Understanding Creditors’ Trusts A PAPER BY PAUL COOPER OCTOBER 2007
Understanding Creditors’ Trusts by Paul Cooper
Understanding Creditors’ Trusts
Summary Creditors should carefully consider the effect of a creditors’ trust as their rights as creditors under the Corporations Act will be impacted - usually to their detriment.
Who Does This Impact? Unsecured creditors, usually in the context of the collapse of a listed corporation.
What Action Should be Taken? •
Ask questions of the administrator/s
•
Understand your rights as a creditor and how your rights will be impacted
•
Obtain legal advice in appropriate circumstances
Contents:
1
2
Creditors’ Trusts: What they are?
2
How does a creditors’ trust work?
2
Risks for creditors
3
Information to be provided to creditors
3
Cases dealing with creditor’s trusts
4
Practical Tips
5
Conclusion
T U R K S L E G AL
PAPER
Understanding Creditors’ Trusts by Paul Cooper
Creditors’ Trusts: What they are? While creditors’ trusts can benefit creditors where they unlock the value of the listed entity, there are traps for unweary credit managers as creditors lose the protection of the Corporations Act (“ (“the Act”) and enter an arena that is far more uncertain, less regulated and invariably more complex. Creditors’ trusts are used to place the debt of the company into a trust which leaves a corporate shell with no liabilities, usually with the objective of ‘unlocking’ the value of the listed corporate shell.
How does a creditors’ trust work? A creditor’s trust is created (pursuant to a deed) which provides that the company’s obligations to creditors bound by the deed of company arrangement (“DCA (“ ”) are compromised and transferred to the trust. On the transfer, the creditors, become beneficiaries of the trust. A payment (or transfer of property) is made to the trust to be administered by the trustee in accordance with the trust deed. The usual obligations which would have been performed by a deed administrator are performed by the trustee including the adjudication of claims and distribution to beneficiaries. By using the trust, the DCA is capable of being “effectuated” when the trust is created, that is, at the time the DCA is executed or soon afterwards. The main purpose behind a creditors’ trust is that the DCA can be terminated at the time (or soon after) the DCA is executed and the company returned to the control of its directors. The company ceases to be externally administered and need not use the words “subject to deed of company arrangement” on its documents.
Risks for creditors ASIC Regulatory Guide 82 (May 2005) contains details of the special risks for creditors. In summary these are: 1 The DCA may be effectuated and as a consequence creditors’ rights against the company extinguished before: a. The amount available for distribution to creditors has been ascertained. b. The trust fund has been received in full by the trustee. c. Creditors of the company/beneficiaries of the trust have received any payment from the deed administrator or the trustee. d. Creditors may have less or no rights if the DCA is not fully complied with by all relevant parties. 2 The significance of the risks in a particular case will depend on the quality of the information the administrator provides to creditors and the actual terms of the DCA, trust deed and related documentation.
2
T U R K S L E G AL
PAPER
Understanding Creditors’ Trusts by Paul Cooper
3 The following factors increase the severity of the risks: a. Creditors’ lack of knowledge and inexperience. b. Inadequate disclosure of material and information. c. Additional complexity. d. Trustees’ identity, skills and remuneration and insurance arrangements. 4 Differences in the way trustees and liquidators are regulated and supervised. 5 Potential difficulties for ASIC and creditors in monitoring and enforcing improper conduct by a trustee. 6 Legal uncertainties for ASIC and creditors in challenging a DCA that has already terminated.
Information to be provided to creditors In ASIC’s guide, emphasis is placed on administrators disclosing information that is material to the creditors’ decision about whether to accept a proposal. ASIC’s guide reinforces the obligation on administrators to provide creditors with a statement setting out the administrator’s opinion about whether or not it is in the creditors’ interests for the company to execute a DCA and the reasons for that opinion. ASIC emphasises that administrators ought to discuss the advantages and disadvantages for creditors of the proposed creditors’ trust when making their recommendation. ASIC considers that an administrator should not recommend creditors approve a DCA proposal involving a creditors’ trust, where creditors are not adequately protected. ASIC considers that it will not be in creditors’ interests to approve a DCA involving a creditors’ trust where: 1 The proposed value of the trust fund cannot be reasonably estimated at the time the proposal will be voted on by creditors. 2 There is reason to be concerned about whether the trustee will receive all of the trust fund or adequate and enforceable security for the trust fund before the DCA terminates. 3 The trust deed permits a person to act as trustee who does not have the necessary skills or may otherwise be unsuitable. 4 The trust deed will not provide processes and rights that are at least as favourable to the beneficiaries as the processes and rights of creditors under the Act. Administrators should also provide a proper explanation and reasons why the DCA involves a creditors’ trust and this explanation ought to identify the legal or commercial reasons for the creditors’ trust.
Cases dealing with Creditor’s Trusts In Open Telecommunications Ltd (Subject to Deed of Company Arrangement) [2003] NSWSC 1198 (3 December 2003) the Court dealt with an application by a deed administrator for directions that the deed administrator would be justified in executing and giving effect to a varied deed of company arrangement and creditors’ trust. Hamilton J described the mechanism proposed by the deed administrator as ‘quite
3
T U R K S L E G AL
PAPER
Understanding Creditors’ Trusts by Paul Cooper
ingenious’ and summarised the effect of the arrangement as follows: 1 The arrangement would remove the sums promised to creditors from the ambit of the DCA to the ambit of a trust deed. 2 The company would no longer be subject to a DCA and it is likely that it could be restored to the Stock Exchange Board and the contemplated additional capital sums raised both to feed the promised amounts into a scheme for the creditors and to restore the company to viability. Although this would take the management of the money outside the ambit of the Act, the money would be held in the creditors’ interests according to the general law of trusts and their position would be protected. Persuaded by the advantages of the course, the Judge made directions noting that there could be no objection on the ground of legality or propriety regarding the proposed course. In West Australian Shed Co Pty Ltd Creditors Trust Deed [2003] WASC 39 (6 February 2003) the Court dealt with an application by trustees of a creditors’ trust to make orders varying the trust property. Under the terms of the trust deed, certain companies were to pay the trustees 50% of net profit generated by these companies in the financial years ended 30 June 2003 and 30 June 2004. Evidence was before the Court that the profit forecast scenario for the years ended 30 June 2003 and 2004 would not be higher than an amount of $135,000.00. There was an offer of $135,000.00 by the directors of the companies to pay this amount to the trustees of the creditor’s trust, thereby avoiding any uncertainty if the forecast was not achieved and avoiding delay. The Court, acknowledging that the vast majority of beneficiaries were in favour of the proposed variation, varied the trust deed by deleting the provision of the trust deed requiring the companies to pay to the trustees 50% of the net profit generated and replaced it with an order that the directors would use their best endeavours to procure payment to the trustees of $135,000.00. The judge was satisfied that the present reasonable estimate is that the beneficiaries would receive less than $135,000.00 under the present arrangement taking into account market conditions and the time cost of not receiving money immediately. Importantly, the Court was only prepared to make the orders subject to the filing of an affidavit confirming that the sum of $135,000.00 was paid into the trust account of the trustees.
Practical Tips When credit managers come across a creditors’ trust, credit managers should: •
ask questions of the administrator and his/her staff;
•
write to the administrator if any questions are not satisfactorily answered;
•
remember that the Act may be relied upon to obtain an injunction to prevent execution of the DCA or to obtain an Order terminating the deed where for example the giving effect that the deed will result in injustice;
•
recognise the appropriate circumstances to obtain legal advice;
•
understand that timing is very important and that it may be better to prevent a DCA from being executed rather than attempting to have the DCA terminated;
•
in appropriate circumstances, recognise the commercial benefit of communicating with other creditors; and
4
T U R K S L E G AL
PAPER
Understanding Creditors’ Trusts by Paul Cooper
•
understand the commercial impact of the creditors’ trust by the time of the second meeting of creditors.
Conclusion The trend in administrations involving creditors’ trusts is towards proper disclosure by the administrator. Creditors are entitled to insist on this and should ensure that administrators comply with their obligations. Creditors will appreciate the importance of carefully considering the effect of a creditors’ trust because, even in circumstances where the trust cannot be performed, the antecedent rights of creditors pursuant to the Act in respect of insolvent trading, preference transactions with third parties and related parties and uncommercial transactions will no longer be available to them.
For more information, please contact:
Paul Cooper Partner T: 02 8257 5730 paul.cooper@turkslegal.com.au
Sydney | Level 29, Angel Place, 123 Pitt Street, Sydney, NSW 2000 | T: 02 8257 5700 | F: 02 9239 0922 Melbourne | Level 10 (North Tower) 459 Collins Street , Melbourne, VIC 3000 | T: 03 8600 5000 | F: 03 8600 5099 Business & Property | Commercial Disputes | Insurance & Financial Services | Workers Compensation | Workplace Relations
www.turkslegal.com.au This Pap er is cur rent at i t s d ate o f p u b l i c at i o n . Wh i l e eve r y c a re h a s b e e n t a k e n i n t h e p re p a rat i o n o f t h i s Pa p e r i t d o es not constitute legal a dvice and shoul d n o t b e re l i e d u p o n fo r t h i s p u r p o s e. Sp e c i f i c l e g a l a dv i ce s h o u l d b e s o u g ht o n p a r t i c u l a r m atters. Tur ksLegal do es not accept resp on s i b i l i t y fo r a ny e r ro r s i n o r o m i s s i o n s f ro m t h i s Pa p e r. Th i s Pa p e r i s co py r i g ht a n d n o p a r t m ay b e repro duced in any for m without th e p e r m i s s i o n o f Tu r k s Le g a l . Fo r a ny e n q u i r i e s, p l e a s e co nt a c t t h e a u t h o r o f t h i s Pa p e r.