TGIF 29 May 2020: 'Not worth the wait' : Court orders DOCAs be terminated with deed funds remitted to liquidators

This week’s TGIF considers a recent decision of the NSW Supreme Court by which two DOCAs were terminated with the deed fund transferred to liquidators for the ultimate benefit of the secured creditor and, indirectly, the proponent of the deeds. 

Key Takeaways 

• Court has ruled a director’s resolution to appoint liquidators valid despite an express prohibition in the DOCA.
  
  
• A deed fund is property of the company and, absent clear language to the contrary, is not held by deed administrators on trust for creditors.
  
  
• In making recommendations to creditors, administrators must explain the commercial risk of a DOCA reliant on trading profits to constitute the deed fund in the future.

What happened?

On 3 February 2014, administrators were appointed to two companies operating in the construction industry, Antqip Pty Ltd and Antqip Hire Pty Ltd.  The administrators recommended creditors approve DOCAs (almost identical in terms) proposed by the sole director of each company whereby control of the companies would revert to that director and deed fund contributions paid from future trading profits of Antqip and an entirely separate, but related entity – Antqip Plant Hire Pty Ltd. The outcome for unsecured creditors was, in a DOCA scenario, marginally superior to a liquidation scenario and avoided the risk of a nil return.

Entry into the DOCAs was approved, the deeds were executed and the administrators became the deed administrators.  When control of the companies reverted to the director, each of them ceased to trade (eliminating one source of monies for the deed funds) and the companies refinanced the secured debt.  

Over the following five years, monies were paid by instalments into each respective deed fund until, as at April 2019, only $153,000 remained outstanding.  At that point, the director passed resolutions that each of Antqip and Antqip Hire be voluntarily wound up and appointed liquidators (notwithstanding both the existence of the DOCAs and an express prohibition in the deeds preventing the director from appointing a liquidator). The secured debt, by this stage, had more than doubled.

The liquidators subsequently commenced proceedings seeking a declaration that their appointments were valid and an order terminating the DOCAs with the deed funds being paid to them. The deed administrators provided an analysis to the Court which revealed that the only creditor who stood to benefit from the termination was the secured creditor and, indirectly, the sole director who had personally guaranteed the debt.    

The relevant questions for determination included whether the director had the ability to appoint the liquidators and, if so, whether the deed funds were held on trust for the pre-DOCA creditors.

Validity of appointment

Clause 25 of the DOCAs provided that officers of the company could not resolve to appoint a liquidator and, if for any reason the company was wound up, the deed administrators would become liquidators.  The liquidators sought to have this clause deleted or declared otherwise void and of no effect.

One of the key submissions in support of this position was that the clause (with no comparable provision in Schedule 8A) was inconsistent with the Corporations Act.  As the Act did not preclude the appointment of a voluntary liquidator to a company under a DOCA, it was argued that the clause should be construed consistent with that possibility.

The Court agreed finding that:

• DOCA’s should be construed as statutes rather than contracts;
  
  
• clause 25 must be read as subject to the Act (and the right to appoint a liquidator) with the inconsistency resolved by adding the words, “Subject to the Corporations Act,” to the commencement of that clause; and
  
  
• as a consequence, the appointment of liquidators was not precluded by the deeds.

Should the DOCAs be terminated?

The liquidators relied on the power to terminate conferred on the Court by s 445D of the Act and submitted that, where a company subject to a DOCA is insolvent, and the remaining deed funds are the only assets, the proper course was to terminate the deed.   A termination would result in the deed funds being applied to payment of the secured creditor (in respect of which the director had given a guarantee) to the exclusion of the creditors who had voted in favour of the deeds.

The deed administrators opposed termination and further contended that the funds held by them were held on trust for those creditors entitled to receive a dividend under the deeds.  

Ultimately, the wording of the deed itself was determinative with the Court concluding that the deed administrators held the deed funds as agents for the companies and not trustees such that the monies within the fund should be properly characterised as ‘property of the company’.  

Whilst acknowledging that DOCAs may be capable of creating a trust (for example, by way of a creditors’ trust), her Honour noted that merely because the deed administrator held funds as the company’s agent for creditors, that did not mean that property was held on trust.  What proved crucial was the absence of any wording to effect a divestment of the company’s interest in the deed funds so that the deed administrators became legal owners with creditors holding a beneficial interest.  

As a result, the deed funds were held to have remained property of the companies to be remitted to the liquidators for distribution to all creditors – pari passu – in the winding up.

Comment

This is an important decision for insolvency practitioners to be familiar with for the guidance provided on the interrelationship between deed administrators and liquidators and the construction which applies to DOCAs.  As her Honour observed, the effect of the decision was that the deed proponent had terminated the DOCAs for his own benefit, being to reduce his exposure to the secured creditor under his guarantee by remitting the deed fund to the secured creditor and leaving unsecured creditors with nothing.

Further, this judgment serves as a cautionary tale for creditors, bound by a DOCA, who remain exposed to the ongoing trading of the company in order to be paid.