developments in deeds of company arrangement - DibbsBarker

DEVELOPMENTS IN DEEDS OF COMPANYARRANGEMENTINSOLVENCY UPDATEALICIA HILL, PARTNERFINANCIAL SERVICESROBERT MULLINSFINANCIAL SERVICESJULY 200911899717 v1 Brisbane 05 08 091

TABLE OF CONTENTS1. INTRODUCTION........................................................................................................32. DEVELOPMENT OF DOCAS.....................................................................................33. RECENT CASES RELATED TO INTERPRETATION AND IMPLEMENTATION OFDOCAS ......................................................................................................................53.1 Priorities and the “pari passu” rule.................................................................53.2 Creditors’ voting rights...................................................................................83.3 Liquidation as an event terminating a DOCA...............................................114. RECENT CASES RELATING TO COURT INTERVENTION ...................................144.1 Refusal to terminate ab initio .......................................................................144.2 Winding-up in the best interests of creditors........................................164.3 Opting for a DOCA instead of winding up....................................................195. CONCLUSION .........................................................................................................2111899717 v1 Brisbane 05 08 092

DEVELOPMENTS IN DEEDS OF COMPANY ARRANGEMENT1. IntroductionThe purpose of this paper is to provide an update on the current treatment of issuesrelating to the use of Deeds of Company Arrangement (DOCAs) under the externaladministration regime in Australia. We begin with a recap of the background anddevelopment of DOCAs in Australia and then examine recent case law involvingdevelopments in judicial interpretation and implementation of DOCAs and courtintervention in the DOCAs procedure.2. Development of DOCAsVoluntary administration in the form of DOCA’s was introduced into Australian law byvirtue of Commonwealth legislation passed in 1993, and exist in its current form as Part5.3A of the Corporations Act 2001 (Cth) (Corporations Act). 1DOCAs were introduced in response to recommendations made by the Australian LawReform Commission in the Harmer Report. 2The Harmer Report recommended theintroduction of the DOCA procedure as a method of providing a flexible, swift,uncomplicated and inexpensive form of administering a company’s affairs prior to any1 For a further detailed consideration see Corporate Law Reform Act 1992 (Cth); C Anderson, DMorrison, “Should directors be pursued for insolvent trading where a company has entered into a Deedof Company Arrangement?” (2005) 13 Insolvency Law Journal 163, 163-164.2 Australian Law Reform Commission, Report No. 45, General Insolvency Inquiry (1988) ALRC 45.11899717 v1 Brisbane 05 08 093

prospective winding up. 3 DOCAs are designed to enable a company, through prudentadministration of its affairs in coordination with creditors, to return itself to solvency. 4A “Stocktake” report issued by the Joint Parliamentary Committee on Corporations andFinancial Services (Joint Committee) in 2004 reported that Deeds of CompanyArrangement represented around 40.5% of appointments of insolvency administrations. 5Views on the success of the DOCA as a form of voluntary administration have beenmixed. 6 The Joint Committee’s 2004 report highlighted a number of concerns over thefunction of DOCAs through attempts to oppress the interest of unsecured creditors andbolster the interests of selected stakeholders. 7 Changes have been made to the legislativeframework over the years to reflect some of these concerns. 8The current status of DOCAs is best summarised by McColl:“While DOCAs are a speedy, efficient, and often fair method of resolving solvencyissues and reinstating companies as a going concern, they bring with them the3 Ibid [54].4 Ibid [59].5Parliamentary Joint Committee on Corporations and Financial Services, CorporateInsolvency Laws: A Stocktake (Commonwealth of Australia Senate Printing Unit, ParliamentHouse, Canberra, 2004).6 See C Anderson, D Morrison, supra n 1.7 For an example of the concern over the use of the DOCA as an instrument of oppression see MHughes, “Oppression, prejudice and discrimination under deeds of company arrangement” (2000) 11Journal of Banking and Finance Law and Practice 124. See also Parliamentary Joint Committee onCorporations and Financial Services, Corporate Insolvency Laws: A Stocktake, ibid [5.21-5.25].8 See changes introduced into DOCA regime by Corporations Amendment (Insolvency) Act 2007 (Cth),and Australian Securities and Investment Commission, External administration: Deeds of companyarrangement involving a creditor’s trust (May 2005, RG 82).11899717 v1 Brisbane 05 08 094

inevitable disadvantage of potential abuse by opportunistic directors andadministrators. 9The global financial crisis has reintroduced a number of high profile instances ofcorporate insolvency into Australia’s public consciousness. This has the potential to bringincreased attention to the effectiveness of the DOCA regime and may be a harbinger forfuture reform.Recent cases have given the courts the opportunity to further consider the law relating toDOCAs, particularly around:(a)interpretation and implementation; and(b)when court intervention is appropriate.3. Recent cases related to interpretation and implementation of DOCAs3.1 Priorities and the “pari passu” ruleInternational Air Transport Association v Ansett Australia Holdings Ltd 10containeddetailed discussion by the High Court of the priority arrangements that may arise duringthe administration of a DOCA and consideration of arrangements potentially designed to9 S McColl, “Voluntary Administrations: How Well are they Working?” (2001) 12 Australian Journalof Corporations Law 194, 215: “If the cases demonstrate how easily the procedure is abused, thenperhaps that should be seen as the down-side of ease of use”.10 (2008) 234 CLR 151.11899717 v1 Brisbane 05 08 095

circumvent usual priority rules prescribed in Part 5.3 of the Corporations Act, inparticular the “pari passu” rule. 11FactsAnsett collapsed in September 2001, and administrators were appointed over thecompany’s affairs. Ansett was, at that time, a member of the International Air TransportAssociation (IATA) Clearing House. “Clearing house” arrangements are part ofagreements between various airlines to provide for the payment for services rendered byairlines that carry the passengers and cargo of airlines also party to the arrangement.Airlines could lodge claims for payment with a clearing house body in which theyamassed a series of debits and credits.In March 2002, the Ansett’s creditors resolved to enter into a DOCA.During the course of the DOCAs administration, the IATA clearing house lodged a proofof debt for around $4 million arising from a clearing house agreement. The DeedAdministrators rejected the poof of debt lodged by the clearing house. Normally, the “paripassu” rule under s 555 of the Corporations Act operates so that creditors of the samepriority receive the same percentage share of the proceeds of administration. Section 555is normally imported into DOCAs under Part 5.3 of the Corporations Act. The DeedAdministrators also sought to recover from other members of the IATA scheme, allegingthat they were indebted to Ansett.11 See also J Harris, A Hargovan, “The Scope of the Pari Passu Rule: Ansett and British Eagle” (2008)17 Australian Insolvency Journal 37.11899717 v1 Brisbane 05 08 096

IssueThe Court was asked to decide whether or not the clearing house arrangement was anagreement designed to give priority to the participating airlines over other unsecuredcreditors. The Court had to determine whether rights accrued between participants underthe clearing house arrangement, or whether rights merely accrued for or against theclearing house itself.DecisionThe High Court found that the contract did not violate the pari passu rule. The airlineswere held to have agreed that their legal rights to payment would arise with the clearinghouse and not with other participants in the scheme. The arrangements stated clearly thatthere was no enforceable debt between the airline participants.Ansett had argued that the clearing house arrangement circumvented the order ofpriorities set out in the DOCA. This argument was dismissed by a majority of the HighCourt. Rather, the Court found that the arrangement reflected legitimate dealings withcompany property before the DOCA came into being. The DOCA could notretrospectively alter these arrangements.The decision indicates the High Court’s willingness to recognise commercial dealingsentered into in good faith between creditors prior to insolvency as having priority over thenormal legislative arrangements under a DOCA. The High Court did not read the11899717 v1 Brisbane 05 08 097

contractual arrangements down in order to impose a particular scheme of determiningpriority between creditors under the DOCA.3.2 Creditors’ voting rightsMaylord Equity Management Pty Ltd v ReelTime Media Ltd 12 considered an applicationfor termination of a DOCA on the grounds that Deed Administrators had unfairly dealtwith the Maylord’s creditor claim. The case provides an interesting example of a DOCAwhich has the effect of suppressing the interests of an individual creditor.FactsReelTime Media Ltd (Reeltime) was placed in voluntary administration on 6 March2008. On 9 May 2008, the creditors of ReelTime resolved to approve a DOCA. MaylordEquity Management Pty Ltd (Maylord), claimed to be a creditor of ReelTime. Maylordvoted against the resolution to execute a DOCA at the second creditors’ meeting. TheDOCA was executed on 30 May 2008, and Maylord applied to have the DOCAterminated pursuant to s 445D of the Corporations Act 2001 (Cth).Maylord sought relief on the grounds that the Administrators had wrongly estimated thevalue of its claim to limit their potentially decisive voting power. Maylord argued thatthis was grounds for termination of the DOCA under s 445D. Maylord valued their claimat $1 million, whereas the Administrators argued that the true value of the claim wasaround $10,000.12 [2008] NSWSC 104511899717 v1 Brisbane 05 08 098

The Administrators argued that even though a loan of $1 million had admittedly beenmade to Reeltime, the loan had been induced by a misrepresentation made by Maylord,and therefore was not claimable under the DOCA.IssueThe Court was required to determine first whether or not the true value of the claim was$10,000, as claimed by the Administrators and then whether or not the Court shouldexercise its discretionary power to terminate the DOCA.DecisionThe Court rejected the Administrators’ claim that they had correctly assessed Maylord’sclaim as $10,000. The Court said the Administrators’ reasoning was “specious” andsuggested that the argument had not been made in good faith. Palmer J stated:“The Administrators have valued Maylord’s claim for $1M at nil by a process ofreasoning which began with a wrong assertion that Maylord had provided “noevidence”, proceeded by misstating the nature of Maylord’s claim and concluded byapplying the wrong basis of assessment.”The Court held that as a result of the unjust estimation of their claim, Maylord had beendeprived of their rightful voting rights at the second creditors’ meeting. The Courtreasoned, based on the material before it, that if Maylord’s full claim had been included,the vote in favour of the DOCA would not have carried as the claims of the creditors who11899717 v1 Brisbane 05 08 099

voted in favour of the resolution were found to have totaled to a mere 25% of the truevalue of Maylord’s claim.The Court noted that the discretion to terminate a DOCA under s 445D(1) was a wide oneand that establishing one or more of the possible grounds for termination of a DOCA wasnot decisive of an application under s 445D(1).The Court found that a strong prima facie case was made out for termination on thegrounds that effect would not have been given to the DOCA but for the unjust procedureemployed by the administrators in the case. It did not find any discretionary factors whichweighed against the termination of the DOCA.The Administrators attempted to argue that the DOCA remained in the best interests of allof the creditors, but the Court rejected this argument. The Court found that theAdministrators had not properly taken into account Maylord’s interest in determining thebest interests of the creditors.The Court’s decision in Maylord reflects on the need to afford full procedural fairness tocreditors under a DOCA. Courts are likely to view inadequate approaches to a creditor’sright to vote on a DOCA arrangement under Part 5.3 of the Corporations Act as givinggrounds for terminating a DOCA.11899717 v1 Brisbane 05 08 0910

3.3 Liquidation as an event terminating a DOCAIn Parker, Re Strongest Link Pty Ltd (in Liq) (2008) 250 ALR 118 the Court consideredan application from a plaintiff who was both a liquidator of the company and a DeedAdministrator under a DOCA to consider whether a DOCA should be terminated on thebasis that it no longer provides assistance to unpaid creditors.FactsMr Parker was the liquidator of Strongest Link Pty Ltd. He made an application to theFederal Court to seek a determination of how he should deal with surplus money held in adeed administration fund on the company’s behalf.The company had been the subject of a court ordered winding-up, which appointed MrParker, the previous administrator, as a liquidator of the company. At the time of MrParker’s appointment as liquidator and the commencement of winding up, the DOCA wasstill on foot. Two creditors had not received dividends to which they were entitledpursuant to the DOCA. A decision to terminate the DOCA would deprive them of thesedividends. The DOCA did not provide for self-termination after the winding up of thecompany. On the other hand, to allow the DOCA to proceed after winding up wouldprejudice unsecured creditors who were not covered by the terms of the DOCA.IssuesThe Deed Administrator sought directions from the Court as to whether the DOCA:11899717 v1 Brisbane 05 08 0911

(a)created a trust whereby the Deed Administrator held funds for either theCompany or Deed Creditors; and(b)should be terminated and the company wound up thus allowing the liquidatorto perform his duties.DecisionThe Court held that the DOCA could be terminated and winding-up commenced, as theDOCA could no longer assist unpaid creditors.The Court noted that section 471A of the Corporations Act prevents officers of acompany from exercising their powers following the appointment of a liquidator. Thismeant that the Deed Administrator (who was an officer of the company) was unable toexercise their powers under the DOCA. Ownership of the company’s assets passed ontothe liquidator.It followed that in a case such as the one before the Court where a company is underadministration subject to a continuing DOCA, after a Liquidator is appointed, the DeedAdministrator ceased to be able to perform any function or power under the DOCA, butthat at the same time, the creditors were bound by the DOCA.The Court then considered whether or not the Liquidator was required to apply the assetsof the company in accordance with the DOCA, or on accordance with the statutoryprovisions relating to liquidation.11899717 v1 Brisbane 05 08 0912

If the administrator were required to comply with the statutory liquidation provisions, theCourt would need to make an order terminating the DOCA, so as to remove theLiquidator from any scenario involving a conflict of duties.The Court concluded after an examination of the case law in the area that the DOCA didnot impress a trust upon the Deed Administrator to hold property on behalf of DeedCreditors. The Court held 13 (at [48]):“There is no reason to impress upon the administrator a trust so that the company isdivested of its assets upon the execution of the deed of company arrangement. It is enoughthat the administrator is obliged to deal with the assets of the company in accordancewith the directions given by the company by its execution of the deed of companyarrangement. …. There is nothing in the statute which suggests that an administrator is tobecome the trustee of any fund created by the company pursuant to a deed of companyarrangement. There is nothing to suggest that the administrator should occupy anydifferent position to a liquidator. The purpose of an administration is to get in theavailable assets and distribute them to the creditors; in the case of an administrator inaccordance with the deed of company arrangement and in the case of a liquidator inaccordance with the statutory scheme.”Given the finding that the Deed Administrator was not impressed with a trust in favour ofthe creditors, the Court found that the Deed Administrator had no further work to do, andcould not assist the unpaid creditors. The Court resolved that it was in the best interests ofall parties to terminate the DOCA under section 445D of the Corporations Act and permitthe Liquidator to wind up the company pursuant to the statutory scheme.13 At para [48].11899717 v1 Brisbane 05 08 0913

4. Recent cases relating to court intervention4.1 Refusal to terminate ab initioIn Parkview Constructions Pty Ltd v Tayeh and Ors 14 the New South Wales SupremeCourt dismissed an application to terminate a DOCA under section 445D(1) of theCorporations Act where it was alleged that the DOCA was “unjust, oppressive,discriminator and unfair”.FactsSydney Civil Excavation Pty Ltd (Sydney Civil) entered into a DOCA and appointedDeed Administrators with the deed providing for termination upon creation of a schemecomprising of the creditors under the deed. The scheme was created immediately after thedeed was executed, and the DOCA subsequently terminated. Parkview sought to have theDOCA terminated ab initio in a way that would render the subsequent scheme invalid.IssueThe Court was asked to determine whether or not the DOCA could be terminated abinitio, in a way that the DOCA could be regarded as never having had any effect.14 [2009] NSWSC 18611899717 v1 Brisbane 05 08 0914

DecisionThe Court found that the DOCA was validly terminated after the arrangement of thescheme by virtue of section 445C(c) of the Corporations Act, which provides that a deedwill terminate on occurrence of circumstances specified in a DOCA.The Court held that termination under section 445C(c) was termination of precisely thesame kind and quality as that which can be achieved through an order of the Court undersection 445D. The Court held that such an order would have no utility, and for this reasonwas not made.Section 445H of the Corporations Act provided that “termination or avoidance, in wholeor in part, of a deed of company arrangement does not affect the previous operation ofthe deed”. Parkview claimed that section 447A of the Corporations Act provided a basisfor voiding a DOCA ab initio.The Court conceded that there was a possibility that such an order could be granted,referring to obiter discussions of the issue in Kyle House Pty Ltd v ACN 000 016 213 PtyLtd 15 . Parkview could not rely on section 447A however because they had not advancedtheir case for reliance on that provision in its submissions.The Court held that there was a clear requirement that parties seeking relief under aparticular provision of the Act identify that provision at the outset. Parkview only everforeshadowed a case for termination of the DOCA based on section 445D of the Act and15 [2007] NSWSC 224.11899717 v1 Brisbane 05 08 0915

this was not granted. The outcome of this case may have altered if relief had also beensought pursuant to section 447A from the outset.4.2 Winding-up in the best interests of creditorsIn Re Storm Financial Ltd (Receivers and Managers Appointed) (AdministratorsAppointed), 16 the Australian Securities and Investment Commission (ASIC) sought ordersfor a winding-up of the company prior to the second creditors’ meeting that wasscheduled to vote on a proposed DOCA.ASIC was relying on section 445D of the Corporations Act which provides that wherecourts are convinced that execution of a DOCA is not in the best interest of thecompany’s creditors, they may make an order to terminate the DOCA.FactsStorm Financial Ltd (Storm) was an Australian financial planning business with a highpublic profile in Northern Queensland. Following the collapse of the global economy inlate 2008, Storm indicated that its directors had resolved to appoint administrators overthe company. On 15 January 2009, the Commonwealth Bank of Australia, as a securedcreditor of Storm, appointed Receivers and Managers over the company and its property.Following the appointment of Administrators, who conducted a routine investigation ofthe company’s affairs, a second creditors’ meeting was called. The Administrators’ report16 [2009] FCA 269.11899717 v1 Brisbane 05 08 0916

ecommended that Storm be wound up. Their recommendation notwithstanding, theAdministrators also enclosed the details of a DOCA proposed by the company’s directors.It would therefore be open for creditors to accept the proposed DOCA, notwithstandingthe recommendation of the Administrators.ASIC, however, intervened by applying to the Federal Court for Storm’s winding upbefore the creditors had the opportunity to vote on whether or not to adopt the proposedDOCA.IssuesThe critical issue was whether or not ASIC’s application should be adjourned to allow thecreditors to consider and vote on the DOCA proposal.DecisionSection 440A of the Corporations Act allowed the Court to adjourn a winding upapplication where the Court was convinced that it was in the best interests of the companyand its creditors to continue under administration.ASIC argued that winding-up was necessary because Storm were insolvent, informationmade available to creditors regarding the DOCA was misleading and that as a result itwas “just and equitable” for the Court to wind up Storm.11899717 v1 Brisbane 05 08 0917

The Court was satisfied that Storm should be wound up on the grounds of insolvency, aswell as on the grounds that it was “just and equitable to do so”. The directors could notsatisfy the Court that it was in the best interests of the creditors to continue with theadministration and consider the DOCA.One important factor in the Court’s decision to grant the winding up application was thedetermination that the information memoranda distributed by Storm’s directors about theDOCA was misleading as to the rights and liabilities attendant on creditors under theproposed DOCA. In particular the directors proposed to establish a fund for creditorscontaining $2 million. The fund was, in actual fact, subject to Supreme Court litigationwhich meant that it may never have become available to the creditors.The Court held that the information memorandum “seriously misdescribes not only thecontingencies that attend the payment of the DOCA sum …but also the difficulties thatwill attend recovering monies for the benefit of creditors”. 17Where challenged proponents of a DOCA will need to provide sufficient evidence thatcontinued administration is in the best interests of the creditors to support theadjournment. 18 A Court will otherwise have the ability to scrutinise and rule on whether itis in the best interests of creditors to proceed with the administration or wind up thecompany. Where information made available to creditors is considered to be sufficientlymisleading the Court and indeed ASIC appear willing to intervene.17 Ibid [49].18 For further discussion see S Guthrie, A Hill et al., “An Imperfect Storm” (2009) 17 Insolvency LawJournal 36.11899717 v1 Brisbane 05 08 0918

4.3 Opting for a DOCA instead of winding upIn Palmer and Collis and Terraplanet Limited (in LIQ), Re Terraplanet Limited (inLIQ) 19 the Federal Court considered an application to have a winding up order terminatedso that a DOCA could be executed. The decision gives useful insight into thecircumstances in which a DOCA will be considered a desirable form of administration forcompanies approaching insolvency.The decision contrasts with the decision in Storm Financial. In Storm Financial, theCourt intervened to prevent execution of a DOCA and impose a winding-up; inTerraplanet the Court intervened to terminate a winding-up so that a DOCA could beexecuted.FactsTerraplanet Ltd, were initially given a winding-up order by the Court.Following the winding up order, Terraplanet Ltd received a proposal to recapitalise thecompany through which $1,800,000 of cash would be injected into the company in returnfor shares. The offer to recapitalize was conditional on Palmer and Collis, beingappointed as administrators of Terraplanet Ltd and the creditors of Terraplanet Ltdresolving to execute a DOCA. Recapitalisation would have meant that ordinary,unsecured creditors of Terraplanet would receive a distribution of approximately 15 centsin the dollar and approximately 2,500 shareholders would retain one share for every eightthey held.19 [2008] FCA 582.11899717 v1 Brisbane 05 08 0919

The Court was also satisfied that the company’s execution of the DOCA was consistentwith the objects of the Voluntary Administration regime established in Part 5.3 of theCorporations Act. The object of a DOCA is to provide for the business, property andaffairs of an insolvent company to be administered in a way that maximised the chancesof the company continuing in existence. The situation before the Court was found to beexemplary of this purpose.The Court also gave significance to Regulatory Guide 82, released by ASIC in May 2005as a guide for Administrators where a proposed DOCA or variation of a DOCA involvesa creditors’ trust. 20The Court noted that the liquidators had complied with the regulatoryguide, indicating the bona fides of the recommendation to accept the proposal in thecreditors’ best interests.5. ConclusionThe recent case law demonstrates a number of lessons from those contemplatingutilisation of the DOCA regime.First, the decisions in Maylord and Storm Financial provide timely reminders of thepotential for abuse of the DOCA regime by company officers seeking to avoid liability, orto oppress the interest of individual creditors. This is one area of insolvency law that maybe targeted for parliamentary review in coming years.20 Supra, n 9.11899717 v1 Brisbane 05 08 0921

Courts have shown a willingness to adopt interventionist approaches to determinewhether or not companies should be wound up, or whether a second creditors’ meetingshould be allowed to consider of vote on a DOCA. The Storm cases indicates that Courtswill order the winding-up of a company where it is in the clear best interests of thecreditors and public at large to do so. By contrast, in the Terraplanet decision, the Courtwas willing to terminate a winding-up in circumstances where the best interests of thecompany clearly favoured a DOCA. This trend towards increased court supervision islikely to continue, with both regulators, creditors and the public at large increasinglydirecting their attention towards potential misuse of Voluntary Administrationprocedures.The Parkview Constructions decision however opens up the door as to whether or not it ispossible for a court to terminate a DOCA ab initio where it is in the interests of justice todo so.With global financial uncertainty and the increase of recourse to arrangements that permitthe continued survival of companies and businesses the utilisation of DOCAs willcontinue and develop further the law surrounding their interpretation, implementation andtermination. The cases discussed in this article provide useful indications of early trends.The material contained in this publication is no more than general comment. Readers should not act on thebasis of the material without taking professional advice relating to their particular circumstances.© DibbsBarker 200911899717 v1 Brisbane 05 08 0922

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