Signed, sealed, regretted: onerous contracts in administration
Administrators do not have the power to disclaim onerous contracts. That power belongs to liquidators alone. This article sets out what administrators can and cannot do, and how to manage onerous contracts in practice without crossing that line.
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Key takeaway |
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Administrators facing onerous contracts have 3 tools available: repudiation, Court protection under section 447A, and a carefully structured DOCA. |
What is an onerous contract?
An “onerous contract” is one where the cost of performance exceeds any benefit the company will receive. In practice, administrators encounter them regularly: unprofitable leases, long term supply agreements, service contracts the company cannot meet, and contracts attached to land carrying environmental liabilities exceeding realisable value.
Every onerous contract on foot during administration remains a live obligation, and under section 443A of the Corporations Act 2001 (Cth), every debt the administrator incurs in performing it is their personal liability.
The disclaimer power belongs to liquidators, not administrators
Section 568 of the Act gives a liquidator the unilateral right to disclaim onerous property and contracts by signed writing. Once disclaimed, the company's rights, interests and liabilities in respect of that property are terminated.
Administrators have none of this. There is no equivalent provision in Part 5.3A, and an administrator who purports to disclaim an onerous contract has no legal basis for doing so. In Featherby v Read [2002] WASC 251, the Court confirmed the point directly: "The notion of disclaiming an onerous obligation is well known in the field of winding up… Those observations appear in the context of a company being wound up, whereas the context before me is that of administration." The Court emphasised that the available relief in administration was instead an order excusing the administrator from personal liability under section 443B(8).
Administrators who regularly act as liquidators are familiar with the disclaimer power and may instinctively reach for it when facing an onerous contract. Purporting to disclaim does not terminate the contract, does not stop liability accruing, and may itself constitute conduct the counterparty can act on.
The repudiation mechanism - a practical alternative
Where an onerous contract cannot be performed and continuing it serves no purpose for creditors, the practical alternative to disclaimer is repudiation. The administrator causes the company to notify the counterparty that the contract cannot be performed. The counterparty may accept the repudiation and elect to terminate. Once terminated, the counterparty's loss crystallises as a damages claim provable as an unsecured debt in the administration or any subsequent liquidation. The ongoing performance obligation ends and so does the administrator's exposure under section 443A. A continuing liability becomes a one-time provable debt without requiring Court intervention.
Before taking that step, administrators must be satisfied that terminating the contract is in the interests of creditors. A contract with value to a potential purchaser or DOCA proponent may be worth more on foot than terminated.
Leases: the 5-business day rule
The statutory framework governing leases is different from other contracts. Under section 443B(2), an administrator is personally liable for rent under any lease the company continues to use or occupy after appointment. The Act provides a 5-business day grace period. Within those 5 days, the administrator can serve a notice under section 443B(3) stating that the company does not propose to exercise rights in relation to the property. That notice relieves the administrator of personal liability for ongoing rent. It does not terminate the lease.
In complex administrations involving large numbers of leases, 5 business days is often insufficient to make informed decisions about which premises to retain. In those circumstances, administrators should apply promptly to the Court either under:
· section 443B(8) for relief from personal liability, or
· section 447A to extend the notice period.
In Crosbie IMO Godfreys Group Pty Ltd [2024] FCA 60, Beach J granted relief under sections 443B(8) and 447A where the administrators faced approximately 150 leases across multiple counterparties and franchise structures. The Court accepted that the complexity of the arrangements made it impractical to form a view within the statutory period, applying the principle that relief is warranted where an administrator "has had insufficient time to conduct the necessary investigations to decide whether he or she thinks it best to retain or give up possession of leased property."
Court protection under section 447A
Section 447A gives the Court power to modify how section 443A applies to specified contracts, removing or limiting the personal exposure that would otherwise attach to every debt incurred in performing them. Courts have consistently granted that relief where continued performance serves creditors:
· In Secatore, in the matter of Fletcher Jones and Staff Pty Ltd (Administrators Appointed) [2011] FCA 1493, Gordon J held that orders under section 447A would "permit the Plaintiffs to make the commercial decision of what is in the best interests of the Company's creditors uninfluenced by concerns of personal liability."
· In Park, in the matter of IG Power (Callide) Ltd (Administrators Appointed) (No 2) [2024] FCA 1244, Derrington J made such orders in respect of a funding deed and 2 pre-administration operational contracts the administrators had to continue performing to preserve the business for creditors, holding that such orders allow an administrator to "continue the commercial operations of the company in question, uninfluenced by possible concerns of personal liability" and "focus on the best outcome for the company's creditors."
· In Crosbie IMO Godfreys Group Pty Ltd [2024] FCA 60, Beach J granted relief across leases, employment contracts and a funding arrangement simultaneously, holding that such orders "will facilitate them making commercial decisions in the best interests of the companies and creditors uninfluenced by concerns of personal liability" and that without the orders, the administrators would have been unable to sustain trading, resulting in a less favourable outcome for creditors.
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Critical insight |
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The test is set out in Re Mentha (in their capacities as joint and several administrators of the Griffin Coal Mining Company Pty Ltd) [2010] FCA 1469 at [30]:
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These applications are not a formality. Each requires careful preparation and credible evidence. An opposed application will be scrutinised closely.
The DOCA path
A Deed of Company Arrangement offers a separate mechanism for dealing with onerous contracts where the company has a future. Under section 444H, a DOCA can release a company from a debt where the deed expressly provides for it and the creditor concerned is bound. The flexibility has real limits, however: a DOCA cannot be used to extinguish the debt of a particular creditor while paying all others in full, without rational commercial justification.
· In Academy Construction & Development Pty Ltd [2024] NSWSC 808, Black J terminated a DOCA that capped one creditor's recovery at $200,000 while all others received full payment. His Honour found that the cap had been chosen "for no better reason than that the deed proponent wished to extinguish" the creditor's claim for that amount, and that no rational distinction had been established between the creditor whose claim was capped and those whose claims were paid in full.
· In Project Sea Dragon Pty Ltd (Subject to a Deed of Company Arrangement) v Canstruct Pty Ltd [2024] FCAFC 141, Jackman J held that "the lack of a valid justification for discrimination against a particular creditor is capable in itself of constituting unfair prejudice or unfair discrimination, even if there is no realistic prospect of that creditor being better off in a winding up than under the DOCA", and that a purpose of "expunging a particular creditor's debt which was unwanted, while paying all other arm's-length creditors in full before restarting operations in an almost identical position to the pre-DOCA state" was alien to the objects of Part 5.3A.
The practical lesson is that differential treatment of creditors under a DOCA needs a commercial rationale that accords with the objects of Part 5.3A that can withstand judicial scrutiny. Where it does not, the affected creditor can apply to have the DOCA terminated under section 445D, and the Courts have shown a clear willingness to grant that relief.
A practical checklist for administrators
1. Identify the exposure: Map the continuing obligations and the debts accruing under each contract. For leases, the clock runs from the date of appointment.
2. Act on leases within 5 business days: Serve section 443B(3) notices for any premises the company does not need. If the portfolio is too large to assess in time, apply to the Court immediately.
3. Assess whether continued performance serves creditors: If the contract has no value to creditors, consider repudiation. If it does, seek Court protection. If neither is clear, get legal advice.
4. Consider repudiation where performance serves no purpose: Notify the counterparty that the company will not be performing. If the counterparty accepts and terminates, the ongoing obligation ends and their loss becomes a provable unsecured claim.
5. Seek section 447A relief where performance must continue: Apply promptly, supported by evidence that the relief is in creditors' interests. Delay increases personal exposure.
6. Structure any DOCA carefully: Releases must be expressly drafted. Differential treatment of creditors requires a rational commercial basis that will withstand judicial scrutiny.
If you are dealing with onerous contracts in an administration, our restructuring and insolvency team can help you assess your options and manage risk.
Authors: Adam Cutri, Garrett Williams & Haya Kaiyum
This publication is intended as a source of information only. No reader should act on any matter without first obtaining professional advice.