Schemes of Arrangement in Australia

A creditors' scheme of arrangement ("Scheme") can be a powerful restructuring tool implemented to achieve a variety of outcomes for a business, ranging from deleveraging or a debt-to-equity conversion to a merger and/or issue of new debt/equity instruments. When managed appropriately, a Scheme can reshape a business' debt and equity profile, setting it up for an improved go-forward operating platform. Below we set out an outline of the Scheme process in Australia and consider some key features that are unique to Australian schemes.

Implementing a Scheme

A Scheme is a formal, binding, compromise between a company and its creditors (or a class or classes of them) sanctioned by either the Federal Court of Australia or the Supreme Court in the relevant State or Territory where the Scheme is filed. Schemes are governed by Part 5.1 of the Corporations Act 2001 (Cth) ("Corporations Act"), and section 411 of the Corporations Act sets out the prescribed process to be followed when implementing a Scheme. Broadly, that process involves:

1. Scheme Terms and Explanatory Statement – The terms of the proposed Scheme are developed by the debtor company in consultation with a core group of its creditors (typically, a group holding enough of the debt that they could together approve the Scheme at the relevant meeting(s) (discussed below)). An explanatory statement to creditors is required to accompany the Scheme, which must explain the effect of the proposed Scheme and set out any material interests of the directors as well as any other material relevant to the making of a decision by a creditor or prescribed information.
2. Lock-Up Agreement – As the implementation of a Scheme is subject to the court timetable and the prescribed timeframes dictated under the Corporations Act, a lock-up agreement is a prudent course of action to ensure that the requisite number of creditors vote in favour of the Scheme (even in the event of future debt trades). Given third parties will not be bound by a Scheme, investors should consider whether additional agreements are required to secure performance of any related obligations.
3. Corporate Regulator – The court will not make an order calling a meeting under sections 411(1) or 411(1A) of the Corporations Act unless the Australian Securities and Investments Commission ("ASIC") has had 14 days' notice of the hearing, and it is satisfied that ASIC has had a "reasonable opportunity" to examine the proposed terms of the Scheme and draft explanatory statement.
4. Scheme Filed – A debtor company or, less commonly, a creditor may make an application to the court under sections 411(1) or 411(1A) of the Corporations Act for the court to make an order calling a meeting of creditors (or meetings of classes of creditors) to consider and vote on the proposed Scheme.
5. First Court Hearing – At the first court hearing, the court considers several procedural and factual elements, including whether the Scheme "is bona fide and properly proposed" and whether there is any apparent reason the Scheme should not receive the court's approval were the majority of voters to approve the Scheme.¹ At this stage, it is not for the court to determine whether final approval should be granted, but rather whether the Scheme has been adequately explained and whether there are any substantial flaws.²
6. Scheme Meeting(s) – At each Scheme meeting ordered by the court, a simple majority (50.1%) in number of creditors present and voting (by person or by proxy) at that meeting who collectively hold at least 75% of the total amount of the debts and claims of the creditors present and voting at that meeting must vote in favour of the Scheme in order to approve it.
7. Second Court Hearing – While the requisite thresholds of creditors may have approved the Scheme, the purpose of the second court hearing is for the court to consider and, if minded to, approve the Scheme. The court is not required to approve the Scheme simply because the creditors (or relevant class of creditors) have voted in favour of the Scheme and may grant approval to the Scheme subject to any alterations or conditions that it thinks just. This was reinforced by the NSW Court of Appeal in Snowside Pty Ltd (as Trustee for Snowside Trust) v Boart Longyear Ltd,³ in which the court held that the primary judge was correct that the power conferred by section 411(6) is not confined to alterations or immaterial conditions.
8. Lodgment of Court Orders – The orders of the court must be lodged with ASIC. It is from lodgment (or such earlier date as the court specifies) that the order takes effect.

Key Considerations

As each class of creditors will vote on the Scheme, determining the creditors for inclusion in each class is vital to mitigate against the Scheme being voted down by a minority group of creditors. The courts have consistently confirmed that each class of creditors should be "confined to those persons whose rights are not so dissimilar as to make it impossible for them to consult together with a view to their common interest".⁴ When considering these "rights", the court in the matter of First Pacific Advisors LLC v Boart Longyear Ltd⁵ found that the context under which the Scheme is being proposed is a key consideration and, in particular, that where the only real alternative to the Scheme is a liquidation of the debtor company, the "rights" of the creditors in a liquidation scenario is the relevant consideration. The decision was considered controversial by some in that it saw secured creditors with differing priorities, and who would receive alternate outcomes out of the Scheme (if approved), being treated as a single class. Notwithstanding this, as at the date of this publication, this decision has not been overturned.

An additional benefit of Schemes in an Australian context is the ability to seek orders under section 411(16) of the Corporations Act restraining proceedings in any action or other civil proceeding except with leave of the court. Such orders are beneficial and seek to mirror the statutory moratorium that applies on creditor claims when a debtor company enters into voluntary administration. As insolvency is not a prerequisite for a company to file a Scheme, such an order is pivotal to insulate the company from creditor action during the court and creditor meeting processes.

Schemes have traditionally placed a hefty evidentiary (and financial) burden upon the applicant debtor company who is required to seek the imprimatur of the court. However, Jackman J recently accepted a much more limited scope of evidence and articulated a set of streamlined evidentiary principles that parties could adhere to when preparing members' schemes of arrangement.⁶ While the relevant case concerned a members' scheme of arrangement, it is a decision that indicates a shift in the approach of the Australian courts to accept a more streamlined approach to the supporting evidence that must be filed to satisfy the court that it can grant orders approving the Scheme.

Conclusion

As Australian courts seek to alleviate the evidentiary burden on parties promoting a Scheme, and in the context of alternative capital providers becoming more active in the Australian restructuring landscape, we hope to see a greater use of the Scheme in 2024 (and beyond) as borrowers and investors alike seek to restructure distressed Australian businesses.

_{1 Re Ellerston Global Investments Ltd [2020] NSWSC 879 at [26].
2 Re Ellerston Global Investments Ltd [2020] NSWSC 879 at [27].
3 Snowside Pty Ltd (as Trustee for Snowside Trust) v Boart Longyear Ltd (2017) 122 ACSR 29.
4 Sovereign Life Assurance Company v Dodd [1892] 2 QB 573 at (583).
5 First Pacific Advisors LLC v Boart Longyear Ltd (2017) 320 FLR 78.
6 Re Vita Group Ltd (2023) 165 ACSR 576.}

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_{This article is prepared for the general information of interested persons. It is not, and does not attempt to be, comprehensive in nature. Due to the general nature of its content, it should not be regarded as legal advice.}

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