The recent decision of the Federal Court in Canadian Solar (Australia) Pty Ltd v ACN 138 535 832 Pty Ltd (subject to deed of company arrangement) [2014] FCA 783, is a useful reminder that a deed of company arrangement (DOCA) approved by a majority of creditors at the second creditors meeting can still be terminated by order of the Court if it is found to be unfairly prejudicial to one or more creditors or contrary to the interests of creditors as a whole. 

This can be particularly important where, as in this case, a DOCA proposal or previous transaction involves suspected “phoenix activity”. That is, where some or all of the assets and/or business of a distressed company are reborn in a new business controlled by parties related to management of the previous entity. Creditors’ debts remain unpaid or only partially repaid, yet management emerges in control of a new company and their actions remain unscrutinised by liquidator investigations.

FACTS

Redset was a distributor and supplier of solar technology. It was owned and controlled by Mr Young. Redset encountered financial difficulties. Mr Young entered into an agreement with “The Mawson Group”, a firm of business advisors, to identify a buyer for and to sell the whole of Redset’s business.

As a result, the AJK Group Pty Ltd (AJK) was incorporated. An employee of the Mawson Group was the sole director of AJK and trustee companies were the shareholders. The same day, Redset entered into an agreement with AJK for the sale of the whole of Redset’s business assets. Payment of the purchase price was structured so that AJK did not transfer any funds to Redset, but simply assumed the secured debts of Redset and some key employee liabilities. Otherwise AJK had the option to decide which unsecured debts might be taken over to keep the business operating. Mr Young was the manager of the solar business now undertaken by AJK. A hefty fee was paid to the Mawson Group.

The effect of the asset sale agreement was to deprive Redset of all its assets, leaving it a bare corporate shell, with its business being reincarnated in AJK. On its face, the transaction had the appearance of a phoenix transaction to which Mr Young committed the company in breach of his fiduciary duties, particularly given his duties extended to the interests of creditors given Redset’s distressed position.

Redset was placed into voluntary administration. The administrators received a DOCA proposal from Mr Young which involved Mr Young selling property owned in his own name to partially satisfy unsecured creditors. However, the administrators circulated a report to creditors recommending that the DOCA not be executed and that the creditors should resolve to wind up the company. In making their recommendation, the administrators noted that on a winding up, the liquidator could pursue further investigations into the propriety of the asset sale to AJK, together with the payment of monies to the Mawson Group.

Contrary to the administrators’ recommendations, a majority of creditors voted to execute the DOCA. There were issues as to the circumstances in which the DOCA came to be approved. There was evidence that revealed that Mr Young had offered some creditors special deals in return for their proxy vote in favour of the proposed DOCA.

DECISION

Canadian Solar, one of Redset’s unsecured creditors, applied to the court for orders terminating the DOCA under section 445D or 600A of the Corporations Act and sought an order that the company be put into liquidation. The deed administrators, who had been the previous administrators of the company supported the orders sought.

The Court had no hesitation in setting aside the DOCA. The Court pointed in particular to the preferential treatment of some creditors under the DOCA and asset agreement to the detriment of other unsecured creditors, who were left with claims against an empty shell company. The effect of the DOCA avoided further investigation by a liquidator into suspect and potentially voidable transactions which might result in a considerably better outcome for the creditors. Further, the existence of the secret deals between Mr Young and certain creditors to corrupt the voting process was a type of equitable fraud.

COMMENT

While the facts of the Canadian Solar case involve instances of obvious wrongdoing by the parties involved, it is also a reminder of the lengths directors of a failing company may go to salvage their business and livelihood. A related party may be the only bidder for distressed assets, and can sometimes result in a successful resurrection of the business. However, to avoid being set aside as an improper phoenix transaction, any deal should be approved by an insolvency practitioner and must ensure that creditors, in particular unsecured creditors, see a greater return than they would in a liquidation.