What is a Deed of Company Arrangement?
In essence, a deed of company arrangement (‘DOCA’) is a contract or agreement between the company and its creditors under which the company agrees to pay a defined dividend to the creditors over a defined period of time and under defined conditions. Before a DOCA can come into being, the company must first enter Voluntary Administration. A DOCA may be proposed during the voluntary administration period (usually 4 or 5 weeks) and is voted on by creditors at a meeting convened for that purpose. If it receives the support of the majority in number and value of creditors, it is implemented. If it does not, the usual outcome is that the company is placed into liquidation.
Creditors are more likely to support a DOCA if the dividend return under the DOCA is forecast to be materially greater than that which would be likely under a liquidation of the company.
It is common for parties related to the company (shareholders, directors, related entities) to contribute funds to increase the pool of money available to pay a dividend. Usually, related parties do not participate in the dividend. With an increased pool of monies and reduced pool of claims against those monies, the return to unrelated creditors may be significantly greater than from straight liquidation, providing a sound commercial basis to support the DOCA.
Why would you, as a company director, wish to propose a DOCA? There are many reasons, the more common being:
- A desire to improve the return to suppliers, employees and other creditors, with whom you may have had long standing business or personal relationships;
- To minimise the potential of a director banning order by ASIC;
- To avoid an adverse notation on your personal credit file, which applies when you are the director of a company that has been wound up in insolvency;
- To avoid being subject to or affected by claims that might be brought by a Liquidator if your company was wound up, for example:
- Insolvent trading
- Breach of duty
- Triggering of personal liability under contractual or statutory guarantees where a Liquidator recovers preferential payments from creditors of the company;
- To avoid a range of other commercial consequences which may be triggered in related entities if one member of a group of companies is placed into (an insolvent) liquidation;
- To the extent possible, ensure preservation of tax losses for setting off against future taxable income of the company.
What outcomes are available from a Deed of Company Arrangement?
Two key outcomes sought by directors under a DOCA are:
- Avoidance of liquidation; and
- Reconstitution of the balance sheet.
Further information about the implications of (insolvent) liquidation are available here.
Reconstitution of the balance sheet will generally involve one or more of:
- disposal of core or non-core assets;
- injection of funds from related parties; and
- compromise of the company’s external debts.
The extent to which external creditors will agree to compromise the amount of debt owed to them will depend on a range of factors, usually commercial, but at times emotions come into play.
Commercially, a rational creditor would prefer to accept a higher dividend under a DOCA than a lower return under a winding up, if that were expected. However, if the size of the expected dividend under a DOCA is small, it may be that the majority of creditors would prefer to forego that dividend and see the debtor company wound up. This is more likely where the relationship between the company and its creditors has soured badly due to extended non-payment of debts owed and a lack of communication from the debtor.
Creditors who are commercial enterprises are primarily motivated by the potential for a dividend, as long as the promised return is not considered to be insulting. Statutory creditors on the other hand, are also influenced by public policy considerations and may oppose a DOCA that finds support among commercial creditors.