Creditors' Compromise: How a Part 14 Vote Binds

Part 14 of the Companies Act 1993 lets a company propose to its creditors that their debts be cut, postponed or otherwise varied. The directors stay in charge, which is the main difference from a voluntary administration, where an administrator takes control. The proposal can come from the board and, among others the Act lists, from a creditor or shareholder with the court's leave. It sets out the terms and the reasons for them, and lists for each class of creditor the creditors affected, what each is owed and how many votes each may cast.

There is no automatic moratorium. The proponent or the company can ask the court to stay proceedings and other enforcement for a period starting no earlier than the date notice is given and ending no later than 10 working days after the result is notified, but that order does not affect a secured creditor's right to take possession of or realise property over which it holds a charge. A bank with a general security agreement keeps its remedies while the vote runs.

The test is applied class by class and counts only those who vote. The Act's words are that a resolution is adopted if "a majority in number representing 75 per cent in value" of the creditors or class voting are in favour, whether they vote in person, by proxy or by post:

The Act uses classes but does not define them. In 2018 the Supreme Court set aside a compromise in which creditors associated with the company had voted in the same class as outside creditors and their votes had carried the value test; it found a material irregularity and unfair prejudice. Where there are several classes, each class's approval is presumed to depend on every other class approving, unless the resolution says otherwise. Once approved, the compromise binds the company and every creditor in the class who was given notice, including those who did not vote. A creditor entitled to vote can apply to the court on three grounds: insufficient notice, another material irregularity in obtaining approval, or, if it voted against, that the compromise is unfairly prejudicial to it or its class.

A trailer manufacturer in New Zealand, constructed for this page like every figure in it, owes its bank US$4.2m under a general security agreement and a mortgage, US$1.55m to 38 trade suppliers, US$0.65m of tax arrears and US$0.80m to its shareholders' family trust. Its accountant estimates that in a liquidation, after the bank and preferential claims, unsecured creditors would receive about 8 cents in the dollar. The directors propose that trade suppliers receive 45 cents over 24 months. The tax is to be paid in full over 18 months under a separate instalment arrangement, and the trust's loan is postponed until the suppliers are paid, in a class of its own so that its vote cannot carry the suppliers'. The bank's debt is outside the proposal. Figures are in US$m and belong to the example.

The compromise binds all 38 suppliers, including the nine who did not vote. A supplier owed US$0.12m that voted against could apply to the court for unfair prejudice, and the court would look at how its treatment compares with the other suppliers' and with what it would receive in a liquidation: on the accountant's figures, 8 cents.

Inside New Zealand, a scheme of arrangement under Part 15 is approved by the court, and voluntary administration puts an administrator in control with a moratorium and can end in a deed of company arrangement. The UK's nearest equivalent is a company voluntary arrangement. It is approved by three-quarters or more in value of the creditors responding, fails if more than half of the total value of the unconnected creditors vote against it, and cannot affect a secured creditor's right to enforce its security without that creditor's agreement. In Australia the equivalent is a deed of company arrangement reached through voluntary administration. On a poll the resolution needs a majority in number and value of the creditors voting, with a casting vote for the chair, and the deed binds unsecured creditors but binds secured creditors only if they voted for it or the court orders it.

Guarantees are usually outside the compromise. A New Zealand High Court decision in 2016 held that a Part 14 compromise cannot release directors' personal guarantees, and in Australia a deed of company arrangement does not stop a creditor recovering under a guarantee from a director or anyone else. A bank's guarantee claim survives the compromise of the company's debt.

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For the secured bank, the compromise changes the cash flow it lends against. In the example, US$1.55m of supplier debt becomes US$0.70m, and the tax arrears are spread over 18 months, but the business must now find about US$0.03m a month for the suppliers and about US$0.04m a month for the tax, on top of its bank payments. Suppliers that have just taken a loss may also want cash on delivery, which raises the working capital need just as instalments begin. The bank's question is whether the plan works with its own debt serviced alongside, and it may be asked to defer principal or hold its overdraft limit.

The bank is also asked, in effect, for its view of the alternative. Without the compromise the business may go into receivership or liquidation, and the bank's recovery then depends on the forced sale of its security. A compromise that keeps a viable business trading is often the better outcome for the secured lender too, which is why banks commonly read the proposal closely even when it does not ask for their vote.