DOCA kept on track: Why the Court is reluctant to de-rail a DOCA

In Shafston Avenue Construction Pty Ltd, in the matter of CRCG-Rimfire Pty Ltd (subject to deed of company arrangement) v McCann [2019] FCA 1426 (Rimfire), Justice Reeves considered an application to set aside a deed of company arrangement (DOCA) under section 445D of the Corporations Act.¹

Background

China Rail and Rimfire Constructions Pty Ltd (Rimfire) entered into a joint venture for the purpose of engaging in construction projects in Queensland.The joint venture company, CRCG-Rimfire Pty Ltd (CRCG), obtained a licence from the Queensland Building and Constructions Commission (QBCC) for engaging in those projects.

The licence required China Rail and Rimfire to each enter into deeds of covenant with CRCG and QBCC whereby, if CRCG were to be wound up, each would pay a defined amount (DCA).  CRCG went into administration less than 24 months later and a dispute arose between China Rail and CRCG over the enforceability of the DCA.

A DOCA was proposed whereby China Rail would contribute $8 million with the result that the creditors of CRCG would receive an estimated 40 to 58 cents in the dollar.In return, China Rail was to be released from all claims arising in relation to the DCA.

At the second meeting of creditors, an equal number of creditors by number voted for and against a resolution to enter into the DOCA.  The administrator, as chair, exercised a casting vote in favour of the resolution and the DOCA was executed.

Why was the DOCA contested? 

The plaintiffs’ principal complaint arose because there was a prospect of creditors receiving a return in a liquidation scenario that was superior to the likely return under the DOCA.

This primarily arose because:

• Under the DOCA, the creditors would receive between 40 to 58 cents in the dollar and the claims against China Rail would be compromised.
• If, instead, China Rail were forced to meet its alleged obligations, the creditors would likely receive 100 cents in the dollar.

Additionally, there were allegations of insolvent trading which would not be investigated or pursued if the DOCA was entered into.

As regards pursuing the claim against China Rail, the Administrators formed the view that there were likely risks and delays that would be associated with obtaining a judgment against China Rail in Australia, and difficulties and expense likely to be encountered in enforcing that judgment in China, where China Rail’s assets were located.

As regards possible insolvent trading claim, the administrators had identified potentially recoverable losses in the order of $800,000 (representing approximately 2-5% of the company’s total debts).  This related to a trading period of around 7 weeks.

Terminating a DOCA

The Court undertakes a two stage process in considering an application to terminate a DOCA under s445D(1) of the Act.  The first is to determine whether one of the grounds in subsection (1) has been established and, if it has, the second stage is to decide whether to exercise the discretion to terminate the DOCA.

Alleged grounds for termination

The plaintiffs submitted that the DOCA should be terminated on three grounds.

Unfair prejudice

The plaintiffs argued that the DOCA was “unfairly prejudicial” to them.  The Court held that, beyond complaining about the fact that they would receive less than the amount owed to them, they had not established any unfair prejudice.  “Unfair prejudice” requires an additional element of unfairness not demonstrated here.

Contrary to the interests of creditors

Secondly, the plaintiffs submitted that the DOCA was contrary to the interests of the company’s creditors as a whole because of the potentially superior returns in a liquidation scenario where the claim against China Rail and the insolvent trading claims could be pursued.
The Court held that:

• the onus is on the plaintiff to establish that there is a “not unrealistic” prospect of obtaining a better return for creditors by pursuing proceedings and investigations; and²
• having regard to the Administrators’ opinions and the evidence presented in relation to the difficulties of pursuing the China Rail claims, the plaintiffs had failed to discharge their onus to show a realistic prospect of obtaining a better recovery by pursuing the claims.³

"Some other reason"

The final ground submitted by the plaintiff was that the DOCA should be terminated for “some other reason” within the meaning of s 445D(1)(g) of the Act.  The “other reason” alleged was that the DOCA was contrary to public policy as it had the effect of excluding investigations of potential insolvent trading by the directors.

In rejecting the third ground, Reeves J observed that the plaintiffs did not point to any particular feature of insolvent trading, nor any other conduct of CRCG or its officers, that warranted investigation in the public interest to show there is some “sufficient reason” for the termination of the DOCA under s 445D(1)(g).⁴

Discretionary matters

Although the Court held that no ground for termination of the DOCA had been made out, it also held that even if such a ground had been made out the Court would not have exercised its discretion to terminate the DOCA.  It cited a number of factors including the caution that is urged when a court is considering whether to terminate a DOCA and the fact that in this case the DOCA was supported by the largest creditor by value and the largest public creditor, the Australian Taxation Office.

Lavan comment

Rimfire again illustrates the Court’s reluctance to terminate a DOCA.  In this case, even if the necessary grounds for terminating the DOCA under s445D had been made out, the Court would not have exercised its discretion to terminate the DOCA.