On 12 September 2018, the High Court of Australia (High Court) gave judgment in the case of Mighty River International Limited v Hughes (Mighty River).1 In that decision, the High Court (by a 3:2 majority) held that a “holding” deed of company arrangement (DOCA) is valid.
A holding DOCA is the colloquial name for a DOCA that provides for the relevant company to essentially be put into a holding pattern, with a moratorium on claims by its creditors, while its administrators pursue investigations or other means of reconstructing the company.
The majority of the High Court confirmed that:
- holding DOCAs can be a valid use of the DOCA process, provided they are formally constituted in accordance with the requirements of Part 5.3A of the Corporations Act;
- in particular, it is permissible to have a DOCA where:
- there is no distribution of property to creditors; or
- there is an ongoing (even indefinite) moratorium while further investigations are conducted and options explored by the deed administrators;
In addition, a number of more general points of guidance can be taken from the Mighty River decision:
- attention should be paid to the actual terms of the DOCA, rather than its label. The High Court considered that the term “holding DOCA” should be avoided given it is not a legislative expression and directs attention away from the specific terms of the DOCA;2
- the courts will take a practical approach to the requirement upon the administrators to express opinions as to the future of the company prior to the second meeting of creditors. It is recognised that administrators will not have perfect information and may not have completed their investigations within the relevant timeframe;
- it is important to ensure clarity and consistency in the drafting of reports, recommendations, and any proposed DOCA, whether in respect of the administrator’s opinions (and related reasoning), the objectives of the DOCA or the terms of the DOCA;
- the DOCA process is a flexible regime, and one that is ultimately intended to be determined by creditors without extensive intervention by the Court. The fact that this puts a potentially heavy onus on an objector to bring matters (and prove them) to the Court is the intention of the Corporations Act; and
- the majority considered it significant that the DOCA in this case contained a clear “quid pro quo” between the company and its creditors as that indicated that the DOCA was not an attempt to subvert the operation of the Corporations Act or to impermissibly extend the convening period.
In this article we consider holding DOCAs and the Mighty River decision in more detail, including the key arguments of the appellant in the High Court and the reasoning of the majority in reaching its decision.
What is a holding DOCA?
A DOCA is an arrangement between a company that has entered administration and its creditors.
It is provided for under Part 5.3A of the Corporations Act 2001 (Cth) (Corporations Act), and comprises one of the three possible “exits” from the administration process (the others being liquidation of the company or returning the company to its directors). DOCAs are therefore the primary means of restructuring a company once it enters administration.
Under the Corporations Act, the administration process is (by default) subject to tight timeframes. The administrator must convene the first creditors’ meeting to confirm the administrator’s appointment and decide whether to appoint a committee of inspection within eight business days of the administration beginning. The administrator is normally required to convene the second meeting of creditors in the period between 15 and 25 business days after the administration begins. The second meeting of creditors is critical, as this is where the administrators present a report on the affairs of the company and their opinions on whether it would be in the company’s interests to exit administration, be wound up or execute a DOCA.3 The creditors vote at the second meeting on which of these courses of action to take.
DOCAs were conceived as a more rapid, simple and flexible alternative to schemes of arrangement and are the most common formal mechanism for restructuring distressed companies. However, the tight time period allowed by the Corporations Act prior to the second creditors’ meeting means there is frequently (especially in the case of large or complex companies or corporate groups) insufficient time for a proper investigation of the affairs of the company, production of the necessary reports or for restructuring or sale proposals to be formulated and considered.
There have been two solutions commonly used to allow administrators more time. The first is to seek a court order extending the convening period for the second creditors meeting under Corporations Act, s 439A(6). The second, employed in this case, is for the creditors to agree a holding DOCA along the lines described above. As with all DOCAs, the terms of a holding DOCA may be varied by a creditors’ resolution in accordance with s 445A. If the requisite majorities – by number of creditors and by value of their debt – are in favour, they may vary such terms of the DOCA as no longer meet their interests. Should a further restructuring proposal arise during the period of the holding DOCA it can be implemented by way of a variation to the DOCA terms.
Despite holding DOCAs being relatively common, until the Mighty River decision there had been no direct consideration of their validity by Australian courts.
The Mighty River case concerned the administration of, and subsequent DOCA in respect of, Mesa Minerals Limited (Mesa). Mesa is an ASX listed entity with a 50% joint venture interest in two manganese mining projects.
Mesa was placed into voluntary administration on 13 July 2016. The second creditors’ meeting was held on 20 October 2016, following an earlier adjournment of the meeting.
In the original s 439A report (issued on 10 August 2016) and a subsequent supplement to it (issued on 13 October 2016), the administrators had repeatedly expressed the view that the best course of action would be for Mesa to execute a DOCA in order to “provide sufficient time for the Administrators to conduct further investigations… and to explore the possibility of a restructure or recapitalisation.”4 The supplementary report had primarily been issued to update creditors on the investigation of potential claims Mesa may have had against its directors, the pursuit of which had been agitated for by Mighty River, a creditor.
At the second creditors meeting, on 20 October 2016, Mesa’s creditors voted in favour of entry into the proposed DOCA and the deed was entered on 3 November 2016 (the Mesa DOCA).
The terms of the Mesa DOCA
According to its preamble, the Mesa DOCA was intended to provide the Administrators with sufficient time to “conduct further investigations into [Mesa’s] property and affairs, and to explore the possibility of a restructure or recapitalisation of [Mesa] to determine the likely outcomes to creditors and form an opinion as to whether a deed of company arrangement or liquidation is in the best interests of creditors of [Mesa].”
The Mesa DOCA provided that (among other things):
- the administrators would (i) further investigate any claims that Mesa had against third parties; and (ii) seek proposals for Mesa’s reconstruction with a view to having its shares continue trading on the ASX;
- there would be an ongoing moratorium during which the creditors could not pursue any claim against Mesa; and
- unless varied, the Mesa DOCA would not make available any of Mesa’s property for distribution to its creditors.
The Mighty River challenge
Following the signing of the Mesa DOCA, Mighty River applied to the Supreme Court of Western Australia to have the Mesa DOCA overturned. In particular, it sought orders declaring that the Mesa DOCA was of no force or effect, terminating or setting aside the Mesa DOCA, or setting aside the creditors’ resolution by which the Mesa DOCA had been approved. Mighty River’s objection appears to have been related to certain disagreements as to the management of Mesa prior to its insolvency and a concern that the moratorium would prevent or delay any attempt to pursue claims against Mesa’s directors, and may bring limitation defences into play.
In response, Mineral Resources (a 60% shareholder of Mesa and one of Mesa’s JV partners) sought either a declaration that the Mesa DOCA was not void, or an order expressly validating it.
Before reaching the High Court, Mineral Resources prevailed at trial before a Master and then subsequently before the Court of Appeal of the Supreme Court of Western Australia.
In the High Court, Mighty River’s case was based on three main arguments:
- that the Mesa DOCA was inconsistent with the objectives of Part 5.3A (including because it impermissibly “sidestepped” the court process to extend an administration);
- that the Mesa DOCA was invalid because it did not specify any property of Mesa that would be used to pay creditor claims; and
- that the administrators failed to form the requisite opinions as to whether the administration should end, Mesa should enter liquidation or Mesa should execute a DOCA.
Each of these arguments were rejected by the majority of the High Court, for the reasons set out in the following sections.
Is a holding DOCA consistent with the objectives of Part 5.3A?
Mighty River argued that the Mesa holding DOCA was inconsistent with the objectives of Part 5.3A of the Corporations Act. More specifically, it contended that the Mesa DOCA was in fact an agreement to extend the time period for the administration of Mesa that had not been approved by Court under section 439A(6). Mighty River referred to this as an impermissible “sidestepping” of the court application process to extend an administration.
The objectives of Part 5.3A
The majority of the High Court noted there were some “difficulties” with Mighty River’s argument that complying with the objective of Part 5.3A was an independent condition of validity for a DOCA.
However, regardless of whether this was a standalone requirement, the majority considered that the Mesa DOCA did operate to fulfil the object of Part 5.3A because it aimed to maximise the chances of Mesa’s survival or otherwise provide a better return than in liquidation. This view was supported by the fact that the ASX “listed shell” of Mesa (which, on the evidence, had an estimated value of between $400,000-900,000) would, as a practical matter, be unable to be sold once the company was in liquidation (the alternative to the DOCA). In addition, the DOCA allowed for the further pursuit of litigation claims or a restructuring proposal.
Furthermore, the majority drew a comparison with schemes of arrangement. The courts have previously recognised that it is valid to devise a scheme of arrangement with the central or sole purpose of securing a moratorium on claims. Given the ‘common premises’ behind DOCAs and schemes of arrangement, the majority considered it appropriate to allow a DOCA with the predominant or sole purpose of obtaining a moratorium.
Finally, the majority noted that the administration process provided a short moratorium period to protect creditors and provide a speedy and efficient process. However, they considered that those objectives were not undermined if the creditors themselves chose, through a DOCA, to extend the moratorium beyond the normal period.
An impermissible sidestepping?
The majority also disagreed with the specific assertion that the Mesa DOCA was an impermissible sidestepping of the court application process to extend an administration. The court noted that whilst the Mesa DOCA had the “incidental effect” of extending the time for the administrator’s investigations, it created “genuine rights and duties” between Mesa and its creditors. Under the Mesa DOCA the administrators were required to investigate potential claims, seek proposals for the restructure of Mesa and to report to creditors on a bi-monthly basis. In return, the creditors accepted a moratorium on their claims.
Must a DOCA specify some property to be available to pay creditors’ claims?
Mighty River also argued that the Mesa DOCA contravened section 444A(4)(b) of the Corporations Act.
Section 444A(4)(b) requires that a DOCA specify (among other things) “the property of the company (whether or not already owned by the company when it executed the deed) this is to be available to pay creditors’ claims.”
The Mesa DOCA stated that, subject to variation of the DOCA, “there will be no property of the Company available for distribution to Creditors under this deed.” Mighty River argued that section 444(4)(b) required the DOCA to specify some property that would be available to pay creditors. In contrast, the administrators argued that section 444(4)(b) required that a DOCA specify the property, if any, that would be available to pay creditors.
The majority favoured the administrators’ construction of section 444(4)(b). They considered that section 444(4)(b) was intended to direct attention to a subject matter that must be addressed by a DOCA, but did not seek to prescribe a minimum obligation that an administrator mist distribute some property, however little, to creditors.
The majority also noted that there were many valid types of DOCAs that did not involve any property of the company being distributed to creditors, including DOCAs that provide for:
- debt for equity swaps;
- creditors’ claims being replaced with rights as beneficiaries of a creditors’ trust (with the trust funded by third parties);
- transferring shares from the members to creditors (including under section 444GA).
The majority saw little legislative purpose in Majority River’s interpretation of section 444A(4)(b), as this would allow the provision to be satisfied if a nominal amount was specified for distribution to creditors (but not if there was no amount at all).
Did the administrators form the requisite opinions on what should happen to the company?
Finally, Mighty River argued in the High Court that the administrators had failed to comply with sections 438A(b) and 439A(4) because they had failed to form the required opinions (and to have notified them to creditors).
Section 438A(b) requires that administrators, as soon as possible after the administration begins, form an opinion about whether it would be in the interests of the company’s creditors for:
- the company to execute a DOCA;
- the administration to end; or
- the company to be wound up.
This argument appears to have been at least partly based on the recital to the Mesa DOCA, which stated that the objective of the DOCA was for the administrators to “form an opinion as to whether a deed of company arrangement or liquidation is in the best interests of creditors of the Company.” The inclusion of this language in the Mesa DOCA seems to have suggested to Mighty River that the administrators had not already formed a view on this issue.
The majority quickly disposed of this argument on the basis that the administrators had specifically stated in their section 439A report to creditors that they considered it was not in the interests of creditors that the administration end or that Mesa be wound up, but that it was in the creditors’ interests that Mesa execute the Mesa DOCA. These opinions were supported by 26 pages of substantial reasoning in the report.
Whilst the administrators opinion was based on “the information available” the majority considered that the obligation to form the opinion as “soon as practicable” necessarily required that opinions could be formed without the administrators having fully investigated and assessed all relevant matters. Section 439A(4) did not require the administrators to provide a quantitative opinion of the likely financial recovery under each possible option.
Therefore, although the majority noted that the recital to the Mesa DOCA was “not expressed in the clearest language” they nevertheless considered that it did not have the effect that the opinions expressed by the administrators in their section 439 report were not genuine.
The majority judgment of the High Court in the Mighty River case is to be welcomed, as a sensible and commercial result in accordance with market expectations and practice. Holding DOCAs are a useful tool to be deployed where in appropriate cases, and can lead to better returns for creditors. The technical arguments of Mighty River were rightly rejected both on technical grounds and by reference to the overarching purpose of the administration regime to provide a simple, flexible and efficient means to rescue distressed companies.