chapter 11 proceedings, but on numerous occasions have ultimately found that a going concern sale or an orderly business wind down is a far superior outcome than a chaotic "free-for-all" that could ensue if the Bankruptcy Courts do not grant the suspension orders sought.

The benefits of "mothballing" orders can be seen by CraftWorks' announcement of a deal for a semi-private sale described by the Court as a "welcome prospect"⁶ in the midst of the COVID-19 crisis.

The cases highlighted in this article illustrate that Australian and US Courts are willing to exercise their discretionary powers to strike a balance between strictly enforcing corporate insolvency/bankruptcy laws and obligations against the stark reality of the ongoing impact of the COVID-19 pandemic.

Limitation on orders available under section 447A

It is important to note, however, that although the powers afforded to the Australian Courts under s 447A of the Act are wide, they are not without limitation. Such limitations were apparent in the recent decision of Kipoi Holdings Mauritius Ltd v Tiger Resources (Subject to DOCA)⁷ (Tiger). Tiger involved a dispute relating to competing deed of company arrangement (DOCA) proposals put forward by the plaintiff (KHML) and another company (YYT) in respect of Tiger Resources' administration. During the administration, the requisite majority of creditors voted for YYT's DOCA proposal. KHML applied to the Court seeking orders to have, among other things, YYT's DOCA proposal set aside. KHML sought to rely, in part, on s 447A of the Act as the basis for the Court's power to grant the orders it sought. YYT submitted to the Court that one limitation on the Court's powers under s 447A was that "rights that have accrued before the date of the proposed 447A order may render orders that are inconsistent with those rights either without power or outside the permissible exercise of the court's discretion."⁸

The Court found that there was "considerable force in YYT's argument."⁹ The Court noted that significant steps had been taken by YYT, the administrators and Tiger Resources' unsecured creditors since YYT's DOCA had been entered into. These steps included the creation of a creditors' trust and the payment of funds into that trust. The Court ultimately held that its power under s 447A was not sufficient to order the unwinding of the creditors' trust. In so finding, the Court observed that an order unwinding the creditors' trust would be tantamount to an order to "unscramble the egg."¹⁰

The Court therefore acknowledged an important limit on its otherwise broad powers under s 447A of the Act, being that proposed s 447A orders interfering with rights accruing prior to the date of the proposed orders may be impermissible.

Conclusion

Despite a large number of support measures introduced by both state and federal governments to support business survival no longer being available, including in relation to rental relief, employee wage subsidies and supplemental insolvent trading protection for directors, the reality is that the COVID-19 pandemic is ongoing in many regions. Accordingly, it may only be a matter of time before the Australian courts are again asked to exercise their broad discretion to assist voluntary administrators in achieving the objectives of Part 5.3A and to otherwise support the Australian community and economy, including by flexibly applying their powers under s 447A in novel ways.

Moreover, with the federal government recently announcing a number of reviews into Australia's insolvency laws (only several months after introducing the most significant reforms to Australia's corporate insolvency regime in almost 30 years¹¹) it is clear that Australia's corporate insolvency framework remains very much an evolving landscape.

The authors gratefully acknowledge the assistance of Nakita Wilkinson and Will Nelson, lawyers in the firm's Australian financial restructuring and insolvency group, for their invaluable assistance in preparing this article.