This article was written by Gavin Rakoczy.
Administration and deeds of company arrangement have continued to have significant influence on major restructurings in the Australian market. In larger restructurings, administrations represent significant transactions where capital is deployed strategically to acquire businesses at significant discounts. A sound understanding of the procedures is key to private equity players for many reasons. Portfolio companies can be exposed to administrations where suppliers, customers or competitors experience financial difficulties. If portfolio companies become distressed, an orderly exit of the investment will often require planning for a controlled administration and deed of company arrangement.
In this article we highlight the different structures and solutions available through the administration and deed of company arrangement procedures.
Administration (also referred to as voluntary administration or "VA") is the primary procedure used to recapitalise Australian companies when they experience financial difficulties or have solvency concerns.
When used strategically, voluntary administration is a useful mechanism to implement changes in the ownership and capital structure of a company, to separate performing from non-performing parts of the underlying business, and to resolve disputes.
This can be done by:
- a sale of all or part of the business of the company during the voluntary administration procedure; or
- a recapitalisation of the company through a deed of company arrangement (DOCA).
Once appointed, administrators have extensive powers to trade the business and to bring about changes in the corporate structure and underlying business. If funded, administrators will generally continue to trade the business pending a sale or recapitalisation.
Administration is intended to be a four or five week process, although it is common for the courts to grant extensions of 3-6 months or even longer in larger or more complex situations.
- borrow funds secured on a first-ranking secured basis, similar to Debtor in Possession (DIP) financing, to allow the business to continue trading pending sale or recapitalisation of the business as a going concern;
- selectively perform (profitable) contracts;
- repudiate (unprofitable) contracts;
- reduce operating expenses, for example by reducing the workforce and exiting onerous leases; and
- buy and sell assets, including the underlying business if appropriate.
During administration, the administrator benefits from temporary statutory moratoriums which prevent landlords and other lessors from terminating contracts, re-entering premises or repossessing equipment. For some types of contracts signed post 1 July 2018, the administrator also benefits from ipso facto protection which prevents counterparties from exercising rights of termination. Importantly, all litigation is stayed during the administration procedure.
Deeds of Company Arrangement
During administration, the administrators will typically seek DOCA proposals. There is no restriction on the parties which can make DOCA proposals. The DOCA procedure is extremely flexible and can be used for many different purposes, including to:
- recapitalise the company;
- compromise the claims of unsecured creditors or in relation to unprofitable parts of the business;
- settle litigation;
- reorganise the business and affairs of the company;
- implement changes of control, including debt-for-equity swaps; and
- hold the business for a longer period of time pending a transaction down the track (using what is commonly known as a "holding DOCA").
M&A during administration
For investors, administration can be seen as a procedure which crystallises merger and acquisition opportunities. Counterparties with an interest in a business have a measure of certainty that there will be a sale of the business or recapitalisation through a DOCA.
In recent cycles, we have seen increasingly creative uses of the DOCA procedure where businesses have continued to trade successfully and to recapitalise despite significant difficulties with creditors, litigation and ownership uncertainty. For example, there have been:
- competitive bid processes resulting in previously closed markets opening up to foreign investment (eg, the CBS acquisition of Channel Ten through a DOCA completed in 2017);
- a complex aggregation structure used to split up and reorganise a complicated business involving thousands of employees, billions of dollars of claims and a holding structure resulting in successful sales achieving billions of dollars of recoveries (eg, the Arrium group administration involving the MolyCop sale in 2016 and the Arrium Australia sale in 2017);
- debt-for-equity swaps implemented in the context of complex disputes and valuation uncertainty (eg, the Paladin administration completed in 2018); and
- the resolution of multiple class action claims combined with an acquisition by an organisation looking to expand into a new market (eg, the Surfstitch administration in 2018).
The below table uses specific scenarios to demonstrate the different structures available through the DOCA procedure. In each structure the group continues trading throughout the administration and subsequent DOCA procedure.
If you would like to understand more about the different types of DOCAs being utilised in the market please do not hesitate to contact us.
1. "Vanilla" DOCA
An insolvent company has a long-term profitable business or other valuable asset, but has, for one reason or another, become insolvent due to an unsustainable unsecured creditor burden.
The "Vanilla" DOCA, being a standard form DOCA used to compromise unsecured creditor claims.
A construction company has entered into an unprofitable contract, resulting in an otherwise profitable business becoming loss-making. This in turn has resulted in the company accumulating an unsustainable unsecured creditor burden.
An administrator can close out the unprofitable contract by repudiating it. A "Vanilla" DOCA can then be used to compromise all unsecured creditor claims against the company, including claims by the counterparty to the unprofitable contract. The DOCA may provide that creditors receive [x] cents/$ from a DOCA fund generated via the injection of capital by the DOCA proponent. Once the funds have been distributed to creditors, the DOCA completes and unsecured creditor claims are extinguished.
Freed of its onerous creditor burden and the loss-making contract, the restructured company can continue as a solvent entity and has avoided liquidation.
2. Creditor's Trust DOCA
A listed company is placed into administration. The administration results in the suspension of the company's ASX listing and, despite the administrators' best efforts, the stigma of administration places great strain on the company's relationships with its key customers and suppliers.
A Creditors' Trust DOCA, being a DOCA coupled with a separate Trust Deed which establishes a trust to pay creditor claims.
A large ASX listed engineering company becomes insolvent and its board appoints administrators. The company has underlying value, but that value will be rapidly eroded by a prolonged deed administration (in particular, key customers are threatening to look elsewhere).
In order to overcome this issue, a Creditors' Trust DOCA is proposed. Under the Creditors' Trust DOCA all unsecured creditor claims are compromised immediately upon execution of the DOCA. The DOCA completes on the day it is approved, allowing the company to return to the control of its directors and continue trading in the ordinary course free of its debt burden.
Contemporaneously with execution of the DOCA, the company enters into a Trust Deed under which the deed administrators are appointed as trustees. The trustee are responsible for making distributions out a trust fund to the company's former creditors once their claims have been adjudicated by the trustees. The trust is terminated once all of the assets in the trust fund have been distributed in accordance with the Trust Deed.
3. Pooled DOCA
Administrators are appointed to an insolvent corporate group. The companies are all party to an ASIC deed of cross guarantee (DXG), which means that in a liquidation scenario the creditors of each company will have claims against all other companies in the DXG group.
A Pooled DOCA, being a DOCA which provides for a single DOCA fund to be established to pay the claims of all unsecured creditors of the group on a pro-rata basis.
A transport business is operated by a group of five companies, with each of the companies fulfilling a different role (one holds assets, the other is the operating vehicle, a third employs staff, etc). The companies are signatories to a DXG, meaning that in a liquidation scenario the creditors of each company can make claims against the other four companies.
A Pooled DOCA is proposed which provides for the release and extinguishment of unsecured creditor claims against each of the five companies. In consideration for this release, unsecured creditors of the companies are able to claim a dividend from a deed fund established pursuant to the Pooled DOCA. The deed fund contains sufficient proceeds so that all unsecured creditors receive a superior outcome as compared to a liquidation.
The Pooled DOCA simplifies what could otherwise have been a complicated liquidation of the five separate companies.
4. Aggregation DOCA
Administrators are appointed to a corporate group comprising a large number of separate companies. The companies are party to two separate DXGs, which is a legacy of a merger several decades ago.
An aggregation DOCA, being a DOCA which establishes a common pool of funds to pay the creditors of each company, but with the funds to be distributed by the administrators rateably between creditors of the different DXG groups.
A large iron ore miner and steel manufacturer enters administration. The group is comprised of 90 companies, 60 of the companies are party to DXG 1 while the other 30 companies are party to DXG 2. There are very substantial liabilities in DXG2 which holds the unprofitable mining operations which have extensive employee liabilities in a closure scenario. In a liquidation creditors with claims against DXG 1 companies are expected to receive 10c/$, while DXG 2 creditors may receive as little as 3c/$.
An aggregation DOCA is executed, which provides for all creditors to be paid from a single DOCA fund. To ensure that creditors of DXG 1 are not disadvantaged as compared to creditors of DXG 2, the DOCA provides the deed administrators with the power to equalise distributions to ensure that all creditors receive a superior outcome than would the case in a liquidation. Following exhaustion of the deed fund, the Aggregated DOCA effectuates.
5. Debt-for-equity (s444GA) DOCA
A large ASX listed corporation has been placed into administration and a DOCA proponent wishes to take control of the company.
A section 444GA DOCA, being a DOCA coupled with a court order under section 444GA of the Corporations Act 2001 (Cth) empowering the deed administrators to transfer shares from existing shareholders to the DOCA proponent.
An ASX listed mining company becomes insolvent, but via various subsidiaries holds valuable operating mines and tenements around the world.
A group of bondholders comprise the majority creditors of the company and propose a DOCA to the administrators. Under the DOCA proposal, the bondholders offer to exchange their bonds for a new bond with a smaller face value and to provide new funding to the company. In consideration for this, the DOCA proposal requires the transfer of all shares in the company from existing shareholders to the bondholders.
The administrators satisfy the court that the proposed transfer of shares will not unfairly prejudice members of the company (ie as the shares are worthless) and the court therefore makes the requested order under section 444GA.
The DOCA is then executed and, once it has been performed, the DOCA is effectuated, leaving the bondholders as the sole shareholders of the restructured company.
6. Distribution and Transaction DOCAs
A large complex corporate group enters administration. To maximise value, the group requires significant restructuring.
A Distribution DOCA for one company (to be used as the vehicle to pay dividends to creditors) and Transaction DOCAs for the other companies within the group (to facilitate their restructuring).
Administrators are appointed to a highly complex group comprising 150 companies, with operations throughout Australia and internationally. The group has grown organically over 50 years, with multiple bolt-on acquisitions. The operating assets are held in various companies in the group, with the businesses not corresponding to the corporate entities.
The DOCA proponent determines that in order to maximise the value of the group, it will be necessary to undertake an extensive restructuring, including rationalising aspects of the business model, downsizing staff, transferring certain assets within the group, and shutting certain loss making sites.
The DOCA proposal provides for one of the companies in the group to execute a Distribution DOCA, which will then be used to pay dividends to creditors of that company and all other companies within the group once the businesses have been sold.
The other 149 companies in the group execute a separate DOCA known as a "Transaction DOCA". The Transaction DOCA empowers the deed administrators to freely transfer assets and liabilities between these companies in preparation for the intended sale of the group's businesses. Creditors of all 150 companies exchange their claims against the companies for a right to participate in distributions from the Distribution DOCA.
After the reorganisation and sale of businesses is completed under the Transaction DOCA and the proceeds have been distributed to creditors through the Distribution DOCA, the DOCAs complete and all creditor claims are released. The companies have continued trading during the entire process.
7. Holding DOCA
A company has entered into voluntary administration and has a valuable asset which may be worth preserving depending on future developments. For this reason, it is premature to finalise a DOCA transaction in the immediate future, with more certainty expected down the track.
A Holding DOCA, being an interim DOCA designed to give the company time to secure a longer-term DOCA proposal.
A company owns a potentially valuable piece of intellectual property, but is embroiled in litigation concerning the validity of its associated patent. If the litigation can be favourably resolved, it will create a positive outcome for creditors. As a result, creditors favour deferring consideration of a DOCA until after the outcome of the proceeding is known.
The administrators therefore propose a Holding DOCA which will not compromise unsecured creditor claims, but instead merely prevent unsecured creditors from taking enforcement steps during the term of the Holding DOCA.
Once the outcome of the litigation is known, the Holding DOCA comes to an end and the company proceeds either into liquidation (if the litigation is unsuccessful) or a variation to the DOCA is executed (likely a "Vanilla" DOCA) in order to recapitalise the company and exploit the intellectual property.