Not As Easy As ACD… - DOCA Terminated For Unfair Prejudice

In the case of Re Academy Construction & Development Pty Ltd (subject to a Deed of Company Arrangement) [2024] NSWSC 808 (Academy), the Federal Court considered an application from a major creditor seeking orders for a Deed of Company Arrangement (DOCA) to be terminated under s 445D(1)(f) of the Corporations Act 2001 (Cth) (Act) and for Academy Construction & Development Pty Ltd (subject to a DOCA) (ACD) to be wound up.

Background

The plaintiff, The Owners – Strata Plan 90889 (Owners Corporation) were the owners corporation in respect of a strata property in Botany, New South Wales that was designed and constructed by ACD.  

The Owners Corporation sought an order that a resolution approving the entry into a DOCA be set aside and that the DOCA be terminated.

On 31 August 2023, the first defendants (Administrators) were appointed to ACD as voluntary administrators.  On 11 September 2023, the Owners Corporation lodged a proof of debt in the voluntary administration, quantified in the amount of $7,127,600 (plus GST and disbursements) as at 31 August 2023.

In email exchanges on 25 and 26 September 2023, there were discussions between ACD’s legal representatives and the Administrators regarding the treatment of certain creditors’ claims and including releases for the past and present directors in the DOCA proposal.

The DOCA proposal dated 26 September 2023 (DOCA Proposal) provided for a deed fund to be established including:

• an amount sufficient to discharge all Class A creditors in full; plus
• an amount sufficient to make available $200,000 to Class B creditors following costs and expenses of the Administration and the payment to Class A creditors.

The Owners Corporation was the only creditor falling within Class B.  Further, the DOCA Proposal provided for payment in a specified order of priority, where Class A creditors would be paid in full before any payment was made to the Owners Corporation.

The consequence of that was that if the deed fund was insufficient to cover the Administrators’ remuneration and disbursements, then the Owners Corporation rather than the creditors of ACD would likely bear the shortfall.

The DOCA Proposal also provided that the Owners Corporation must accept their entitlement under the DOCA in full settlement of any and all claims against the company.

The Court noted that the Administrators’ report to creditors “significantly understated the potential recoveries of a liquidation and overstated the advantage in a DOCA”.

At the second meeting of creditors, the majority number of creditors voted in favour of the DOCA despite the Owners Corporation representing nearly 90% of the total value of admitted creditor claims.  The DOCA had the effect that the Owners Corporation would only be paid after all other expenses, remuneration, priority employee claims and claims of ACD’s other creditors had been paid first, exposing the Owners Corporation to the risk that its claim would not be met at all if there was a shortfall in the deed fund.

The DOCA also provided for third-party releases to release and discharge all claims all parties (including directors and associated entities) once the arrangement in the DOCA was effectuated.  This meant that the Owners Corporation’s claim risked not being met if the deed fund was not sufficient to cover the Administrators’ remuneration.

Decision

Whether the DOCA was oppressive, unfairly prejudicial to, or unfairly discriminatory to the Owners Corporation

In determining whether a DOCA should be set aside for oppression, unfair prejudice or unfair discrimination, regard should be given to the general principles underlying Part 5.3A of the Act. Justice Black noted several considerations, including a creditor’s right to be paid or wind up a company, or have the company administered by the administrator in a way which will see the creditor paid from the company’s property.

The Court noted that whether to terminate a DOCA pursuant to s 445D of the Act involved a two-stage enquiry:

• first, whether one of the grounds in s 445D(1) is established; and
• second, after the first question has been established, whether as a matter of discretion the DOCA should be terminated.

The Court also made relevant observations in respect of s 445D(1)(f), including that:¹

• an order terminating a DOCA may be made if that deed is oppressive or unfairly prejudicial to, or unfairly discriminatory against, or more of the company’s creditors or is contrary to the interests of the creditors of the company as a whole;
• the fact that a DOCA is not supported by the majority creditor is not in itself a sufficient basis to set it aside;
• Part 5.3A of the Act assumes that the creditors are best placed to judge their interests;
• the mere fact that a creditor is prejudiced by the operation of a DOCA is not sufficient reason to terminate the deed;
• the test under s 445D(1)(f)(i) is not merely discrimination or prejudice, but unfair discrimination or unfair prejudice;
• Part 5.3A does not require a pari passu distribution.  What is required is a better return to creditors than an immediate winding up;
• when deciding whether a deed unfairly prejudices or discriminates against a creditor or group of creditors, consideration must be given to what those purportedly prejudiced creditors would receive on a winding up;
• there must be reasonable grounds for differentiation between creditors of an equal class that accord with the object and spirit of Part 5.3A;
• there will be circumstances where ordinary commercial common sense will demand a loss of priority and some degree of discrimination;
• where a deed proposes to preserve the company to achieve the objects of Part 5.3A, there should be no expectation of equal treatment of unsecured creditors where such treatment would defeat that purpose; and
• if there is no prima facie evidence of misfeasance, concealment or a materially inadequate preliminary examination, and the DOCA offers both real financial benefits credibly estimated on preliminary investigation to exceed those available on liquidation, and indirect or collateral benefits from the survival of the company’s business; and no worthwhile avenues for further recovery in liquidation are identified, a major creditor’s curiosity or preference for further exploration of speculative claims is unlikely to render termination of the DOCA in the interests of the creditors as a whole.

In this case, the Court found that the Administrators and ACD did not have any commercial or principled basis for the differential treatment of the Owners Corporation in the DOCA. 

There was a requirement under the DOCA that the Owners Corporation’s proof of debt be adjudicated and admitted before it could receive any payment.  The fact that the Owners Corporation’s claim was large and complex, and may have been costly to adjudicate, was not a justification for the deed proponent to arbitrarily cap the claim to avoid or minimise the requirement for adjudication of the claim.

The Court also considered that the Administrators’ calculation of the estimated returns under a DOCA and a liquidation were uncertain because they did not account for potential unfair preference and insolvent trading claims. There was no objective basis for the $200,000 cap on the Owners Corporation’s claim and held that it was an amount chosen simply to extinguish the Owners Corporation’s claim for that amount.

Justice Black was satisfied that there was a basis for terminating the DOCA on the ground that it was oppressive and unfairly prejudicial or unfairly discriminatory against the Owners Corporation pursuant to s 445D(1)(f) of the Act.  Additionally, there was no rational basis for the DOCA to rank the Owners Corporation behind the claims of other creditors, a position that put the Owners Corporation at risk of not being able to recover the amount of $200,000.  

The Court also held that the third-party releases were contrary to the purpose of Part 5.3A of the Act.  The proposed releases were fundamental to the DOCA and the director and ACD intended to include such releases.

Lavan Comment

This case highlights that the Courts are clear that differential treatment of creditors under a DOCA is not necessarily unfairly prejudicial or discriminatory and is permissible to an extent.  However, the Court’s decision in this case highlights the importance that all creditors need to be treated equitably and compelling rationales are required to substantiate differential treatment.

Further, administrators have limited time to consider creditor claims, especially where claims are legally complex and time consuming.

This case is a reminder for administrators to:

• carefully consider whether any differential treatment to creditors is commercially justifiable and not merely opportunistic; and
• ensure that DOCAs comply with and meet the requirements of Part 5.3A of the Act.

Third-party releases in favour of directors and officers of a company in a DOCA may also be viewed as an abuse of process where the court views a DOCA as being used to shield such parties from liability rather than for a genuine restructuring of a company for the creditors’ benefit.

Ultimately, this case is a useful demonstration of the Court’s willingness to terminate a DOCA if it is perceived as oppressive, unfairly prejudicial or discriminatory.

If you have any questions regarding this decision or the matters summarised in this paper, the experienced Lavan team is here to help.