What conditions apply to the sale of assets/the entire business in a restructuring or insolvency process? Does the purchaser acquire the assets “free and clear” of claims and liabilities? Can security be released without creditor consent? Is credit bidding permitted? Are pre-packaged sales possible?
Restructuring & Insolvency (2nd Edition)
A voluntary administrator may sell assets, noting, however, it is not permitted to sell assets subject to security without consent (a receiver will often be appointed and have control over such assets). Administrators can apply to the court if such consent is not given and the court may make an order if it is satisfied that the secured creditor is adequately protected.
Liquidators appointed in the context of either voluntary or compulsory liquidations can sell or otherwise dispose of unencumbered property of the company without needing to seek approval from the court or other parties to the liquidation. The purchaser will acquire the assets unencumbered unless there are debts or liabilities passing to the purchaser as provided for in the sale documentation. If assets are encumbered, consent of the encumbrancer will be required unless a court directs otherwise. A liquidator owes fiduciary duties to the company. In realising company property, a liquidator (or administrator) has a duty to obtain the highest possible prices for the assets of the company, keeping in mind that the winding up should not be unnecessarily protracted. Property may be sold in any way the liquidator deems fit, including private contract and, usually, public auction. While creditors may purchase assets of the company, the purchase price will not be able to be set off against the debt owed to the creditor by the company. Instead any funds raised by the sale of company property will be for the benefit for the creditors as a whole, to be distributed according to the relevant distribution rules.
As previously noted, a receiver is under a statutory obligation to obtain market value or, in the absence of a market, the best price obtainable in the circumstances pursuant to section 420A of the Corporations Act. Upon a sale, the receiver will transfer the asset free of security interests (a release will be provided by the appointing secured creditor) and often the terms of any intercreditor arrangements will provide for the automatic release of subordinated security. In circumstances where an automatic release mechanism is not provided for, director negotiations will need to take place with the subordinated secured creditors.
Schemes of arrangement
The terms of the scheme itself can provide for the disposal of assets and any associated release of security provided. Such releases will not be automatic (unless specifically provided for in an approved scheme) and will need either agreement from the creditors or the provision of such release in associated finance and security documents.
In an informal reorganisation of a company the conditions of the reorganisation and sale or use of assets are as negotiated with the relevant creditors.
Credit bids are permissible under Australian law and generally a means of pursuing loan to own strategies, but are rare given the need for a sales process to be conducted and the need for proceeds to flow.
The “pre-pack sale” in the traditional English and US tradition has had limited application in the Australian restructuring environment due to the stringent obligations placed on insolvency practitioners and the protections afforded to creditors under both statute and common law. However, the use of pre-packs may increase following the introduction of the ILRA and the safe harbour protection.
Attempts to effect a “pre-pack” are also restricted by the specific obligations on receivers vis-à-vis the disposal of assets. Section 420A of the Corporations Act requires a receiver to, upon the sale of an asset, either achieve a price not less than market value (if a market exists for the asset), or alternatively the best price reasonably obtainable. Australian Courts have identified certain steps that a receiver should take in order to comply with the second limb of the obligation, which include a market or auction sale process and marketing campaign, which has made “pre-pack” sales difficult for receivers to achieve. Accordingly, pre-packs tend only to be used in circumstances where:
(a) there are limited alternative sale options available to the insolvency practitioner appointed and there is evidence to support the assumption that any delay in sale may be fatal to the underlying business; or
(b) a market testing sale process has already been undertaken prior to the appointment of the receiver or administrator.
Notwithstanding the above, the market may well evolve such that we see more pre-packs if it can be demonstrated clearly that junior creditors and shareholders are out of the money.
Restructuring: transfer of activities
At the request of the company in distress or the public prosecutor, the court appoints a judicial administrator to organise and effect the transfer of activities. The administrator is free to determine the process and conditions, and acts under the supervision of a delegated judge. The transfer is subject to the court’s scrutiny. Subject to certain exceptions, the transfer will be free from any liens and binding on all (secured) creditors. Pre-packaged sales are not possible.
The trustee must sell all assets in the interest of the estate and creditors. He can sell the assets or activities through a private or public sale process. The assets are sold free and clear of any liens or encumbrances. After realising all assets, the trustee must call a final meeting of creditors to approve the accounts, costs and distribution of proceeds. A credit bid is available to certain creditors (such as the first ranking mortgagee in case of a sale of the mortgaged real estate). Pre-packaged sales are not possible.
In respect of the liquidation of the estate, the trustee is only entitled to sell unencumbered assets that are part of the bankrupt estate. The trustee is not entitled to sell assets that are owned by or secured in favour of a third party, unless with consent of such parties. The trustee is entitled to demand from a secured creditor to, within a reasonable period of time set by the trustee, exercise its rights with regard to the secured assets, for instance by foreclosing its right of pledge or right of mortgage, by failure of which that creditor loses its right to do so in favour of the trustee. In case of a suspension of payments the administrator does not have such possibility.
Under Dutch law any party may bid on pledged assets, including lenders or pledgees, in a public or private sale process with or without the approval of the court. Therefore, the pledgee is allowed to bid for pledged shares in a Dutch company and may do so by way of a credit bid (i.e. bidding by way of (effectively) set-off with the outstanding debt). We note that appropriation of shares by a pledgee is not permitted under Dutch law.
While pre-packaged deals are still theoretically possible, the European Court of Justice in the Estro bankruptcy ruled that the Dutch pre-pack process is not in line with the Transfer of Undertaking Directive. Therefore, all rights and obligations of employees of the bankrupt transferor of an undertaking are automatically transferred to the transferee in case of a sale through a pre-pack. This has material implications for Dutch pre-packs, as a potential buyer will be (very) reluctant to acquire an undertaking from a bankrupt transferor if (the rights and obligations of) the employees of such undertaking are automatically transferred.
Under Section 363 of the Bankruptcy Code, debtors are able to sell some or all of their assets. Those sold in the ordinary course of business do not require court approval while those sold outside the ordinary course do require notice, a hearing, and court approval. Debtors are required to demonstrate a legitimate business reason for the sale – a standard which is relatively flexible, as courts consider many relevant factors pertaining to the proceeding and the proposed sale.
Debtors may also sell their assets pursuant to the chapter 11 restructuring plan. Selling assets under section 363 of the Code allows property to be transferred to a buyer “free and clear” of all liens and encumbrances if the debtor can show (a) it is permitted under nonbankruptcy law; (b) the entity consents; (c) a lienholder of the property is oversecured; (d) such interest is the subject of a bona fide dispute; or (e) the interest holder can be compelled to accept a money satisfaction.
The Code also permits a holder of a lien securing an allowed claim to “credit bid” its interest, generally up to the face amount of its secured claim—in most cases, regardless of what the claim holder actually paid for the claim.
In amicable proceedings, if the debtor intends to use or sell its assets, there will be no permissions required other than contractual consents of creditors.
During safeguard proceedings, however, if the observation period has started, the debtor is allowed to carry out day-to-day transactions and any transaction that would entail the sale of an important asset of the business would be subject to the insolvency judge’s authorisation. The judge may indeed authorise the sale of certain assets on a piecemeal basis if the situation so requires.
In judicial reorganisation, the same rules as for safeguard proceedings apply. If the court orders the liquidation of the debtor’s assets, a liquidator is appointed. The liquidator will liquidate all the assets of the company in order to best distribute proceeds among the creditors. Either the debtor’s business can be sold as a whole in the framework of a sale plan or its assets can be sold on a piecemeal basis either through a public auction or by mutual agreement.
Under controlled management proceedings, the debtor cannot dispose of its assets without the receiver’s prior approval.
The bankruptcy receiver, with the supervisory judge’s approval, may immediately sell perishable movable assets.
Assets may only be sold with the prior consent of the relevant practitioner/court. There is no credit bidding process provided under Luxembourg law and a receiver would not be entitled to sell assets that are owned by or secured in favour of a third party, without that party’s approval.
Directors Duties and Liabilities
The Companies Act 1993 imposes high standards on directors to avoid reckless trading. The key duties that a director should most bear in mind when a company is in a position of financial difficulty are those in sections 135 and 136 of the Companies Act 1993 which are commonly referred to as the reckless trading or 'insolvent trading' provisions.
Under both sections 135 and 136 the duty owed by the director is to the company, and not to the shareholders or creditors. The liability of directors under these provisions is civil. Any damages or compensation awarded for breach of such duties must be paid by the directors to the company in insolvency for distribution to all creditors in accordance with their statutory priorities. The prospect of liability for reckless trading claims is a common catalyst for directors to place a company into voluntary administration or liquidation.
Section 135 states that a director has a duty to the company not to trade recklessly. It provides that a director must not:
- Agree to the business of the company being carried on in a manner likely to create a substantial risk of serious loss to the company’s creditors; or
- Cause or allow the business of the company to be carried on in a manner likely to create a substantial risk of serious loss to the company’s creditors.
Section 135 is not intended to penalise directors merely for taking legitimate business risks. In fact, the preamble to the Companies Act 1993 reaffirms the economic and social value of a company “taking business risks”. It is only the taking of illegitimate business risks which will warrant a finding of reckless trading.
Section 136 sets out a director's duties to the company in relation to incurring obligations. It provides that a director of a company must not agree to the company incurring an obligation unless the director believes at the time on reasonable grounds that the company will be able to perform the obligation when it is required to do so. A director's belief under section 136 must be held on reasonable grounds. The director’s belief at the time is a subjective test, although the decision must be made on reasonable grounds, which is an objective test.
In a Court application relating to a breach of director's duties a shareholder or creditor cannot in the normal course obtain compensation payments directly. Remedy for a breach is to be sought by the company, or by a shareholder on behalf of the company (with the leave of the Court by a derivative action under section 165).
However, post-liquidation of a company, section 301 of the Companies Act 1993 allows a liquidator, a creditor or a shareholder of the company to bring actions against directors (and others) where, among other things, such directors (and/or others) have misapplied, retained, or become liable or accountable for money or property of the company, or been guilty of negligence, default, or breach of duty or trust in relation to the company.
The Court may grant relief directly against the directors in their personal capacity with the liability of the directors usually extending from the time that the company was in peril and the reckless actions were taken by the directors. The Court is given a wide discretion under section 301(1)(b)(ii) to order the director to “contribute such sum to the assets of the company by way of compensation as the Court thinks just”.
Section 126 of the Companies Act provides that a director includes (in addition to someone occupying the position of director, by whatever name called) a person in accordance with whose directions or instructions a director of the company may be required or is accustomed to act, and a person in accordance with whose directions or instructions the board of the company may be required or is accustomed to act.
However, a professional advisor will not be a shadow director if the person provides advice only in a professional capacity. A receiver is also excluded from the definition of a director.
Shadow directors will owe the same duties as are imposed by the Companies Act on directors, including the duties relating to reckless trading. Penalties associated with a breach of those duties will also apply.
Related company liability in liquidation
A liquidator may seek an order of the Court under section 271 of the Companies Act 1993 that a company related to a company in liquidation, but not itself in liquidation, pay all or part of the claims made in the liquidation (a contribution order). The definition of 'related company' is broad and includes majority shareholders, subsidiaries, companies which are both related to a third company or companies where the businesses of the two companies are carried on such that the separate businesses of each company are not readily identifiable.
In determining whether to grant a contribution order the Court will have regard to the extent to which the related company took part of the management of the company in liquidation, the conduct of the related company towards creditors of the company in liquidation, and the extent to which the circumstances that gave rise to the liquidation are attributable to the actions of the related company.
In bankruptcy proceedings, the requirements for the sale of assets depend on the type of proceedings. While in ordinary proceedings the receiver in bankruptcy must generally follow more strict rules with regard to the realization of assets, in particular where it is envisaged to realize an asset of the insolvent debtor by means of a bilateral sale outside of an auction process, there is larger discretion in case of summary bankruptcy proceedings. In each case, the secured creditors must consent to such asset not being sold by public auction and all creditors must be given the possibility to submit a higher offer for real estate property or other assets of high value. Sales generally occur on an 'as is where is' basis and, thus, the acquired asset would not necessarily be free of claims and liabilities. No representations and warranties are typically given by the receiver in bankruptcy. Upon completion of the sale, the security will be released. Credit-bidding is available to a secured creditor only.
In composition proceedings, the insolvent debtor typically requires both the consent from the administrator and the competent court (or, if one has been formed, the creditor committee) if it wishes to sell its assets or even the entire business during the moratorium phase. The administrator's consent is sufficient for the sale of current assets, though. Court approval can also be sought at the outset of the proceedings which allows a pre-packaged restructuring (including a pre-packaged sale to an independent third party) under Swiss law. The consent of a secured creditor will be required for a release of a security interest. The terms of the disposal, including representations and warranties, will have to be negotiated between the seller and the purchaser. Again, credit-bidding is only available to a secured creditor and subject to contract.
There are no specific rules with respect to the sale of asset/the-entire in insolvent company, and transaction will be subject to the approval of the creditors as set forth in Section 8 above, which are in such circumstances the material stakeholders, if not the actual owners of the company/assets sold.
The sale method is a contractual matter and can be done on an AS IS basis without any representation with respect to the company or the sold assets. A "free and clear" sale of control in Companies is possible, and it will usually also include the transfer of all the company's current obligations and certain assets and rights to a trustee for the benefit of the creditors (this is the common technique, for example, for the sale of traded "Shell" corporations in the Israeli Stock Exchange).
A court officer may release a collateral without the secured creditor consent, by selling a pledged asset in the ordinary course of business, subject to proper protection to the creditor and that the sale is required for the recovery of the company; a release of a fixed charge shall also be subject to the court's approval. Such asset's sale proceeds shall be pledged in favor of the secured creditor, up to the amount of the original asset.
Credit bidding is not permitted, and the realization of collaterals is only permitted in accordance with the specific provisions of the law, as set forth in Section 2 above.
Pre-packed sales are not prohibited, but will be subject to scrutiny with respect to their influence on the company’s creditors, and to the duties of officers and directors in insolvency and distress situations towards the creditors of the company.