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My Company is in Financial Distress. Is a Creditors’ Scheme of Arrangement the Right Option?

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If your company is struggling to stay financially viable, you may be facing insolvency. Before this occurs, one option you may be considering is to negotiate a Creditor’s Scheme of Arrangement.      

This is a scheme that addresses the rights of your companies’ creditors (people or companies that it owes money to). This article explains how a Creditors’ Scheme of Arrangement works, including:

  • what compromises you can propose to creditors regarding your companies’ debts;
  • the processes involved; and 
  • when you can use this restructuring technique.

What Is a Creditors’ Scheme of Arrangement? 

A Creditor’s Scheme of Arrangement (Scheme) allows you to restructure your company’s debt obligations. Restructuring debt can occur in a circumstance where your company is in financial distress and is:

  • seeking to reduce; and/or 
  • renegotiate its debts 

to improve its financial position and continue operations. 

You may want to restructure your company’s debt to ensure that every effort is made to maintain/restore liquidity (cash flow). 

Before a Scheme is entered into, your company will be required to prepare documentation that sets out the:

  • purpose of the scheme;
  • the compromises made by the parties to the Scheme; and 
  • the powers of the Scheme’s administrator (the Scheme’s administrator is a person who oversees the Scheme, usually this is a registered Liquidator, either by themself or with a group of creditors). 

What Does a Scheme Include?

A Scheme can include a number of different proposals to reduce your companies’ debt obligations. You could:

  • renegotiate interest payments;
  • increase the period of time before you need to fully pay ; or
  • propose swapping debt for equity (shares in your company). 

For example, due to the COVID-19 pandemic, Virgin Australia has been looking to restructure its debt through a Scheme offering its debt to be swapped for equity in the airline.

Does My Company Need to be Solvent?

A Scheme is an option available to a company when it is solvent (has assets that can cover its liabilities) and is a preferred strategy if you want to avoid placing your company into voluntary administration.   

While proposing a Scheme is an option if your company is insolvent, doing so opens the business to risk. This is because it may expose your company’s directors to personal liability associated with insolvent trading. You need to seek tailored legal advice in these circumstances. 

How a Scheme Applies to Creditors    

A Scheme ultimately allows your company to continue to trade. A Scheme is proposed to creditors on the basis that the creditors, or a class of creditors, will be in a better position if a Scheme is agreed than they would be in if your company went into Voluntary Administration or Liquidation. 

When you negotiate a creditors’ schemes of arrangement, it is common practice to ask creditors if they will accept your company either:

  • repay a smaller amount of the debt; or
  •  payment of the debt being deferred to a future date.

To receive approval for any Scheme, you need approved by a majority of your company’s creditors, at a creditors’ meeting. The creditors at this meeting must represent at least 75% of the total creditor pool. This is to ensure that you address the concerns of the majority of creditors.

Where the majority of your company’s debt is owed to a handful of key creditors, consider seeking their support in advance of the creditors’ meeting, and document agreed terms.                

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When to Involve the Court and Regulator  

Before you can enter into a creditors’ scheme of arrangement, you need to:

  • inform the Australian Securities and Investment Commission (ASIC) about your proposed Scheme and provide them with an explanatory statement; and
  • apply to the court, which will then determine whether to make an order convening a creditors meeting and, pending the creditors’ approval, ultimately approve the terms of the Scheme.

ASIC has the opportunity to consider the Scheme’s terms before the court makes an order convening a creditor meeting. It is a statutory requirement that ASIC has at least a 14-day notice period. This is to allow ASIC time to:

  • examine the terms of the compromises set out in the Scheme; and 
  • prepare a statement or submissions to the Court in relation to the compromises sought (certain exemptions can be made to shorten the 14-day notice period in circumstances where the Court or ASIC permit).

Once a court grants an order convening a creditors’ meeting, the creditors will vote on the proposals set out in the explanatory statement. If a majority of creditors resolve to approve the Scheme, the Court will then need to be approached again to:

  • examine the Scheme; and 
  • determine if the proposals are fair and reasonable 

before the court grants approval.

The court may require certain conditions to be met in order for it to grant approval of a Scheme. The court will not approve any scheme that does not comply with public policy, even in circumstances where a majority of creditors have resolved to approve the Scheme at a creditors meeting.     

Once the court approves the Scheme, the court’s final order must be provided to ASIC before the Scheme can commence. 

When Are Creditors Schemes of Arrangement Used?

Many companies facing insolvency prefer to avoid Creditors’ Schemes and instead utilise other restructuring options, such as voluntary administration. This is because:

  • the documentation associated with a Creditors’ Scheme of Arrangement is very complicated; and
  • it can be both time-consuming and costly to go through the process of providing certain materials to creditors, ASIC and the court.      

There are circumstances where a creditors’ scheme would be preferred. For example, your company may seek to benefit from a Scheme as: 

  • clauses in the contract allowing a party to terminate the contract should insolvency occur cannot be triggered when a company applies to enter into a Creditors’ Scheme of Arrangement; and
  • Creditors’ Schemes of Arrangement can bind secured creditors that do not vote to approve the Scheme.

Key Takeaways

If your company is struggling to remain financially viable, then you may be facing insolvency and considering ways to manage your debt. There are a number of ways you can approach this, including a Creditors Scheme of Arrangement.

Whether you are a company director or a creditor, it is important to understand your obligations, options and rights. If you need assistance in relation to insolvency, LegalVision’s LegalVision’s insolvency lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.

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