NSW Supreme Court provides guidance for administrators as to the law regarding material omission or misstatement in administrators’ section 439A reports.

Background

Mr Ryan was the sole shareholder and director of Recycling Holdings Pty Ltd (the Company). Liquidators were appointed to the Company and the liquidator appointed voluntary administrators pursuant to s436B of the Corporations Act 2001.

At the time of the liquidation, the Company was pursuing a claim against three of its creditors (Salmat, Mediaforce and Fuji) for breaches of exclusivity clauses in service contracts. In that proceeding, Salmat, Mediaforce and Fuji had brought a cross claim against the Company (amongst others) in respect of unpaid monies.

In October 2014, at the second creditors meeting, a resolution was carried that the Company execute a DOCA. The effect of the DOCA was to:

  • return control of the company to Mr Ryan; and
  • establish a fund for distribution pro rata to creditors that would comprise both the proceeds of the litigation and the sale of the Company’s plant and equipment. 

If everything went to plan, the creditors were to receive a dividend of 100 cents in the dollar. If the anticipated proceeds of the litigation materially changed and the creditors were to receive less than 100 cents in the dollar, the creditors could terminate the DOCA.

Just under two months later, Salmat, Mediaforce and Fuji commenced proceedings for orders to:

  1. have the DOCA terminated or declared void on the basis of certain misstatements and omissions;
  2. have the DOCA terminated on the basis of non disclosure of voidable transactions; or
  3. have the administrators removed on the basis of actual or perceived bias.

The orders were sought on the basis that there were material omissions from, or misstatements in the information provided to creditors in the administrators’ s439A(4) report and at the second creditors’ meeting.

What were the material omissions?

Misstatements and omissions regarding the litigation

The creditors contended that that the administrators’ report omitted a number of vital pieces of information about the litigation including information about the merits and the existence of a conflict of interest which created an incentive to settle the claim.

The Court found that the failure to properly inform the creditors about facts known to or reasonably discoverable by the administrators about the litigation was a material omission.

Voidable transactions

The creditors also contended, and the Court agreed, that the administrators had failed to investigate or disclose in their report a potential unfair preference or uncommercial transaction recoverable from Mr Ryan of up to $500,000 and that this was a material omission.

Grounds for Termination?

Brereton J suggested that where there has been a material omission, it does not follow that the court is predisposed in favour of termination.  Relevant considerations include:

  1. the importance of the information;
  2. whether the creditors were actually misled; and
  3. the present attitude of the creditors once disclosure is made.

Given the relatively unusual circumstances of this case, Brereton J refused to exercise his discretion on the basis that the DOCA would likely have been approved by the creditors whether or not the omitted information had been disclosed and it was not oppressive or unfairly prejudicial to or unfairly discriminatory against one or more creditors, or contrary to the interests of creditors as a whole.

On his view, under the DOCA, the creditors would either receive 100 cents in the dollar as a result of the litigation, or, have the option of terminating the DOCA and pursuing the voidable transactions.

Reasonable Perception of Bias

Salmat, Mediaforce and Fuji argued that the administrators should be removed because of a perceived bias based on:

  1. certain pre-appointment discussions between the administrators, the liquidator and Mr Ryan concerning the terms of the DOCA; and
  2. other ambiguous circumstances such as the fact that certain potential voidable transactions were overlooked by the administrators, and, that the administrators furthered the interests of Mr Ryan – at least indirectly - in the pursuit of the litigation.

Ultimately the Court held that the matters discussed and the actions of the administrators did not lead to a reasonable apprehension of bias.

Brereton J confirmed that pre-appointment discussions will not be unreasonable if they involve a discussion of the potential terms of a DOCA with the proponent. In his Honour’s view, it is to be expected that administrators will form some preliminary views in respect of a DOCA and that predisposition towards a DOCA – particularly in the context of an appointment by a liquidator does not indicate disqualifying bias in favour of one interest or against another.

Comment

This decision is a reminder that while material omissions in a DOCA should be avoided, they will not always be fatal.  Further, a reasonable perception of bias will not necessarily arise in circumstances where an administrator has conveyed their preliminary views on a DOCA to the DOCA’s proponent prior to the administrator’s appointment.