Schemes of Arrangement

Objective of schemes of arrangement

Schemes of arrangement provide a statutory mechanism by which some compromise or arrangement can be agreed between a company and all or some class of its creditors (creditors’ schemes or schemes) as well as all or some class of its members.¹   Subject to some policy considerations, there are no limitations on the terms of a creditors’ scheme. As such, a scheme involves nothing more than proposals to alter or modify the relationship between the company and its creditors – though it must satisfy the question: "could a majority of creditors who would be bound by the proposal conclude in good faith that it is in their best interests"?

The principal policy considerations which impact any creditors’ scheme are:

(a) it cannot result in an insolvent company continuing to trade;

(b) it must not involve confiscation or expropriation of the rights of creditors, but rather some element of "give and take" between the company and its creditors;

(c) it cannot bind creditors whose claims are not yet in existence;

(d) it cannot be used as a means of avoiding or circumventing some process or procedure for which provision is otherwise made in the Corporations Act 2001 (Cth) (CA); and

(e) it is no objection to a scheme that it facilitates the preservation of a company's tax losses.

Proposing a scheme

Unlike the voluntary administration (VA)/deed of company arrangement (DoCA) regime, there is no prescribed form of interim administration for a company which intends to propose a creditors' scheme. The current common practice is that the company's directors and officers remain in control of the company while the scheme is being formulated.

An alternative approach which was once more typical is for the company to apply for the appointment of a provisional liquidator (see discussion under Appointment of Interim or Provisional Liquidator). Even in that circumstance, though, the company's directors will often be involved in the development of the proposed scheme.

Procedure for proposing a scheme

If the company's directors remain in control of its affairs, they should secure the benefit of the safe harbour provisions (see Informal Workouts for a discussion of these provisions). Once that is done, the procedure involves:

• preparing the scheme document and an explanatory memorandum;
• giving notice to ASIC of the intention to propose a scheme and providing it with copies of the scheme documentation as well as the explanatory memorandum;
• applying to the court for an order convening a meeting or meetings of creditors to consider the scheme;
• holding the creditors' meetings;
• subject to the creditors' meetings agreeing to the scheme, applying to the court for an order approving the scheme; and
• lodging a copy of the court order approving the scheme with ASIC.

A typical timeline for implementing a scheme is as follows: 

Creditors' claims pending approval of the scheme

Unlike the VA/DoCA regime, there is no automatic moratorium on creditor's claims if the directors of the company retain control of its affairs (rather than a provisional liquidator appointed). However, the court may restrain a creditor or creditors generally from taking proceedings against the company once a scheme has been proposed,.²

For a scheme to be proposed, its documentation need not be complete. It is sufficient that its essential commercial terms have been made publicly known.

The court may either restrain an individual creditor from taking proceedings or (on the basis of a recent decision) issue orders affecting creditors generally. Applications may also be made for such an order to apply to creditors in countries other than in Australia.

Schemes of arrangement

As with a DoCA, most often, a creditors’ scheme, will provide the terms upon which the creditors of a company (but usually only its unsecured creditors) agree to compromise their claims against the company. As such, it will usually be structured to achieve a financial restructure of the company's affairs.

There are a number of discretionary factors that a court will consider when approving schemes. Importantly, so far as any financial restructuring of the company is concerned, the scheme must have the result that the company is solvent. Against that, there is no objection to a scheme being structured so as to permit the company to take advantage of its accrued tax losses.

Unlike a DoCA, a scheme may also provide for a compromise in relation to a particular class of a company's creditors which has no effect on other creditors of the company. So, for example, if a company’s lenders represent a very substantial percentage of its total liabilities, they may agree to a compromise of their claims on the basis that the company should be allowed to continue to trade and to continue to pay its trade creditors in the ordinary course. Such a scheme would proceed on the premise that it will provide a better return on the lenders’ claims than would be the case in the event of the company's liquidation.

However, while a scheme may provide for differential treatment of a company's creditors, if that treatment results in creditors who, say, would rank pari passu in a liquidation not being entitled to receive dividends calculated by reference to the same rate, then separate meetings of each class of creditors must be convened to consider the scheme. Equally, if a company has creditors who have rights against the company which can be differentiated but where the scheme treats them in the same way, there would need to be meetings of each group or class of creditors convened to consider the scheme. These "class rules", as they are known, can make the implementation of a scheme more difficult. They certainly give each group of creditors a power to veto the scheme as each class meeting must approve the scheme by the required statutory majority.

Voting on schemes of arrangement

For a scheme to be approved, it must be agreed by a majority in number of creditors who attend and vote at the meeting of creditors convened to consider the scheme and who represent at least 75% in value of the creditors voting on the scheme.³

Where the creditors of the company who are to be bound by the scheme must be divided into classes, meetings of each class of creditors must be held and each of those meetings is required to approve the scheme by the same majority.

If there are "insiders" (such as directors or shareholders) who vote on the scheme or others who have some extraneous interest which will be advanced by the implementation of the scheme, the court, on the application to approve a scheme, can, in effect, either, discount their votes or order further meetings to consider the scheme - at which those "insiders" may not vote.⁴

Voting by “shareholder creditors”

In recent times, an issue which has had an impact on the administration of insolvent companies is the making of claims by shareholders who assert that they have suffered losses as a result of the company having failed to comply with its continuous disclosure obligations. Those obligations are relevant only for companies whose shares are traded on the stock exchange. The effect of those obligations is to require those companies to disclose information to the exchange when that information could have an impact on the company’s share price.

The alleged failure to comply with that obligation has resulted in a number of class actions by shareholders. In response to the impact of those claims, the CA has been amended to provide that, in the event that such a claim is successful, the consequential liability of the company to its shareholders is subordinated to its liability to all its other creditors if the company is liquidated. A further amendment provides that shareholders with such claims are bound by a creditors’ scheme even if no meeting has been convened for them to vote on the proposal for the scheme.⁵

Implementation of a scheme

If a scheme is to be effective and able to be implemented, it must be approved by the court.⁶   The court has a broad discretion as to whether it will approve the scheme. However, it will typically take the approach that creditors are the best judges of what is in their commercial interests and it will not withhold its approval by reference to financial or similar considerations.

The effect of a scheme

A creditors’ scheme will bind both the company and the class or classes of creditors whose claims are the subject of the compromise or arrangement for which the scheme provides.⁷ This includes dissenting secured creditors, where the requisite majority of the class that includes those dissenting secured creditors has approved the scheme.

Notwithstanding a creditors’ scheme effects a compromise of the claims of creditors, this will not adversely affect their rights under any guarantee given to them by a third party on account of their claims against the company, unless the terms of the scheme explicitly release the claims under those guarantees.

A creditors’ scheme may not bind third parties. So, if scheme managers are appointed to administer the scheme, then, typically, they will undertake an agreement with the company for its own benefit and for the benefit of its creditors to perform their duties in that capacity.

Similarly, if a third party is to make a contribution to a fund for the benefit of creditors whose claims are to be bound by the scheme, the court, in the ordinary course, will require that the third party undertake, by an agreement with the company, to make that contribution. In such circumstances, there will usually be a stipulation in the scheme to the effect that, if the contribution is not made, the scheme will cease to have binding effect.

Effect of schemes of arrangement outside Australia

Where a company has operated outside Australia, then, as with a DoCA, a creditors’ scheme will not automatically have extraterritorial effect. Rather, application needs to be made to the relevant courts for the scheme to be recognised and to operate in the other jurisdictions in which the company’s assets and business interests are located.

Powers of scheme manager

The powers of the scheme manager appointed to administer a creditors’ scheme will be subject to express provision in the scheme documentation. Those powers will depend on the role which the scheme manager is to play. This varies from simply calling for creditors to submit their claims, adjudicating those claims, and distributing payments from a scheme fund, to having overall responsibility for the management of the company’s business and affairs.

Advantages and disadvantages of creditors’ schemes

So far as creditors’ schemes are concerned, their advantages and disadvantages are almost the opposite of those for a VA/DoCA. The disadvantages are:

(a) there is a relatively complex and expensive process for implementing a creditors’ scheme;

(b) a creditors’ scheme must be approved by a majority in number and 75% in value of creditors who vote and there is no provision for a casting vote in the event of a “deadlock”;

(c) if a scheme discriminates between creditors or they have different rights against the company, they need to be divided into classes to consider the proposed scheme and each class has to agree to the scheme by the statutory majority; and

(d) if a scheme is to be varied or terminated, this may be done only by proposing a new scheme.

However, advantages include:

(a) a scheme may bind a company’s creditors not only to a compromise of their claims against the company but also to a compromise or release of their claims against third parties, provided that doing so is sufficiently connected with the implementation of the scheme;

(b) a scheme does not require the commencement of formal insolvency proceedings;

(c) a scheme is flexible and can achieve a variety of outcomes, for example, debt-for-equity swaps, balance sheet restructures, extensions/rescheduling of debts, and transfers of obligations to another company under an amalgamation;

(d) a scheme may bind a class of the company’s creditors such as its lenders or its secured creditors; and

(e) if the company is a public listed company whose shareholders have claims as creditors because the company has breached its continuous disclosure obligations, those claims can be subordinated to the claims of other creditors without the shareholder creditors participating in the meetings convened to consider the scheme.