Some years ago it became fashionable to avoid statutory protections of the Deed of Company Arrangement provisions of Part 5.3A, by resolving to enter into a DOCA which would immediately terminate and be replaced with a trust, extinguishing creditors’ claims in the VA/DOCA procedure and replacing them with claims as beneficiaries to the like extent against a trust fund, which would comprise of any company assets and often, some funding by a director or third party. Described by one judge as ‘ingenious’, it certainly was not envisaged that this would be permitted or even necessary, given the flexibility of Part 5.3A to achieve an arrangement which would further the objectives set out in s435A. Worrying, and open to abuse, were other phrases that sprang to mind, and which were used by ASIC when it was sufficiently concerned to issue specific guidelines in 2005 about the use of creditors’ trusts (RG 82, May 2005).
The ASIC Guidelines opine that it would be rarely appropriate for such a route to be adopted, since a DOCA could usually achieve the same objectives, and that it would amount to abuse if, for example, a creditors trust was used in order to facilitate return of an insolvent company to its directors to continue trading. Once the DOCA terminates, there is no need to advertise the company as subject to a DOCA (see s450E, subject of our AMI Blog). Also, many other protections which creditors have to apply to court, and to terminate the DOCA for default and resolve to liquidate the company, do not apply once the DOCA has terminated. As beneficiaries of a trust, the [former] creditors do have some rights under trust law, and of course the trustee is a fiduciary, but depending on the terms of the trust deed, they are unlikely to have the same security of payment of their agreed dividends, or the same rights if they are not paid, and there is a real danger that in resolving for the creditors trust, creditors will not be fully informed of this erosion of their rights.
Nevertheless, the ASIC Guidelines do not say that creditors trusts are unlawful, and they acknowledge that they are not always an abuse. ASIC considers that s435A does not, despite its width, always justify use of a creditors trust mechanism as consistent with the objects of Part 5.3A. They consider that a trust would not be appropriate if it was inconsistent with the public interest, or if there was no sound and compelling reason for using a trust rather than a DOCA.
Creditors trusts have proved attractive as enabling a company to trade in the company name free from the DOCA tag, and have proved a way of achieving a backdoor listing on the ASX. They enjoyed some popularity in Western Australia in the mining sector in more recent years.
However, in Parkview Constructions Pty Ltd v Tayeh [2009] NSWSC 186, Barrett J expressed reservations, endorsing the cautious approach of the ASIC guidelines. In that case he could not see any need for use of the trust rather than the DOCA. He said that the administrators would have a ‘heavy burden’ of explaining to creditors why a creditors trust was needed. The ASIC guidelines state that they would consider disciplinary action against administrators who did not discharge that burden.
Now Bergin CJ in Eq, in Bevillesta Pty Ltd (In Voluntary Administration)[2011]NSWSC 417, 10 June 2011, has taken what might be described as a more liberal view of creditors trusts. Ultimately, she did so by concluding that the ASIC Guidelines had interpreted the law too strictly by requiring a ‘compelling’ commercial reason before allowing a trust in a VA. In fact, in this case, the administrators went carefully through the ASIC Guidelines in their report to creditors, and specifically stated that they could not find a compelling reason, but that they nevertheless found that, despite being ‘very risky’, the trust proposal was in the best interests of creditors. ASIC intervened in the proceedings, and seemed to have mistakenly argued that the administrators, who had applied to court for directions, should not have done so. Given that ASIC’s own guidelines encourage such applications, as the judge pointed out, the administrators could not be criticised here for bringing the application, given that the professional consequences threatened in the ASIC Guidelines. If anything, the judge was impliedly critical of ASIC, who were ‘amicus curiae’ but not very friendly, more adversarial in their stance here.
Not only could the administrators not be criticised for bringing the application for directions, they could not be faulted for compliance with the ASIC Guidelines, in that they explained to creditors in painstaking detail the relative advantages and disadvantages of their rights and remedies, as far as they could tell, in a creditors trust compared to a DOCA, and they explicitly warned them that there was no guarantee that the funder would provide the ‘top up’ funds which might lead to the promised 100% payment of unsecured creditors. In this case, the Funder rejected several of the amendments proposed by ASIC and the administrators. In particular, if the company should go into liquidation or the trust deed terminate by resolution of the beneficiaries, the funder was entitled to be repaid amounts it had paid into the trust fund to that point. There would be no such right within the DOCA regime. A reading of the s439A report extracts suggests that the administrators are no fan of creditors trusts as a rule.
Ultimately, commercially the administrators recommended it because there was a chance, albeit one fraught with risks, that creditors would get something, possibly, though with no security promised, 100%, as against a nil dividend on liquidation, and something in between in various DOCA scenarios. This deal was being presented as a take-it-or-leave-it deal by the Funder, which was promising to put in 2.5 million if it could be done through the trust. And what was the reason, sound, compelling or otherwise, why this had to be done through a trust? As far as the judge could ascertain from counsel, the company wished to ‘clean up its balance sheet and remove some creditors’.
Bergin CJ concluded that, absent any clear evidence of insolvent trading, a sound commercial reason put forward by the administrators, who would have to comply with the ASIC guidelines as far as disclosure to creditors was concerned, would not amount to abuse of Part 5.3A. In this case the administrators had discharged the ‘heavy burden’ which she seemed to agree with Barrett J, had to be discharged.
“Where the creditors stand a chance of receiving something under a structure that is somewhat controversial and prima facie unsafe, but nothing under a structure which is conventional (liquidation) there seems to be a commercial reason that may present as compelling and if not certainly sound.”
Comment:
ASIC are right to be concerned about creditors trusts. They avoid the mechanisms put in place to protect creditors, and to some extent, the public interest, in Part 5.3A. Like pre-packs, they were never envisaged by the legislature, and little thought has been given into their impact. Creditors trusts certainly lend themselves to abuse. Administrators must surely be on their guard as to why directors or others are pushing this route, particularly if it is a dealbreaker. Starting from a position of scepticism might reflect the view of ASIC and Barrett J. However, in this particular case, the administrators’ report was almost a model of perfection, and certainly few of those creditors could be said to be under any illusions about the risks, it was a case of caveat emptor. The risks of abuse of Part 5.3A by directors is not down to creditors trusts alone, and not foreign to DOCAs. DOCAs still enable companies to be returned to the directors in circumstances where they fly under the radar of a liquidator’s scrutiny in relation to insolvent trading or voidable transactions. That is the price we pay for allowing in s435A, the survival of a company or its business in the interests of creditors, or a better return than on a liquidation.
However, should we be endorsing opportunities for contracting out of the protections in Part 5.3A and for possible abuse? Should we permit Part 5.3A to be substituted with trust law, including State-based Trustee Acts which do not offer the same protections to beneficiaries as DOCAs do to creditors.
More work needs to be done on whether creditors trusts are lawful within Part 5.3A, whether the ASIC guidelines are sufficient protection, the lack of supervision and regulation of trustees once the DOCA has terminated, and whether trust law can protect beneficiaries(creditors). Ultimately, even if Bergin CJ’s position reflects a plausible interpretation of the law, and reflects the exemplary nature of the administrators’ report here, the question should be whether these trusts should be outlawed in a VA situation.
Until that question is decided, we should all maintain the approach of caveat emptor, rather than amicus, to the creditors trust.