Undercover Administrators?

In 2016 the Dutch Lower House passed legislation which if confirmed by their Senate would initiate quite unique reforms to their restructuring laws.

According to an unofficial translation of the explanatory memorandum, the Continuity of Enterprises Act 1 was intended to facilitate so-called ‘pre-packaged’ insolvency administrations (‘pre-packs’).   Pre-packs describe a sale that is negotiated in anticipation of a formal insolvency administration and implemented immediately after the appointment is made, thus structured to bypass some of the issues caused by formal insolvency:

• Suppliers shortening or even cancelling credit terms
• Key customers switching to suppliers seen as more financial
• Key staff seeking alternate employment.

However, pre-packs usually occur without a comprehensive sale program, and so raise questions about whether the best outcome for creditors is achieved.  A UK study found that pre-packs provided unsecured creditors with a ‘paltry benefit’ – with no distribution in 60 percent of cases.  The same study found that 63% of pre-packs resulted in a sale to a ‘connected party,’ which many Australians would describe as a ‘phoenix.’

Ordinarily, Dutch Courts appoint an insolvency practitioner as a ‘bankruptcy trustee,’ whose conduct and decisions are supervised by a judge of a specialist bankruptcy Court.

Under the proposed reforms, the intended trustee and judge would be appointed up to two weeks before the expected formal appointment.  The pre-appointment appointment  will allow them to supervise and assess the sale process, thereby addressing some of the questions otherwise raised.  The application would be made without any public notice, and there would be no public disclosure of any appointments.

Legislation in limbo

The Dutch Senate had put the legislation to one side, apparently waiting on the outcome of litigation initiated by employees of a company who claimed that a pre-pack sale was a transfer of business, thereby resulting in the automatic transfer of the employees and their entitlements to the acquirer.

The Court found in favour of the employees in June 2017, which means that Dutch employers (and possibly others in Europe, because the ruling reflected an EU-wide directive) will not be able to use pre-packs to rationalise a workforce, or renegotiate employment conditions.

At the time of writing it is not clear whether the legislation will be permanently shelved, or whether it might still be taken forwards, perhaps with modification.

How does that compare to Australia?

In Australia formal insolvency via a voluntary administration is far quicker than the painfully slow (and horrendously expensive) US Chapter 11 procedure, but even a quick administration will last for some months.  For that reason, most large restructuring is done ‘informally’ – out of Court – which avoids the issues arising from loss of confidence.

The position under Safe Harbour

As Australia moves towards implementing the Safe Harbour reforms discussed here, one of the questions being raised is whether entering the Safe Harbour regime will require public disclosure.

At first glance it seems hard to think that entering Safe Harbour would not require disclosure, but it is important to remember that directors of ASX-listed companies already have significant disclosure obligations, some of which are discussed here.  Those rules impose an obligation on directors to ensure that the market is kept informed as to the financial position of their company.  Arguably, if a company is insolvent then that should have already been disclosed, whether there is a safe harbour mechanism or not.

Is there anything in the legislation that requires an additional disclosure?

There are two notable aspects to the Safe Harbour mechanism which suggest that it may have been specifically designed to avoid any additional disclosure.  First, there is no requirement  for appointment of a restructuring adviser as a pre-condition.  Although the involvement of a ‘restructuring adviser’ would bring advantages, it would be a very clear reference point in any later analysis about the adequacy of disclosure.

Secondly, by structuring the safe harbour as a carve out to the existing directors’ duty rather than a defence against a breach, arguably all the directors are doing is continuing to ensure that they comply with their duties, which surely is so unexceptional as to not require disclosure.

Others may have different views, but my own is that it is arguable that there is no need for special disclosure that a board is accessing the safe harbour.  That would be a good thing, because advisers will be able to operate ‘undercover’ – with a successful turnaround more likely in the absence of negative publicity.