Ashurst Restructuring Roundup

Terminating DoCA's (Part 2) – Unfair Prejudice or Injustice

Canstruct Pty Limited v Project Sea Dragon Pty Limited (No. 4) [2024] FCA 112 ("Canstruct")¹ 

Commissioner of State Revenue v McCabe (No. 2) [2024] FCA 662 ("McCabe")

Academy Construction & Development Pty Limited [2024] NSWSC 808 ("Academy Construction")

Section 445D(1) of the Corporations Act 2001 (Cth)  provides, amongst other grounds, that a DoCA may be terminated if the court is satisfied that:

"(e) effect cannot be given to the deed without injustice or undue delay; or

(f) the deed or a provision of it is, an act or omission done or made under the deed was, or an act or omission proposed to be so done or made would be:

(i) oppressive or unfairly prejudicial to, or unfairly discriminatory against, one or more such creditors; or

(ii) contrary to the interests of the creditors of the company as a whole."

In Academy Construction the DoCA provided that all but one of the company's ordinary unsecured creditors were to be paid 100 cents in the dollar on their claims.  The creditor (the Owners Corporation of a strata apartment block) was to have its claim capped to the amount of $200,000. It had claimed $7,840,360 in proceedings against the company, seeking compensation for defects in the strata apartment block which had been built by the company.

By way of contrast with the circumstances in Canstruct, where the claim of the creditor which was subject to discriminatory treatment had been quantified (discussed in our earlier Restructuring Roundup) the claim by the Owners Corporation was still being litigated.

That circumstance, by itself, was not sufficient to distinguish the case from Canstruct and it was held in Academy Construction (at [64]) that:

"… the Administrators and [the company] made no attempt to establish that a pari passu distribution as between other creditors and the Owners Corporation, after the Owners Corporation's claim was properly assessed, would result in a distribution of $200,000 or less to the owners corporation.  The Administrators and [the company] also did not establish any rational distinction between the position of [the other ordinary unsecured creditors] whose claims were allowed in full, and the position of the Owners Corporation, where any uncertainty in the amount recoverable by the Owners Corporation would necessarily have been addressed in the valuation of that claim in the proof of debt process.  There is here no suggestion that there was any proper commercial imperatives in respect of any future trading by [the company] to prefer all creditors other than the Owners Corporation, by paying their claims in full, to the Owners Corporation, although that approach no doubt encouraged other creditors to vote in favour of the Resolution."

Having regard to the effect of the DoCA on the Owners Corporation, the court in Academy Construction held that there were grounds to terminate the DoCA.

It might be noted that in the case of a claim that is yet to be quantified, it seems that it would be open for an administrator to make a just estimate of the claim and having done so, assess the appropriateness of any discriminatory treatment of that claim as against other claims, subject to there being a rational basis for discriminatory treatment. The Court commented in Academy Construction that "the fact that a creditor's claim is large and complex, and may be relatively costly to adjudicate, provides no basis for arbitrarily capping it to a figure chosen by a deed proponent to avoid or minimise the need for a proper adjudication of the claim..."

In McCabe, the Commissioner of State Revenue sought to have the DoCA terminated because it was claimed that it was unfairly discriminatory and unfairly prejudicial so far as the Commissioner's interests were concerned.  The basis of that claim was described as follows (at [209]):

"…the proposed return to the Commissioner was estimated to be between 7.8 and 17.4 cents in the dollar, as compared with the estimated return to all other admitted participating creditors of between 16.9 and 37.8 cents in the dollar.  Although the estimated returns as between the Commissioner and the other admitted creditors differed, his overall share of the available pool was 60%, in circumstances where the Administrators admitted proofs of the Commissioner's debt in its entirety, and where the assessments remained the subject of unresolved objection."

As noted, the Commissioner's claim was still the subject of objections.

Moreover, the Court said (at [217] and [218]):

"217 Although it is true that no express rationale is to be found in the [administrators'] Report, it is relatively plain how the directors arrived at the 60:40 split.  As is referred to in the Report, the directors' ROCAP disclosed 'other ordinary unsecured creditors' claims of $6.5 million'.  That figure represents 40% of the total amount of $15.9 million in outstanding debt, when account is taken of $9.4 million said to be owed to the [Commissioner].

218 Further, unlike any other creditor, the [Commissioner] has received $631,748.43 pursuant to its garnishees:  that is, it has received 100 cents in the dollar for a portion of the [Commissioner's] debt."

Beyond that, the basis for propounding the DoCA in McCabe and the justification for the discriminatory treatment which favoured the company's unsecured creditors other than the Commissioner was explained by one of the company's directors in these terms (at [133]):

"(a) that I wanted the businesses to continue in operation;

(b) that I was concerned about saving the jobs of the employees;

(c) being able to provide ongoing service to our customers into the, future;

(d) that the [Commissioner's] debt was disputed (and … I wanted to ensure that the companies has had the opportunity to go through the legal channels to dispute it (if that was appropriate));

(e) the claim by [the Commissioner] included penalties and interest, unlike other claims of creditors;

(f) that [the Commissioner] had already garnisheed money from the bank accounts .. (and [the Commissioner] has continued to garnish amounts after the date of the DOCA); and

(g) that there were a number of trade creditors … that it was important to pay to ensure that the business would continue to support… businesses into the future."

So, contrasting McCabe and Academy Construction, in McCabe:

(a) there was a rational basis both for discriminating against the Commissioner in the manner proposed as well as arriving at the amount to be allowed on account of the Commissioner's claim; and

(b) the proposal was also calculated to facilitate the continued operation of the company's businesses by maintaining the goodwill of its other creditors.

whereas in Academy Construction, neither of those conditions were satisfied.

Additionally, and this would seem to be a fundamental consideration in all cases, in McCabe, the Court concluded (at [225]):

"Self-evidently, there is no certainty as to the potential quantum of any recovery in a liquidation.  There is insufficient evidence to establish that any creditor, including the Commissioner, would be worse off under the DOCA than in liquidation.  What evidence there is suggests that most creditors will indeed be better off under the DOCA …"

It should be noted that it is the applicant seeking termination of the DoCA who bears the onus of establishing that it and, possibly, other creditors will be worse off under its terms than in the event of the company's liquidation; McCabe at [235].  Accordingly, to the extent that that issue cannot be resolved it will be a consideration which militates in favour of the DoCA continuing in place; see, eg, McCabe at [225] and Sino Group International Ltd v Toddler Kindy Gymbaroo Pty Ltd [2023] FCAFC 110 at [138].

In each of Canstruct, Academy Construction and McCabe, the Court approved the observations of McKerracher J in Decon Australia Pty Limited v TFM Epping Land Pty Limited (No. 2) [2021] FCA 32 at [202]–[203] in relation to the test of what amounts to a DoCA being unfairly prejudicial or unfairly discriminatory in these terms:

"(c) The test under section 445D(1)(f)(i) is not merely discrimination or prejudice, but unfair discrimination or unfair prejudice.  Some degree of discrimination is not necessarily unfair.  …

(d) When deciding whether a deed unfairly prejudices or discriminates against a creditor or group of creditors, consideration must be given to what those purportedly prejudiced creditors would receive, or would be likely to receive, on a winding up, and the reasonableness of any conclusions reached by the administrator on that question …

In respect of determining what is unfairly discriminatory:

(a) There must be reasonable grounds for differentiation between creditors of an equal class … that accord with the object and spirit of part 5.3A.  Circumstances may exist where certain creditors must be paid in full to ensure their continued support for the company to allow it to continue to trade …

(d) Ultimately, if there is no prima facie evidence of misfeasance, concealment or a materially inadequate preliminary examination, and the DOCA offers both real financial benefits credibly estimated on preliminary investigation to exceed those available on liquidation, and indirect or collateral benefits from the survival of the company's business; and no worthwhile avenues for further recovery in liquidation are identified, a major creditor's curiosity or preference for further exploration or speculative claims is unlikely to render termination of the DOCA in the interests of creditors as a whole."