TGIF 9 August 2024 – A ‘burden on all taxpayers’? When will a DOCA be terminated in the ‘public interest’?

This week’s TGIF considers a recent decision of the Federal Court of Australia (Commissioner of State Revenue v McCabe (No 2) [2024] FCA 662), where Justice Derrington determined that potential tax fraud and evasion did not justify the termination of a DOCA on ‘public interest’ grounds.

Key Takeaways

• Any challenge to a DOCA must be accompanied by sufficient evidence that creditors would be worse off under the ongoing DOCA than a liquidation, and that there has been substantial wrongdoing on the part of the directors to warrant the DOCA’s termination.
  
  
• There may be commercial reasons to depart from general distribution principles where the purpose of the DOCA is to return and keep a company solvent. What is required is a better return to creditors than an immediate winding up.
  
  
• Courts take a pragmatic approach when considering whether to terminate a DOCA, particularly when the DOCA has been executed and the company returned to profitable trading. This is particularly so when a liquidation and associated investigations would be of considerable cost to creditors.

Background

In 2008, two colleagues (Mr Donaldson and Mr Gallagher) founded the Comlek business to supply engineering, electrical and labour hire services to various industries in Queensland. The business expanded to be 26 different companies or trusts (Comlek Companies).

In September 2022, the Commissioner of State Revenue (Commissioner) issued the Comlek Companies with notices of investigation, alleging deliberate tax default and business structuring to avoid payroll tax.

As at November 2022, the payroll tax liability of the Comlek Companies was approximately $9.3 million. Mr Donaldson provided the Commissioner with a proposed repayment arrangement for this amount, and claimed that the directors of the Comlek Companies were not aware of the outstanding liability as they had solely relied on their accountant’s advice regarding payroll tax obligations.

The Commissioner rejected the repayment proposal. This caused the directors to place the Comlek Companies into voluntary administration.

There were two Deed of Company Arrangement (DOCA) proposals — one proposed by the directors of the Comlek Companies, and the other proposed by a competitor. The Administrators recommended the directors’ proposal. The Commissioner voted against the directors’ proposal. The result of the vote was that a majority in number voted in favour, but a majority in value voted against the DOCA resolution. The Administrators exercised their casting vote to pass the resolution for the directors’ proposal. The DOCA was then executed on 9 February 2023.

In March 2023, the Commissioner commenced proceedings seeking orders that:

• the directors’ DOCA be terminated under each of section 445D(1)(a), (b), (c), (f) and (g) or section 447A of the Corporations Act 2001 (Cth); or
  
  
• in the alternative, the Administrators’ casting vote in favour of the directors’ DOCA be set aside.

The Commissioner’s primary submission was that the DOCA should be terminated because it was detrimental to the interests of the public generally and to commercial morality for the DOCA to remain on foot. This was because the DOCA would subvert the purpose of taxation law and shield the directors from scrutiny and claims for breaches of duty (a submission falling under the ambit of ‘some other reason’ in section 445D(1)(g)).

The Commissioner also submitted that the Comlek Companies should be wound up because the companies had failed to keep written financial records.

He complained that the DOCA was unfairly prejudicial because he would receive less than other creditors.

The Commissioner also submitted that certain disclosures in the Second Report to Creditors were false or misleading. This was because there was a failure to disclose material information about payroll tax liabilities or the failure of the Comlek Companies to maintain books and records, and the Administrators’ failure to report or investigate the taxation liability of the Comlek Companies.

Decision

Her Honour’s judgment set out an analysis of what ‘public interest’ and ‘commercial morality’ mean. She also set out the factors considered by the courts when determining whether allowing a DOCA to continue would be contrary to the public interest.

Her Honour concluded the public interest includes considerations of commercial morality and that the terms are not ‘disaggregate’. Invocations of commercial morality do not, in fact, warrant substantially different consideration than invocations of the public interest in having the law applied in accordance with its intended legislative purpose.

However, an invocation of commercial morality may warrant some additional consideration as to whether the conduct in question is “so far outside societal norms of acceptable commercial behaviour as to warrant condemnation”.

In this case, the Court did not order the termination of the DOCA.

The Court held that, to the extent ‘some other reason’ in section 445(1)(g) is relied upon, the reason will be assessed in the context of the statutory language in section 445D and the purpose of that provision. That purpose is to preserve businesses, subject to a DOCA not being contrary to the interests of the creditors as a whole. A DOCA that is fraudulent, wrongful or for an illegal purpose will fall outside the norms of conduct in section 445D.

Her Honour considered there was insufficient prima facie evidence filed by the Commissioner of wrongdoing on behalf of the Comlek Companies, or that any creditor would be worse off under the directors’ DOCA. There was no evidence that the directors had misused the voluntary administration process. By the time the application was heard, the Comlek Companies had executed the DOCA, were trading profitably, and had retained over 80 employees. It was commented that, if anything, it would be against public interest and legislative intent to make the employees of a profitable company redundant.

The Commissioner also argued that the directors’ DOCA was unfairly prejudicial as, under the DOCA, the estimated returns were lower for the Commissioner than the other admitted creditors. However, the Court determined there may be reasons for a DOCA to depart from general distribution principles where the purpose of a DOCA is to keep a company trading. What is required is a better return to creditors under a DOCA than an immediate winding up. This is achieved if some creditors are better off than in a winding up and none is worse off under the DOCA than they would be under a winding up. In this case, there was insufficient evidence to establish that any creditor would be worse off under the DOCA than in a liquidation.

The Court also found the Commissioner had not discharged the onus of establishing there were false or misleading statements in the Second Report to Creditors.

Comment

This case provides good commentary on what a court may consider when determining whether to terminate a DOCA for public interest concerns. Most importantly, this case highlights that any challenge to a DOCA must be accompanied by sufficient prima facie evidence:

• that creditors would be worse off under the DOCA than in a liquidation, and
  
  
• for challenges such as this, that there has been substantial wrongdoing on the part of the directors to warrant the DOCA’s termination.

The judgment was also pragmatic. The Court was not willing to disturb a DOCA that had been executed and returned a company to trading, and where a liquidation and any resulting investigations would be of considerable cost to creditors. Also, this case reinforces that a DOCA can depart from pari passu distributions where the purpose of the DOCA is to keep a company trading.