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Focus: Court approves a creditors' trust

15 July 2011

In brief: The NSW Supreme Court has recently authorised administrators to recommend a deed of company arrangement involving a creditors' trust to creditors, despite the Australian Securities and Investments Commission's published objections to these arrangements. Partner Michael Quinlan (view CV) and Lawyer David Harris report.

How does it affect you?

  • This decision, Re Bevillesta Pty Ltd (in voluntary administration)1 , shows that, despite the objections of the Australian Securities and Investments Commission (ASIC) to the use of creditors' trusts as having the potential to subvert the statutory protections of the Corporations Act 2001 (Cth) (the Act)2 , the courts are still willing to approve their use in certain circumstances.
  • Administrators are able to present potentially risky proposals to creditors, such as the use of creditors' trusts, as long as the creditors are fully informed of the risks involved in the proposal.
  • The courts are more likely to approve these arrangements in a situation where the creditors stand little to no chance of otherwise receiving any return in the event of liquidation.

Background

Bevillesta Pty Ltd (the Company) is the registered proprietor of the land where the Top Ryde Shopping Centre is located. In February 2011, administrators were appointed to the Company. On the same day, receivers were appointed to the Company under a fixed and floating charge with a syndicated group of banks.

The administrators approached the NSW Supreme Court for directions under section 447A of the Act that they would be justified in presenting a deed of company arrangement (DOCA) and associated trust deed at a meeting of creditors of the Company, and recommending to the creditors that it would be in their interests for the Company to execute the DOCA and trust deed.

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Creditors' trust

A creditors' trust involves an arrangement whereby the creditors agree in a DOCA to relinquish their rights and claims against the company in exchange for becoming beneficiaries under a newly created trust. The company and/or a third party promise to transfer property to the trustee, which is then used to pay out the creditors' claims against the company in part or in whole. Under a creditors' trust, the trustee assumes the obligation to pay out the creditors from a trust fund and the company is no longer burdened by the released debts. Typically, on execution of the DOCA and trust deed, the DOCA will terminate and the company will return to the control of the directors.

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The proposal

In this case, the administrators submitted to the court that the Company had no assets beyond those secured by the charge to the chargeholders, and that they had not identified any voidable transaction or insolvent trading claims of value. The result of this was that there would be no surplus funds for the unsecured creditors in the event of liquidation.

By contrast, based on an estimate of the Company's indebtedness, the proposed DOCA and creditors' trust would result in the unsecured creditors receiving close to 100c in the dollar. Under the proposal, the unsecured creditors would relinquish their rights against the Company in exchange for becoming beneficiaries under the newly created trust, under which they would prove their claims and share in the distributions. Meanwhile, the Company would be left to continue in receivership, owing only the secured debts, and no longer in voluntary administration or subject to a DOCA.

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ASIC guidelines

ASIC has issued regulatory guidelines that are critical of DOCAs involving a creditors' trust. These guidelines highlight the risks to creditors of the proposal and explain that, in ASIC's view:

it is likely to be abuse of Part 5.3A or otherwise contrary to the public interest for a DOCA to involve a creditors' trust where... there is no proper and compelling legal or commercial reason why the continued existence of the company or its business could not be achieved under a DOCA that does not involve a creditors' trust.

ASIC appeared as an intervener, claiming that the proposal constituted an abuse of Part 5.3A of the Act. It submitted that the proposal undermined the policy of the Act, by moving the creditors away from the protection of a statutory regime governing DOCAs, which contains various procedures to safeguard creditors. ASIC also submitted that there was no 'compelling' commercial or legal reason for the proposal to be implemented.

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The decision

Chief Justice Bergin disagreed with ASIC's submissions that the proposal was an abuse of Part 5.3A. Her Honour noted that the administrators had an obligation to make the creditors aware of the special risks that were inherent in the proposal. However, she was satisfied from reviewing the documentation the administrators had prepared that the administrators had satisfied the heavy burden of explaining these implications to the creditors, including the differences between the statutory protections and the proposal contained in the DOCA and trust deed.

Chief Justice Bergin also held that, so long as there is a 'sound', but not necessarily 'compelling' (as ASIC had submitted), reason to adopt the proposal, then the administrators would be justified in putting it to the creditors. Her Honour explained that it would not be an abuse of Part 5.3A for the creditors to adopt a 'risky' proposal, provided that they did so with informed consent. The fact that the creditors stood a chance of receiving some returns under the proposed trust regime, whereas they stood no chance of receiving anything under the liquidation regime, was held to be a sound reason to adopt the proposal.

Accordingly, the court made the orders sought by the administrators, who recommended the DOCA and creditors' trust to the Company's creditors.

The creditors subsequently voted in favour of the DOCA and creditors' trust at the second creditors' meeting, held on 8 July.

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Conclusion

This case shows that, as long as the risks of a DOCA involving a creditors' trust are fully explained to creditors, administrators can recommend a DOCA featuring such a trust where the proposal will produce a better result than will a liquidation. This is so even where the proponents of the DOCA and creditors' trust do not explain the reasons why their proposal includes such a trust.

Footnotes
  1. [2011] NSWSC 417.
  2. ASIC Regulatory Guide 82, 'External Administration: Deeds of company arrangement involving a creditors' trust: A guide for registered liquidators appointed under Part 5.3A' (May 2005).

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