Where to from here (now that ipso facto reform has become law)? Unresolved impediments to company restructures in a VA context

With the enactment of the ipso factoreform in September this year (which commences operation on 1 July 2018), it is the genuine hope of many insolvency practitioners and others in the market that voluntary administration will become a less value-destructive and, therefore, a more useful tool for company restructures. In particular, the reform seeks to prevent suppliers and other contractual counterparties from terminating a contract with a company in administration solely on the basis of its insolvency or formal administration. This in turn gives the company breathing space to continue to trade during a formal restructure, preserve the enterprise value of its business and facilitate the sale of the business as a going concern.

Unfortunately, there remain shortcomings in Australia's insolvency law regime which will continue to undermine the utility of voluntary administration as a restructuring tool for companies in financial hardship. Three of those obstacles to restructuring through a voluntary administration are discussed in this article. The first arises from deficiencies in the ipso facto legislation itself; the other two are the result of registration requirements and vesting rules found in the Corporations Act 2001 (Cth) (Corporations Act) and the Personal Property Securities Act 2009 (Cth) (PPSA).

Obstacle 1: Deficiencies in the ipso facto legislation

A key deficiency in the ipso facto legislation, as observed by many, is its non-application to contracts that are entered into before 1 July 2018. This means existing suppliers or counterparties with contracts entered into prior to 1 July 2018 will continue to enjoy the benefit of their ipso facto rights and may, at any time following the commencement of the ipso facto regime, exercise such rights to the detriment of a company in administration.

In addition to this temporal limitation, the ipso facto regime also appears to be subject to certain jurisdictional limitations. Generally speaking, Commonwealth legislation is restricted in its operation to activities within Australia. In other words, a Commonwealth statute is presumed to have no operation outside of Australia unless the statute, by express words, provides that it is to apply extraterritorially. 

The stay on enforcement of ipso facto rights is incorporated into Parts 5.1, 5.2 and 5.3A of the Corporations Act. The Corporations Act itself, being Commonwealth legislation, is presumed to have no extraterritorial operation. There are no express words in the Corporations Act (as amended by the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act 2017 (Cth)) which provide for the extraterritorial application of the ipso facto regime. 

The relevant stay on enforcement applies to "rights" that arise "by express provision (however described) of a contract, agreement or arrangement". The word "rights" is not specifically defined in the legislation to include rights exercisable outside of Australia, and the phrase "contract, agreement or arrangement " is not defined to include a contract, agreement or arrangement, which specifies a foreign law as its governing law. 

If it is correct that the ipso factoregime has no extraterritorial application, then the following situations may arise: 

A foreign counterparty to a contract, even if governed by Australian law, may enforce its ipso facto rights against a company in administration, insofar as that enforcement takes place outside of Australia. 

Example: A supplier which normally supplies goods to the company's operations in New Zealand may decide to terminate its supply agreement following commencement of the company's administration in Australia. 

To remedy that situation, the voluntary administrator may need to apply to the New Zealand Court for recognition of the company's administration as a "foreign proceeding" under the UNCITRAL Model Law on Cross-Border Insolvency and, upon obtaining recognition, seek a mandatory injunction requiring the supplier to continue supply and/or a declaration to the effect that the supply agreement remains on foot (which injunctive/declaratory relief would, for the purposes of Article 21(1)(g) of the Model Law, have been available to the voluntary administrator under the law of Australia).

By analogy, in Hayes; Pumpkin Patch Originals Ltd (Admin Apptd) (In Rec), Re v Pumpkin Patch Originals Ltd (Admin Apptd) (In Rec) [2016] FCA 1353, the Federal Court of Australia recognised the voluntary administration of a New Zealand company as a foreign main proceeding for Model Law purposes, and effectively extended the operation of the stay on Court proceedings and enforcement actions (found in the NZ equivalent of Part 5.3A) such that it applied in Australia to Australian creditors and lessors. A similar extension of the stay on enforcement of ipso facto rights could potentially be achieved via a Model Law application. 

Alternatively, the administrator may need to apply to an Australian court for injunctive/declaratory relief and, following that, seek to enforce those orders overseas. 

An Australian counterparty to a contract governed by foreign law could potentially enforce its ipso facto rights against a company in administration, even if that enforcement takes place inside Australia. 

Example: According to the choice of law rules in Australian law, the proper law of a contract (which is generally the governing law specified in the contract itself) dictates whether the contract, or a particular right or obligation in the contract, is enforceable. By way of example, say a supply contract specifies New Zealand law as its governing law, and assuming New Zealand law does not impose any stay on enforcement of ipso factorights; if New Zealand law were to dictate whether a contractual right is enforceable, then the Australian ipso factolegislation will not apply to stay the enforcement by the supplier of its termination rights triggered by the administration of the Australian company. 

If the administrator applies to an Australian court to injunct the supplier from terminating the contract, a difficult question of private international law may arise as to whether Australian law (as the lex fori concursus - that is, the law applicable to the insolvency of a company) may override the proper law of the contract and apply to stay the enforcement of ipso factorights in those circumstances. 

The jurisdictional limitations of the ipso facto regime could detract from the effectiveness of the regime and, by extension, the effectiveness of voluntary administration as a restructuring tool. In addition to all the grandfathered contracts, overseas suppliers and counterparties with contracts that are governed by foreign law may also fall outside of the scope of the stay on ipso facto enforcement. With such a broad class of contracts/counterparties exempted from the stay, administrators could find themselves in a position not too dissimilar from the one before the reform was enacted, namely, where termination of contracts is the norm, not the exception. 

Obstacle 2: Obstacles to obtaining new moneys

A second obstacle to company restructures via voluntary administration arises from the PPSA and section 588FL of the Corporations Act, which make it difficult (albeit not impossible) for companies in administration to grant effective security for new finance.

According to a recent line of authorities starting with K.J. Renfrey Nominees Pty Ltd (Trustee), in the matter of OneSteel Manufacturing Pty Ltd v OneSteel Manufacturing Pty Ltd [2017] FCA 325 (per Justice Davies) (Re Renfrey), ^[1] where a security interest arises after a company enters into voluntary administration, and is therefore registered on the Personal Property Securities Register afterthe appointment of administrators, section 588FL of the Corporations Act applies to vest that security interest in the company immediately upon its creation, even if it was registered within 20 days after the security agreement came into force. This is because, for the purposes of section 588FL(2)(b)(ii), the registration is relevantly made afterthe following times:

• "the time that is the end of 20 business days after the security agreement that gave rise to the security interest came into force; or
• the time that is the critical time [in the context of a voluntary administration, "critical time" means the date on which the administrator is appointed],

whichever time is earlier…".

In relation to security interests granted by a company in administration, the registration will inevitably be made after the critical time (being the earlier of the two). It follows that, subject to one exception, all post-administration security interests will vest in the company upon creation. That one exception is if a court, on application, makes an order under section 588FM of the Corporations Act extending the time for registration.

Under section 588FM, the Court may grant such an extension if it is just and equitable to do so. In Re Renfrey, the Court confirmed that nothing in section 588FL of the Corporations Act or section 267 of the PPSA (the provision which vests an unperfected security interest in a company upon commencement of its external administration) precludes the making of an order under section 588FM once section 588FL(4) has been triggered by the creation of a post-administration security interest.

Although the Court is empowered by section 588FM to extend the registration time, whether that extension will be granted remains a discretionary matter for the Court. In other words, there will always be a degree of uncertainty for both the administrator and the secured party as to the effectiveness of the security arrangement at the time it is entered into.^[2] Relevant to the Court's discretion are, amongst other things, the interests of creditors, any delay in registration (and the impact of any such delay) and the presence or absence of prejudice to unsecured creditors (attributable to the failure to effect registration earlier).

Accordingly, if an administrator wants to:

• obtain finance from a new lender for the purposes of restructuring the company in administration and the lender demands that security be given by the company to secure the post-administration advance; or
• take supplies from a new supplier (or an existing supplier whose supply agreement has expired or who has not previously registered its security arrangement with the company on the Personal Property Securities Register), and the supplier requires that, going forward, its goods and services be provided to the company pursuant to a retention of title arrangement (which is generally a security interest for the purposes of the PPSA and the Corporations Act),

then, on each occasion, it will be necessary for the administrator to apply to the Court pursuant to section 588FM of the Corporations Act seeking an extension of the registration time.^[3]?  The need to make such Court applications could deter new financiers and suppliers (or give them additional bargaining power vis-à-vis the administrator), and will likely be a cost burden and a distraction for the administrator, who should instead be focusing on restructuring the company and/or selling the company's business as a going concern.

Obstacle 3:  Distractions from restructuring efforts - verifications of PPS security interests and disputes with secured parties

Lastly, and related to the second obstacle described above, the vesting rules in section 267 of the PPSA and section 588FL of the Corporations Act mean that the process of verifying PPS registrations and determining the validity of security interests granted by the company has become a significant distraction for administrators, diverting their time and energy from the core objects of Part 5.3A. Although invalidation of one or more security interests could ultimately result in an increase in the company's assets (and, in some cases, a massive windfall for the company: see In the matter of OneSteel Manufacturing Pty Limited (administrators appointed) [2017] NSWSC 21), the exercise of verification often entails significant legal costs and ends up in disputes and litigation with secured parties, which are, for obvious reasons, value destructive for the company's business.

This is especially the case in mining and mining services companies which often hire a large number of items of plant and equipment, which are the subject of PPS security interests. The task of verifying the large number of PPS registrations recorded against these companies (and other companies whose businesses are heavily reliant on leases or supply contracts) can be time-consuming and costly and can easily divert resources from, and therefore hinder, any restructuring efforts.

Interestingly, the final Whittaker Report on the Review of the Personal Property Securities Act 2009 (2015) questioned the policy rationale behind the vesting rule in section 267 of the PPSA and examined arguments both for and against the retention of that section. One of the arguments advanced against section 267 of the PPSA is that the apparent antecedents to that section did not operate as broadly as that section. For example, section 266 of the Corporations Act did not avoid a charge simply because it had not been registered before insolvency – if a charge were granted shortly before insolvency, the chargee could still register after insolvency, provided that it did so within 45 days of the charge being granted. Section 267 of the PPSA also has a much broader reach than section 266 of the Corporations Act, because of the breadth of the concept of “security interest”.

Although the Whittaker Report ultimately recommended that section 267 be retained, it also recommended that section 267 be disapplied in relation to a "PPS lease" that is not also an in-substance security interest under section 12(1) of the PPSA. That recommendation was made following submissions by the hiring industry which has been hard hit by the current regime. The reason is that the concept of a PPS lease (which is a deemed security interest under the PPSA) currently captures hiring arrangements of an indefinite term; and hirer companies, not knowing that such leasing arrangements are “security interests” under the PPSA, often fail to register their security interest against the hiree company (or do so incorrectly). As a result, the hirers find themselves on the wrong end of the vesting rules when a hiree company goes into external administration and lose valuable assets that were on hire to the company. If the recommendation in the Whittaker Report is adopted, it will provide welcome relief for the hiring industry. Not only that, it may also spare administrators (who, in the future, are appointed to hiree companies) from the significant legal and administrative burden of having to determine whether any of the PPS leases to which the company is a party have vested upon its administration.

It is not apparent from the explanatory memorandum to the PPSA and other background material to that legislation why Parliament has decided to apply vesting in a voluntary administration scenario (and not simply in a liquidation scenario). It may be because, previously, section 266 of the Corporations Act also applied to certain unregistered charges upon commencement of a voluntary administration. However, in light of the latest insolvency law reforms and the legislative intention behind those reforms - namely, to facilitate attempts at company restructures and to reduce the stigma currently associated with business failure, further consideration should be given to the question of whether it is desirable to continue to apply the vesting rule to companies in administration. 

^[1]Subsequent cases in this line of authority include: Mentha, in the matter of Arrium Finance Limited v National Australia Bank [2017] FCA 818; Woods, in the matter of Paladin Energy Ltd (Administrators Appointed) [2017] FCA 836 and Re Ten Network Holdings Ltd (Administrators Appointed)(Receivers & Managers Appointed) [2017] FCA 1144. ^{Back to article}

^[2]There is also a question of whether section 588FM relief can be sought in advance of the security agreement being entered into. Back to article

^[3]As part of this application, the administrator may also want to apply for orders under section 447A of the Corporations Act, excluding or limiting his personal liability (as administrator) under the new finance and security arrangement. ^{Back to article}