Update on Creditors Schemes of Arrangement in Australia

by DLA Piper
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In the past, criticism has been levelled at Australia's corporate restructuring system for being unduly conservative and not providing distressed companies with adequate support or flexibility to execute effective restructuring proposals and avoid formal insolvency.

In response to these concerns, over the past two years the Australian government has implemented a suite of reforms to its corporate insolvency regime. The government has introduced a safe harbor for directors of distressed companies and has imposed a moratorium on the enforcement of ipso facto clauses when a company enters into voluntary administration or receivership or proposes to undertakes a scheme of arrangement. Please also see our recent articles "Holding" Deeds of Company Arrangement, Phoenixing reform, Assigning liquidator rights to sue, Safe harbour and ipso facto reforms as well as this further update on this topic.) There is, however, still room to move.

Over the past few years, Australia has seen a shift in the market's appetite for greater flexibility in dealing with distressed companies. Stakeholders and courts have displayed a willingness to give effect to less traditional, more novel restructures. It is in this context that we have seen an increase of the use of the more uncommon scheme of arrangement, which has been effectively used in some of Australia's most high-profile and largest restructurings, among them Atlas Iron, Boart Longyear, Centro, 9 Network, Opes Prime, Lehman Brothers, Bis Group and Alinta Energy.

A creditors scheme of arrangement is a binding court-approved compromise or arrangement between a company and its various creditors under Part 5.1 of the Corporations Act. The process is heavily court supervised, with court approval needed to convene meetings of creditors, for the scheme booklet and for the scheme itself (once it has been approved by creditors). The process is time intensive and can take six months or more to conclude. However, during this approval process, there is no embargo or moratorium on the company continuing to do business, and the distressed company remains in the control of its directors and officers. Because the company can continue to trade during the process (subject to any ipso facto provisions) and enter contracts, borrow money and incur other debts, despite the lengthy court process, a scheme of arrangement can generate a more orderly transition through the restructure process without significant, granular business interruption.

Schemes of arrangement can be effectively used to restructure a company's liabilities without the need to engage in a formal insolvency process (such as external administration). Formal insolvency processes can often have a significant deleterious impact on a company's value, reputation and ability to survive. Schemes of arrangement offer the flexibility that more commonly used insolvency processes (such as deeds of company arrangement) cannot achieve. For example, in recent restructurings, schemes of arrangement have be used to:

  • Compromise the claims of certain classes of creditors, while not compromising, or effecting, the claims of other creditors
  • Release of creditors' claims against third parties (such as third party financiers)
  • Bind creditors, such as foreign bondholders, even where the contracts that give rise to their debts, or their status as a creditor, is governed by foreign law
  • Lower the consent threshold in finance documents to allow for further amendments following the implementation of the scheme, in order to facilitate a broader restructuring without the need for a further creditors' scheme, and
  • Implement the restructuring of a company against the wishes of a dissentient minority of secured creditors in circumstances where more than 75 percent of the secured creditors support the restructuring

While traditionally schemes of arrangement have often been considered to be cost prohibitive, it appears that the Australian market has begun to recognize the value in the flexibility these schemes offer, along with the ability to avoid the loss of value that is so often associated with a drawn-out insolvency processes and eventual liquidation.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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