This week’s TGIF considers a refusal by the Federal Court to declare void or terminate a DOCA on the grounds of alleged prejudice & injustice or due to omissions in the administrator’s report to creditors.

Background

R Developments Pty Ltd (the Builder) operated a residential construction business and entered into a contract for the construction of a residential property in 2012.

Shortly after construction commenced, a dispute arose under the construction contract. The Builder purported to terminate the contract. However that termination was later found to be invalid and the owners were awarded damages for the Builder’s abandonment of the contract.

A subsequent appeal from that decision was dismissed with costs with the owner of the property later commencing a winding up application in respect of the unpaid judgment debt. Before the winding up application was heard, the Builder appointed an administrator.

At the second meeting of creditors, a resolution was passed that a deed of company arrangement (DOCA) be executed.

Under the DOCA, a payment of $50,000 was to be contributed to the deed fund and all related creditors (the most substantial being the sole director of the Builder) agreed to waive their rights to participate in any distribution. Less than two weeks after the document was executed, the property owner (and judgment creditor) brought an application for the DOCA to be declared void or terminated.

The Application

The applicants relied principally on s 415A(3)(a) of the Corporations Act 2001 (Cth) (the Act). This section allows the Court to set aside a resolution voted on at a creditors’ meeting if, amongst other things, the resolution would not have passed had the votes of related creditors been disregarded and the outcome is either contrary to the interests of creditors as a whole, or prejudicial to the interests of creditors who voted against the resolution.

The applicants also alleged that there were matters omitted from the administrator’s report that could reasonably be expected to have been material to the ultimate decision to execute the DOCA.

The Decision

The Court dismissed the application with costs.

Was the DOCA unfairly prejudicial?

Her Honour was not persuaded that the applicants had demonstrated to the relevant standard that the DOCA prejudiced them to the extent it was unreasonable. In addition, there was no evidence that the applicants would fund any investigations in a liquidation scenario to investigate any suspicious dealings by the Builder prior to its administration.

Her Honour observed that, given the related creditors had waived any entitlement to participate in the deed fund, the DOCA, on one view, discriminated in favour of the applicants.

Were there defects in the DOCA so as to render it void under the Act?

The applicants argued that:

  1. there had been a failure to correctly specify the moratorium period under the DOCA as required by s 444A(4)(c) of the Act; and
  2. ambiguity arose on the face of the DOCA which could be read that all legal action was barred indefinitely.

Both contentions were rejected by her Honour as sufficient to justify a declaration that the DOCA was void. The Court indicated such issues were properly matters that should be addressed in a variation of the DOCA by a meeting of creditors.

Had there been an omission in the report to creditors?

The submissions from the applicants with respect to alleged omissions centred on what they suggested were inadequate investigations by the administrator before execution of the DOCA was recommended. These included:

  1. a failure to investigate the controlled entities of the sole director or his family members;
  2. limited interrogation of the trading of the Builder either before or after the litigation which ultimately led to its demise; and
  3. no explanation of the benefit of the DOCA to the director or the related creditors.

Notwithstanding the above, her Honour was not prepared to find that the report to creditors contained any omissions that would have been material to the creditor’s decision. What was critical to this conclusion was the lack of evidence that any of the alleged omitted matters would have lead to a greater return to the unrelated creditors. Her Honour’s view was that, at best, a greater distribution would be dependent on funding, proof of voidable transactions and a finding of insolvency which, on the unchallenged evidence of the administrator, may be a pursuit that was commercially unviable given the associated costs involved.

Comment

The decision serves as a reminder that the investigation to be performed by a voluntary administrator is intended by Parliament to be a swift and practical one. When considering the adequacy of the administrator’s investigations, one has to take into account the time constraints under which the administrator was working.

Also, it is not enough to point to material omissions in an administrator’s report as a basis for terminating a DOCA. Discretionary factors, such as the lack of funding available to a liquidator to pursue possible claims may weigh against termination, even in the case of material omission.