This month we will discuss the use of creditors' trusts and how they can be used by individuals who need to avoid the usual restrictions of a personal insolvency agreement.
What Is a Creditors’ Trust?
In the world of insolvency when one thinks of a creditors’ trust it is usually with regard to corporate structures and their implementation as part of a Deed of Company Arrangement (“DOCA”). Indeed the use of creditors' trusts is becoming more and more common.
Simply put, a creditors' trust effectively transforms creditors of a company into beneficiaries under a trust. The ‘beneficiaries’ become entitled to share in a trust fund that is established for this special purpose. The administrator becomes the trustee of the trust and is charged with distributing the trust fund to the beneficiaries.
While a company is subject to a DOCA, there is a stigma associated with having to carry the label “Subject to Deed of Company Arrangement”, and there are limitations as to what can be done with the company. The use of a creditors' trust can avoid these issues.
Creditors’ trusts are usually employed as part of a DOCA. A creditors' trust must be approved by creditors at a meeting held during the voluntary administration process. The practical effect of the process involved is that the DOCA is entered into, then soon afterwards it is terminated upon the execution of a creditors’ trust. The result is an early, and often immediate, exit from external administration and a resumption of normal business. This is the major reason for the increasing use of creditors’ trusts.
Creditors’ Trust and Personal Insolvency
Although creditors’ trusts are mainly used by companies, there is no reason (legal or otherwise), why an individual can’t employ a creditors’ trust. Indeed, we at de Jonge Read have applied this strategy for some years now in relation to personal insolvency.
Our client had recently engaged de Jonge Read to assist him in relation to the proposed liquidation of two companies of which he was a director. As a result of the liquidation of the two companies, he would become liable for significant debts that he personally guaranteed. In addition, it was highly likely he would receive Director’s Penalty Notices from the Australian Taxation Office. We also expected the liquidation of the companies to lead to insolvent trading claims by the liquidator(s). This was taken into account in the development of our strategy.
The amount he was potentially exposed to personally was in excess of $3m, not counting the insolvent trading claims. Our client was still a director of four other companies. He stated that it was very important for him to remain a director of those companies.
We recommended our client enter into a Personal Insolvency Agreement (“PIA”) pursuant to Part X of the Bankruptcy Act (“the Act”). This allows individuals to enter into a formal agreement with creditors in full and final satisfaction of their debts and avoid bankruptcy.
While under a PIA, our client would not be allowed to be a director of a company for the duration of the agreement which could be three to four months or more. This scenario was not acceptable to our client given his desire to continue as a director. Again, this needed to be considered as part of our project management. While the PIA is listed with credit reporting agencies and the National Personal Insolvency Index, this was not a significant issue for our client.
Just as we would with a DOCA, we worked with our client’s lawyer in putting together a creditors’ trust which became part of a PIA. To offer the creditors a PIA, a registered trustee in bankruptcy needs to be appointed as the Controlling Trustee (CT).
The CT, among other things, carries out investigations into the financial affairs, of the person offering the PIA, reports to creditors on the results of their investigations, and makes a recommendation to the creditors as to whether or not they should accept the proposed PIA and why.
Generally, to gain the support of a CT, it needs to be demonstrated that the PIA offered will generate better results for the creditors than bankruptcy. Our client had no assets whatsoever. It was therefore unlikely that the creditors would receive anything at all if our client became bankrupt.
Usually, a PIA proposes a payment arrangement to creditors, either as a lump sum, by payments over a period of time, or by a combination of an up-front payment and instalments over time.
The Offer That Couldn't Be Refused
We assisted our client in formulating an offer and a lump sum of $100,000 was proposed and gained the support of the CT. The $100,000 would be put into creditors’ trust and, thus, be made immediately available to the beneficiaries, subject to the trustee’s requirements for adjudicating claims and distributing the trust funds.
The immediate availability of the funds was to achieve two purposes.
Firstly, it is arguable that the creditors, as passive beneficiaries of a trust, do not have the same protection or rights as a creditor under the Act, remedies under trust law notwithstanding. In other words, it is possible that creditors under a creditors’ trust will be in a weaker position when it comes to recovering money that had been offered for the PIA. Therefore, for obvious reasons, the prospect of having funds paid upfront as opposed to payments over a period of time would be more attractive and secure for the creditors.
Secondly, and more importantly for our client, having funds immediately available in a creditors’ trust would allow for the PIA to be terminated on the same day that it is executed. Even though our client was disqualified as a director as soon as he signed the PIA, once the PIA was completed by execution of the creditors’ trust he was able to be re-appointed as a director.
The voting for a PIA is done by a special resolution. A special resolution is a resolution passed by a majority in number and at least 75% in value of the creditors represented at the meeting and who vote on the proposal.
As alluded to previously, the proposed liquidations would play a pivotal role in our strategy. Once the two companies are placed into liquidation, the liquidator of each of those companies would be able to vote for the shortfall to creditors for each company pursuant to the insolvent trading provisions of the Corporations Act 2001. Thus, the liquidators will have two votes for significant amounts.
Following the appointment of the liquidators to the client’s companies we communicated our client’s proposal and explained how acceptance of the offer would provide a better return for the creditors of the companies in liquidation. Subsequently the liquidators made the insolvent trading claims and were admitted for voting purposes on the PIA.
With the support of the liquidators the client’s proposal was accepted by creditors and full and final settlement of debts of well over $3m in debts was achieved for $100,000.
We were able to achieve an excellent outcome for our client. By using a creditors' trust he was able to extinguish a huge debt and remain a director of four companies without any interruption at all.
Should you have clients or associates that you know are struggling with financial issues or need assistance in reviewing their business affairs in preparation for what’s around the corner, our team of Strategists would be pleased to discuss options that are available on how to best design and implement insolvency strategies.
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