Creditors' compromise Part 1: the New Zealand Supreme Court view
In a judgment of the Supreme Court of New Zealand (released 11 days prior to the decision in Lehman Brothers referred to below), the Supreme Court considered a compromise proposal by Trends under Part 14, section 230 Companies Act 1993 (read our previous updates on the Court of Appeal and High Court decisions). A compromise under Part 14 does not require Court approval once it has been approved by the required majority of creditors at a vote. Rather, under section 232, a creditor may apply to the court for a declaration that the compromise does not apply to a particular creditor or class of creditor if there has been unfair prejudice or material irregularity in obtaining the approval. A number of creditors had challenged the proposal by Trends, including Callaghan Innovation, the second largest of Trends' creditors affected by the compromise. Heath J found there had been unfair prejudice in the grouping of arms' length creditors with insider creditors for voting purposes and set the compromise aside. The Court of Appeal agreed that there had been unfair prejudice, and also found there was material irregularity because of the inadequate provision of information to creditors. Trends appealed.
The appeal by Trends turned on the approach to be taken to the classification of creditors. The Trends proposal had just one class of creditors, regardless of whether those creditors had any association with the company. Furthermore, under the proposal, those with smaller debts would be favoured over those with larger debts. The challenging parties voted against the proposal but it was nevertheless approved by the required majority (being a majority in number and 75 percent in value). The vote only passed the value threshold because the creditors who were associated with the company and who voted in favour of the proposal held approximately 74% of the total debt owed by Trends. The majority (William Young, Glazebrook and O'Regan JJ) commented that differential treatment of creditors is not necessarily unfair. "But differential treatment between creditors in the same class will almost inevitably raise concerns as to classification…"
In the case of Trends, the majority ultimately found that the compromise was objectionable because the arm's-length creditors were bound by a decision made by those on "the other side of the bargain". This was contrary to the policy objectives of Part 14. In addition, and also objectionable, was the fact that creditors being offered a minimal return on their investment were treated for voting purposes as part of the same class as creditors who were offered substantially better returns under the compromise.
Elias CJ and Ellen France J also dismissed the appeal, but for slightly different reasons. They considered that classes should be constituted based upon legal rights, and the inclusion of those with materially different legal rights in the same class is a "material irregularity" under s232(3)(b).
The minority also noted that when there could be possible claims in a liquidation against the directors of a company, that raised questions of conflict of interest in the promotion of a compromise by those directors to avert liquidation.
See the decision here.