You can't always get what you want: Implementing Chapter 11 restructurings involving Australia debtors

It is perhaps a result of Australia's penal colony roots that its corporate insolvency and personal bankruptcy laws have leant more towards punishment rather than salvation. More likely, the lengthy absence of legislative support for a holistic culture of business rescue is simply a function of inheriting traditional English insolvency laws and keeping them for the first 100 years of the Australian Federation. Regardless, there has long been reticence on Australian lawmakers on both sides of the political spectrum to institute a Chapter 11 style regime in Australia or indeed undertake any deep reforms of the corporate insolvency regime.

The thought of having a debtor-in-possession style corporate restructuring regime in Australia has been seen as an anathema. The Financial System Inquiry Interim Report (July 2014) noted that:

"The [FSI] considers adopting [Ch 11] would be costly and could leave control in the hands of those who are often the cause of a company's financial distress."

But, The Financial System Inquiry Final Report (November 2014) highlighted some elements of Chapter 11 that merited further assessment and since the time of that report, change has been afoot. As detailed in this publication over previous editions, several recent legislative changes arising from Australia's National Innovation and Science Agenda (November 2015), such as the introduction of a prohibition against the enforcement of ipso facto clauses in commercial contracts and the 'safe harbour' quasi-defence for insolvent trading, have taken Australian corporate insolvency laws a little closer towards the United States approach. These small, incremental changes have been aimed at encouraging Australian companies to engage earlier and more deeply with solvency issues and to take well-planned and reasonable risks to facilitate a company's recovery.

Adopting concepts from the Bankruptcy Code and tempering old English law principles is a feature of the increasing competition between Anglo and American legal and cultural influences in Australia. It is a phenomenon that has grown since the birth of Australia's modern corporate insolvency regime. It is also a reflection of the internationalisation of Australian businesses. From the cross-border insolvency perspective, the recognition of the globalisation of Australian businesses and the need for a modern approach to provide more effective and efficient mechanisms for dealing with cases of cross-border insolvency began with the adoption of the UNCITRAL Model Law (the "Model Law") through the Cross-Border Insolvency Act 2008 (Cth) (the "CBIA") over 10 years ago.

Australia's trading relationship with the US

The US has long been one of Australia's top three trading partners despite the increasing prominence of Australia's regional Asian trading partners. According to Australian Department of Foreign Affairs and Trade statistics, the US remains Australia's largest two-way services trading partner and the wider trading relationship between the two nations continues to experience growth.

A simple search of Dun & Bradstreet's Business Browser (which relies on publicly available information relating to public companies) can tell you that there are nearly 3000 US companies with an ultimate parent company in Australia. It is not unreasonable to expect that private companies add a multiple to that number.

Coupling this commercial context with the recognition that the US and Australia are two of the more advanced economies to have adopted the Model Law, there appears to be significant possibilities for cross-border insolvencies involving Australia and the US.

While the recent legislative reforms may have inched Australia closer to embracing a culture of corporate rescue, there remain critical challenges in achieving a Chapter 11 reorganisation through recognition of the Chapter 11 case in Australia as a main foreign proceeding.

Chapter 11 vs voluntary administration

A number of those challenges can be explained by the gaps between the debtor protections available through a Chapter 11 filing and the protections that a voluntary administration process affords Australian companies and directors.

The closest equivalent that Australia has to a Chapter 11 restructuring is administration, however it is a stretch to call the processes similar. Where a Chapter 11 is debtor-led, a voluntary administration, although often voluntarily involving existing management and equity holders, is creditor-led. An administrator is typically appointed to an Australian company if the company's board resolves that the company is or is likely to become insolvent. This type of appointment is commonly referred to as a 'voluntary administration' although the Corporations Act 2001 (Cth) (the "Corporations Act") does not expressly use the term 'voluntary' other than in a passing definitional reference.

One similarity between a voluntary administration and with a Chapter 11 restructuring is that the voluntary administration applies a moratorium on creditors taking certain actions against the company during the period of the voluntary administration. But, that stay is at the same time narrower and wider than the automatic stay applying in a Chapter 11 case.

It is well known that upon a Chapter 11 filing an extensive automatic stay against claims enforcement applies to both secured and unsecured creditors and purports to have worldwide operation. The stay provides a period of time in which all judgments, collection activities, foreclosures, and repossessions of property are suspended and may not be pursued by the creditors on any debt or claim that arose before the filing of the bankruptcy petition.

The similarities between a voluntary administration moratorium and a Chapter 11 stay are that the moratorium in each process places a stay on:

• Taking steps to wind-up the company
• Some secured creditors enforcing their security interests
• Lessors or third parties (for example equipment lessors) on retaking possession of lease property or property owned by the third party
• Commencing or continuing court or enforcement proceedings against the company or its property

Where the Chapter 11 automatic stay and voluntary administration moratorium diverge is the treatment of directors and a specific class of secured creditors. The stays under a voluntary administration are narrower than the Chapter 11 stays in respect of secured creditor claims but are wider in the sense that directors are more protected. Secured creditors with security over the whole or substantially the whole of the assets of the company may take enforcement action if they do so within the 'decision period' (a period of 13 business days from the notice of appointment of the administrator) or with consent of the administrator or the Court. Under a voluntary administration the enforcement of personal guarantees provided by directors in respect of the obligations of the company is restricted. These two differences highlight the limitations in seeking recognition of a Chapter 11 case as the exclusive means of effecting a capital restructure of an Australian company with the US as the centre of its main interests.

The Model Law and the CBIA

Under Article 20 of the Model Law (which has the force of law in Australia), upon recognition of a foreign proceeding as a foreign main proceeding, a number of stays apply, including:

• the commencement or continuation of individual actions or individual proceedings concerning the debtor's assets, rights, obligations, or liabilities;
• execution against the debtor's assets; and
• the suspension of the right to transfer, encumber, or otherwise dispose of any assets of the debtor.

Where a Chapter 11 case is recognised as the foreign main proceeding in Australia, the Article 20 stays would, superficially at least, emulate the Chapter 11 automatic stay. But, the Article 20 stay remains subject to Australian laws relating insolvency moratoriums. Relevantly, under the Corporations Act the stays or suspensions are the same as would apply if the stays or suspensions arose under Chapter 5 (other than Parts 5.2 and 5.4A) of the Corporations Act. Chapter 5 of the Corporations Act gives secured creditors with security over the whole or substantially the whole of the assets of a debtor company the ability to enforce their security interests.

In this way, obtaining orders from an Australian court to recognise a Chapter 11 case in respect of an Australian debtor as the foreign main proceeding and the connected stays and suspension may still leave a gap for secured creditors to exploit to enforce their security interests. Secured creditors of Australian companies remain capable of exerting their own agency and can preserve the Australian ethos of creditor-led, rather than debtor-led, corporate restructuring. For an Australian debtor-led Chapter 11 filing, maintaining the effectiveness of the Chapter 11 stays could require separate lock-up arrangements with secured creditors.

This is especially significant where the Australian company is not included as a debtor in the Chapter 11 case.

Directors' risks and protections

Any time that an Australian company faces liquidity issues, Australian insolvency laws can create significant potential liabilities for directors. The Corporations Act contains a particularly severe regime for insolvent trading which is stricter than that of any other nation (with the possible exception of Germany). Directors can become personally liable for the debts incurred, including tax liabilities, by an Australian company that is insolvent. Although the recent reforms mentioned at the top of this article may have provided some comfort for directors to look to trade and preserve value through to a successful restructuring, those reforms were not intended to allow a company to trade beyond the point where it is no longer viable. The application of the Model Law through the CBIA in Australia does not alleviate this risk for a director of an Australian company before it enters administration, but once it is in voluntary administration the risk of liabilities for insolvent trading will cease.

Directors of Australian companies who have provided personal guarantees can also obtain the benefit of a stay on enforcement of those guarantees while the company is in voluntary administration. Such a stay would not apply where the sole basis for a stay is the recognition of a foreign proceeding, such as a Chapter 11 filing.

Directors of Australian companies will therefore continue to experience significant pressure to appoint administrators, even where a Chapter 11 case has been recognised as the main foreign proceeding.

Other limitations

Chapter 11 reorganisation plans will often propose a debt-for-equity swap as part of a capital restructure. An increasingly used mechanism in Australian voluntary administrations is for an administrator of a deed of company arrangement (the key restructuring agreement voted on by creditors during the voluntary administration – akin to a plan of reorganisation) to use section 444GA of the Corporations Act to seek leave of the Court to transfer the ownership of shares in the company.

This power is now being used to effect debt-for-equity swaps and to cram down valueless equity interests.

A limitation of a Chapter 11 reorganisation plan is that a debt-for-equity swap in respect of the Australian company could only be implemented by agreement of all stakeholders or by the application of a voluntary administrator to the Court.

As a result of the treatment of secured creditors and directors under the Australian voluntary administration process, effecting a Chapter 11 reorganisation solely through recognition of the Chapter 11 case in Australia as a foreign main proceeding is problematic. Debtors and creditors may need to look to use the voluntary administration process in conjunction with lock-up arrangements to ensure that directors of Australian companies obtain protection from personal liabilities, secured creditor rights are adequately suspended, and mechanisms to effect debt for equity swaps remain available.