TGIF 12 July 2024 – Prospective judgment creditor successful in having Deed of Company Arrangement terminated

In In the matter of Academy Construction & Development Pty Ltd (subject to Deed of Company Arrangement) [2024] NSWSC 808, the New South Wales Supreme Court had to determine whether to terminate a Deed of Company Arrangement (DOCA) on the basis that it was oppressive, unfairly prejudicial or discriminatory.

Key Takeaways

• While a Deed of Company Arrangement (DOCA) can provide for differential returns between creditors, it must have a sound underlying commercial rationale for doing so.
  
  
• Where a DOCA materially disadvantages a creditor or a minority of creditors, there will be a greater risk of aggrieved creditors challenging the commercial rationale put forward.
  
  
• Administrators should carefully consider the comparative benefits and disadvantages of a DOCA versus liquidation. If benefits or disadvantages are over- or understated to creditors voting to approve or reject a DOCA, this could provide a further basis for challenge.

Background

The DOCA in this case was entered into by Academy Construction & Development Pty Ltd (ACD). ACD had constructed three residential apartment buildings in Botany, New South Wales.

The plaintiff, being the Owners Corporation in respect of those apartment buildings, had filed proceedings against ACD and the apartment developer, alleging defects in the common property. The Owners Corporation sought damages of approximately $7.8 million.

During these proceedings, the Court made procedural orders requiring ACD to file and serve lay and expert evidence. Given the costs associated with the litigation, ACD resolved to appoint voluntary administrators. The Owners Corporation lodged a proof of debt in the voluntary administration in the amount of $7,127,600 plus GST and legal and experts’ costs.

At the second meeting of creditors, creditors were asked to vote upon a proposed DOCA, the effect of which was as follows:

• A deed fund would be established;
  
  
• ‘Class A’ creditors, who were ordinary unsecured creditors other than the Owners Corporation, would be paid from the deed fund in full; and
  
  
• ‘Class B’ creditors, the Owners Corporation, would be paid from the deed fund in a maximum amount of $200,000.

All creditors voted to approve the DOCA, save for the Owners Corporation (who was a 90% creditor). This meant that a majority of creditors in number, but not value, had voted to approve the DOCA. The administrators, who had the casting vote, decided to vote in favour of the DOCA. In doing so, and in recommending that creditors vote in favour of the DOCA, the administrators considered that the DOCA would provide a better return for all creditors than a liquidation scenario.

Against this background, the Owners Corporation applied to the Court for an order under s 445D of the Corporations Act 2001 (Cth) (the Act) that the DOCA be terminated, and that ACD be wound up.

The principal question for the Court was whether the DOCA was oppressive, unfairly prejudicial, or discriminatory.

Decision

The Court ultimately ruled that the DOCA was contrary to Part 5.3A of the Act and therefore void, because it purported to release directors and related parties of ACD rather than just ACD itself. The Court did not consider that these clauses could be excised or that orders could be made varying the DOCA because the proposed releases were a fundamental aspect of the DOCA that creditors had voted upon.

The Court also considered that the DOCA should be terminated for the reasons advanced by the Owners Corporation.

While the authorities make clear that a DOCA can provide for differential returns among creditors, the Court considered that the DOCA in this case lacked sufficient commercial justification for the differential return to the Owners Corporation.

The ACD parties submitted that the differential treatment of the Owners Corporation was justified because, unlike other ordinary unsecured creditors, the Owners Corporation’s claim was disputed and subject to considerable uncertainty. Further, the ACD parties submitted that the DOCA would result in material time and cost savings with respect to the resolution of the Owners Corporation’s claim.

The Court did not accept these submissions. His Honour Justice Black identified that the terms of the DOCA required the administrators to adjudicate the Owners Corporation’s proof of debt in any event. This meant that the time and cost savings associated with the DOCA were overstated. Further, the adjudication would remove the uncertainty associated with the Owners Corporation’s claim, leaving the Owners Corporation in the same position as all other ordinary unsecured creditors. In these circumstances, Justice Black held that:

1. there was no objective basis for the DOCA to impose a cap of $200,000 on the recovery by the Owners Corporation; and
   
   
2. there was no rational basis to treat the Owners Corporation differently from other unsecured creditors.

The Court also considered that the estimated returns in a liquidation scenario had been understated at the time creditors voted to approve the DOCA. This was because the liquidation returns did not account for potential unfair preference and insolvent trading claims that a liquidator might pursue.

Comment

This decision highlights the difficulties that can arise with respect to proposed Deeds of Company Arrangement. Like the case here, administrators will often have limited time to consider creditor claims, particularly claims that are legally and factually complex and the subject of existing litigation.

This case confirms that, while a Deed of Company Arrangement can provide for differential returns between creditors, the deed must have a sound underlying commercial rationale for doing so. Where a deed materially disadvantages a creditor or a minority of creditors, there will be a greater risk of aggrieved creditors challenging the commercial rationale put forward.

Another important reminder this case provides is the need for careful consideration of the comparative benefits of a proposed DOCA versus liquidation. If benefits or disadvantages are over- or understated, this could provide a further basis for challenge.