A legal perspective on GAME’s Diablo III pre-order situation

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As a lawyer with specialist knowledge on the topic of ‘insolvency’, I initially had a professional interest in the appointment of administrators to GAME.  As a gamer with a deposit paid at GAME for Diablo III, my professional interest became a personal concern.

Australia’s administration and liquidation laws are complex, voluminous and unless you have a working knowledge of the system set out in the Corporations Act 2001 (Cth) (Act), they are unlikely to make much sense.  For example, it seems to fly against common sense that:

  • someone who has paid for a pre-ordered game won’t get it;
  • GAME was continuing to trade (despite being under administration); or
  • people are being fired by PricewaterhouseCoopers (PWC), who are accountants and not the directors of the company.

I’ll try and not make this article too ‘legalistic’, but at the same time, I want to give you a more in-depth understanding about why things are happening, how Australia’s administration and liquidation system works and what happens next.

Why the director of a failed company can own a Ferrari

The principle that directors of companies are separate from the company themselves goes back over a hundred years to the shoe shop of Mr Salamon on Whitechapel High Street in East London (that’s another story, and not an exciting one).  Importantly, the Court in that case held that, among other things, a director cannot be held liable for the debts of a company.

This is why, if things go badly, a company director can throw their hands in the air, have the company wound up, jump into their sports car and drive home to their multi million dollar mansion knowing that the car and the house are safe (well, at least from the company’s creditors).

While it sounds unfair, it’s a rule with a practical purpose – without that protection, who in their right mind would ever open a business or run a shop?

However, even in Salamon’s case, there were exceptions to the rule.  Fast forward to modern Australia, section 588G of the Act states if a company incurs a debt and there were reasonable grounds for suspecting that the company was insolvent at the time the debt was incurred then the director/s who caused the debt to be incurred can be personally liable for that debt.

With a business as large as GAME, constantly turning over stock and expenses (such as rent), this exposure could have been huge.

Importantly, there are defences available to directors.  For example, section 588H(6) states that it is a defence to the insolvent trading claim if the director took reasonable steps to prevent the company incurring the debt which includes, among other things, appointing an administrator.

Therefore, by appointing an administrator to the company, the directors of GAME will be protected from any claim that they are personally liable for the debts incurred after that point but the company must now work its way through the ‘voluntary administration’ process.

Applying CPR, or digging the grave

Make no mistake, GAME is in cardiac arrest.

While that may sound dire, think of an administrator as someone who applies CPR, although it is the creditors who decide whether the company ‘lives’ (and in what form) or ‘dies’ (is wound up in liquidation).

An administrator’s job is to investigate the affairs of the company and take over responsibility for the business (if it can continue to be run) until it is time for the creditor’s to decide the company’s fate at the second creditor’s meeting, usually 5 weeks after the appointment.  The administrator, having conducted the investigation, will recommend to creditors what they think should happen next out of the options available.

The reason that the administrator may chose to run the business between the appointment and the second creditor’s meeting is because an entity which is trading has value.  Someone may offer to buy it, presenting an attractive outcome for creditors (if the price is right).

It is a tough decision to keep trading, particularly because the administrator takes responsibility for certain debts incurred running the business after their appointment, however, in practice, they usually make that money back and rarely continue to trade if there is too much risk involved.

As you may know, the decision has been recently made to close around 60 GAME stores and let go a wide range of staff.  This is most likely because the cost of running those stores was too high and the administrators did not want to take on too much risk as they could be personally liable for various debts necessary to keep the stores open.

Employees who were owed money as part of their employment can make an application to General Employee Entitlements and Redundancy Scheme (GEERS) and they will be paid what they are owed.  GEERS is like a Government safety net that makes sure people are not left in the cold if their employer goes into liquidation.

The closure of stores and letting go of staff, however, is not a good sign for the continued existence of GAME in Australia.

At the second creditor’s meeting, the creditors of the company then decide whether to:

(a) hand the company back to the directors (which is rare);

(b) enter into a deed of company arrangement (a contract which allows the company to continue, but usually subject to conditions such as, for example, creditors being paid out over time); or

(c) wind up the company (appoint a liquidator and start ‘digging the grave’).

In my experience, the best outcome is usually through a deed of company arrangement where a buyer is found for the business which usually means that the creditors get more money back than they would get if the company were simply wound up.

If, however, the debt problems are so bad that a deal with creditors cannot be made or agreed then usually the company is wound up (or placed into liquidation).  This means that a liquidator is appointed to the company whose job is to ‘dig the grave’ (ie. sell everything for the best price possible and pay the creditors what is left after costs such as the liquidator’s fees and employee entitlements are paid out).  The creditors usually only get a few cents out of every dollar they are owed.

The story of GAME is not an uncommon one, and appointments of administrators are becoming more frequent.  Just remember, the appointment of an administrator is never a good thing, but until the second creditor’s meeting, there is always a chance the company may survive in another form.

We’d like to extend a HUGE thanks to Andrew for this insightful and informative legal perspective on this particular facet of the Australian gaming industry. We’re also very excited to have Andrew on hand to offer his professional opinion for future matters! – Steve