The erosion of part 5.3A protections through the mechanism of the creditors’ trust – a parallel but essentially unregulated regime of administration

Over the past decade, insolvency practitioners have developed an intrigue for the use of the creditors’ trust. Many have sought to structure their Deeds of Company Arrangement’s (DOCA) in a way that interfaces with a creditors’ trust through the mechanism of a creditors’ trust deed.

In a nutshell, under a creditor’s trust arrangement, the DOCA addresses the insolvency of the company while the company’s property is settled on trust for the benefit of the company’s creditors. The creditors entitlements are transferred to the newly formed trust with the DOCA terminating upon the establishment of the trust. All claims of creditors against the company are extinguished and become trust claims against the trust fund pursuant to the trust deed. Under this arrangement, creditors undergo a transition in status from a creditor of the company to a beneficiary under a trust.  Accordingly, upon the creation of the creditors’ trust all creditor claims to be bound by the DOCA are converted from a right to prove as a creditor to a right to participate in the trust fund.

The creditors’ claims under the DOCA are quite simply substituted for corresponding claims as beneficiaries of a trust comprised of the remaining company assets and funds from a third-party proponent (typically, a director of the company). In practice, this type of arrangement is not overly legally complex provided that the terms of the DOCA include appropriate provisions to ensure the transition from DOCA to the Creditors’ Trust. Under this type of arrangement, the DOCA is accompanied by a creditors’ trust deed which sets out the parameters for the review and determination of creditors claims.

Advantages

A question often asked by insolvency practitioners is whether there are any compelling reasons to incur the extra costs of compliance with the regulatory guidelines[1] (as far as disclosure to creditors is concerned) and the added legal costs of drafting a creditors’ trust deed to establish such arrangement. One must not overlook the statement, albeit obiter dicta, articulated by Barrett J in Parkview Constructions Pty Ltd v Tayeh: [2]

“Administrators recommending to creditors the adoption of a deed of company arrangement that will give birth immediately to a creditors’ trust and then itself promptly die bear a heavy burden of explaining to creditors the implication of the shift from a regime incorporating a court administered scheme of creditor protection to one in which creditors become passive trust beneficiaries.”

Importantly, what benefits can such arrangement provide for the company under external administration?

1. The Creditors Trust is an effective means for accelerating the termination of the DOCA as the DOCA is terminated immediately upon its execution and replaced with the creditor’s trust, thereby allowing the company to swiftly emerge from the spectre of external administration.
2. The company is then able to continue to trade unconstrained by s 450E(2) of the Corporations Act (which requires the company to place a notification on all documents that it is “subject to deed of company arrangement”).
3. Accordingly, the often lengthy process of adjudicating on creditor’s claims is able to occur while the company enjoys the benefits of early release from DOCA.
4. For an ASX listed entity (or an entity seeking ASX listing), the company can:
   • apply to the ASX for quotation of its securities;
   • make changes to its share capital;
   • make changes to the structure of its board composition; and
   • make changes to its principal business activities.

Disadvantages

While the Creditors Trust Deed is said to be made against the framework of Part 5.3A of the Corporations Act, there is a dearth of literature and commentary as to whether a Deed Administrator could confer Corporations Act type powers on a trustee acting pursuant to a creditors’ trust deed, being a private instrument. The most common (and perhaps most important) criticism of the mechanism of the creditors’ trust is the stripping of the procedures and processes (and the concomitant protections) a beneficiary would normally have enjoyed under the Corporations Act had they remained a creditor under DOCA. By way of example, the supervisory and remedial jurisdiction of the court under ss 445D and 447A cannot be invoked by a beneficiary under a creditors’ trust.

The main risk to creditors under such arrangement is that the DOCA will be effectuated and the creditors’ rights against the company released before the trust fund has been received in full by the trustee. The release of rights also occurs before the beneficiaries of the trust have received any payment. Accordingly, a beneficiary may well have less legal rights or no legal rights if the DOCA proposal is not complied with. Under a creditor’s trust arrangement, an aggrieved beneficiary seeking to appeal a trustee’s adjudication of its claim is left to rely on the terms of the trust deed, the law of equity and the provisions of the Trustee Act 1925 (NSW)[3] (or the equivalent State or Territory legislation, noting generally there is a lack of uniformity across State and Territory legislation).

In the past, the judiciary’s attitude toward the use of the creditors’ trust as an insolvency tool has been divided. In Parkview Constructions Pty Ltd v Tayeh[4], Barret J emphatically expressed his concern with such arrangements:

“This outcome causes me considerable disquiet. There are two reasons this… Second, it is a matter for concern, at a public policy level, that the protective aspects of Part 5.3A in relation to deeds of company arrangement, including the role of the court, can be and have been avoided by the creation through a deed of company arrangement of a parallel but essentially unregulated regime of administration.”[5]

In Bevillesta Pty Ltd[6], Bergin CJ opined that an Administrator who had put forward a sound commercial reason for the use of a creditors’ trust and made every effort to make the creditors aware of the special risks that may be encountered with the use of a creditors’ trust, would not be considered to have recommended an arrangement which amounted to an abuse of Part 5.3A of the Corporations Act.

However, it is worth noting that the “sound commercial reason/s” referred to by Bergin J in Bevillesta Pty Ltd must be more than simply the company’s desire to trade unconstrained by s 450E(2) of the Corporations Act (which requires the company to place a notification on all documents that it is “subject to deed of company arrangement”. Perhaps greater justification is required because a company is able to make an application to the court seeking leave to trade unconstrained by s 450E(2) under a DOCA arrangement.[7]

Comments

There is no doubt the creditors’ trust is an “ingenious”[8] and efficient tool which can be used to rapidly accelerate the company’s emergence from the spectre of administration. However, there remains serious legal and policy considerations around their use to effectively circumvent Part 5.3A protections which creditors would have otherwise enjoyed under a DOCA. In the past decade, courts have demonstrated divergent opinions around their use. While there remains the possibility for abuse, there has not yet been a wide incidence of abuse with these types of arrangements. However, as these types of arrangements become more widely used in the future, it remains to be seen whether ASIC (or the legislature itself) will intervene to prevent such abuses from occurring. To view all formatting for this article (eg, tables, footnotes), please access the original here.