Court terminates director friendly DOCA on application of minority creditor

The voluntary administration regime is intended to maximise the chance of a company continuing or to provide a better return to creditors than an immediate winding up of the company.  The regime offers great flexibility.  This leaves it open to abuse by directors and related entities seeking to avoid legitimate debts, scrutiny of their conduct or to obtain a direct benefit for themselves.

Recently, Results Legal successfully obtained a judgment in the Supreme Court of New South Wales on behalf of a client to terminate a deed of company arrangement (DOCA).  The company was placed into liquidation.

After our client won a trial in the Federal Court against the company, the company was placed into voluntary administration by its director.  Our client also successfully opposed an appeal by the company in the Full Court of the Federal Court of Australia.

The DOCA was voted up on the voices of the 12 related and director friendly creditors who also agreed not to participate in any dividend from the deed fund (related creditors had the voting majority in both numbers and value).  The DOCA was forecast to provide a return of 1.97 cents in the dollar to the participating creditors.

Our client commenced further proceedings in the New South Wales Supreme Court to set aside the DOCA and place the company into liquidation on the grounds that entry into the DOCA was an abuse of the administration provisions under Pt. 5.3A of the Corporations Act 2001 (Cth) (Act) by the director.

On 10 July 2020, Justice Black terminated the DOCA and placed the company into liquidation.  His key findings are below.

  1. The two creditors who would benefit in a minimal way from the DOCA, at the point it was executed, opposed it. However, they would not benefit because the deed fund was exhausted by the deed administrator’s remuneration and outlays before the hearing.
  2. The twelve creditors who voted in favour of the DOCA were associated with the company and its director. They would receive no apparent benefit from the DOCA other than any collateral advantage obtained by the director and related parties of deferring or avoiding any claims against them.
  3. The DOCA did nothing to promote the continued operation of the company’s business.
  4. The entry into the DOCA was an abuse of the process of Pt 5.3A of the Act and that an order should be made to preserve the integrity of Pt 5.3A of the Act.

To read the full decision of Justice Black in Re Citadel Financial Corporation Pty Ltd (subject to Deed of Company Arrangement) [2020] NSWSC 886 in the New South Wales Supreme Court, please click here.

Notably, this judgment followed an earlier landmark decision in Australia for the general proposition that the views of unrelated creditors, in these circumstances, will prevail over those of related creditors.  We conducted that case leading to the judgment in 2014 (a link to the judgment in Re Sales Express Pty Ltd (Administrators Appointed) [2014] NSWSC 46 is here).

Takeaways

  1. Where creditors vote in favour of a DOCA which offers no benefit for them and which the unrelated creditors do not wish to have imposed on them, generally speaking, the interests of the unrelated creditors will prevail.
  2. Directors and related parties cannot use the voluntary administration regime through their control of the majority of creditors, to avoid having their conduct of the affairs of the company scrutinised, at least where the unrelated creditors desire that to happen.
  3. It is a double-edged sword for creditors who seek to vote in favour of a DOCA yet stand to receive no financial benefit (via an agreement to defer not to participate in any deed fund). Their views at voting or review time will generally not apply over those of the unrelated creditors that are affected.
  4. Insolvency practitioners should bear this decision in mind when determining what recommendation to make in their section 439A report and regarding the exercise of the casting vote on any resolution to adopt a DOCA.
  5. Unrelated creditors have strong rights in these circumstances and may achieve significant returns by developing and executing a strategy to exercise those rights.
  6. Creditors should take specialist advice regarding these matters without delay. Failing to act swiftly can result in the loss of rights.
  7. Directors and DOCA proponents should get specialised advice regarding DOCA proposals to avoid easy challenges by disgruntled creditors.

With the anticipated tsunami of new insolvencies as a result of the COVID-19 pandemic and recession, being aware of these key principles has never been more important for creditors, insolvency practitioners and directors.

Contact Us – We are here to Help!

If you need legal advice or representation of specialist commercial lawyers concerning a case involving your business, please contact our team at Results Legal on 1300 757 534 or use our contact form to send us a message.