Ashurst Restructuring Roundup

Terminating DoCA's (Part 1) - Misleading Information – Administrators' Reports

Sino Group International Limited v Toddler Kindy Gymbaroo Pty Limited [2023] FCAFC 110 ("Toddler Kindy")

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

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

Applicants for the termination of a DoCA must establish one of the grounds specified in s 445D(1), Corporations Act ("CA").

In the context of information provided to creditors in respect of a proposed DoCA, paragraphs (a) to (c) of that section are relevant, and provide that a DoCA may be terminated if:

"(a) information about the company's business, property, affairs or financial circumstances that:

(i) was false or misleading; and

(ii) can reasonably be expected to have been material to creditors of the company in deciding whether to vote in favour of the resolution that the company execute the deed; was given to the administrator of the company or to such creditors, or

(b) such information was contained in a document that accompanied a notice of the meeting at which the resolution was passed;

(c) there was an omission from such a document and the omission can reasonably be expected to have to have been material to such creditors in so deciding."

For the most part the information provided to creditors of a company about a proposed DoCA will be communicated to them by way of the administrators' report published to them under s 75-225(3), Insolvency Practice Rules (Corporations) 2016. 

When preparing that report administrators must be conscious of their "duty to act independently and impartially in the administration of the company's affairs"; Toddler Kindy (at [70]).

As to whether information is false or misleading, the court in Toddler Kindy summarised the relevant principles at [62], and they include:

"(1) The test for whether information is false or misleading or contains a material omission is determined objectively.

(2) The inquiry is directed to the adequacy of the information presented to creditors to enable their decision making, not to the intention or conduct of any person who provides the information.

(3) It is the objective quality of the information that is assessed, not whether anyone was in fact mislead.

(4) The inquiry is directed to information available at the date of the hearing and is not limited to information available as at the time the information is produced.

(5) Estimates as to recoverability may be misleading in circumstances where no qualifying information or doubt is express as to the recoverability of certain amounts…

…

(10) ….the information or omission is of a kind that can reasonably be expected to have been material to creditors in deciding whether to vote in favour of executing a DOCA.

(11) …."material" means something which was relevant and did affect, or might have affected, the outcome (being the decision to execute the DOCA).

(12) The information or omission need not reasonably be expected to be material to all creditors, but it must affect a sufficient number.

(13) The test of materiality is objective.

(14) In deciding whether the materiality test is satisfied, all the information about the company's business, property, affairs or financial circumstances that has been found to be false and misleading or to have been omitted, should be considered collectively."

See also Canstruct at [234] and McCabe at [165]

The materiality test does not require creditors to have made a different decision – the focus is on the relevance of the information and whether it might have affected the outcome.

Omissions from report to creditors with regard to likely dividend

In Toddler Kindy the options identified as being available to creditors were a DoCA or liquidation of the company. The voluntary administrators recommended the DoCA as that was in the best interests of creditors.

The basis of that recommendation was that, if the creditors agreed to the company undertaking the proposed DoCA, it was "estimated that [creditors] will receive a dividend of 100 cents in the dollar"; Toddler Kindy (at [46]).

By way of comparison, the voluntary administrators observed that "in the event that the company is wound up, then it is our view that the unsecured creditors are likely to receive only about 33 to 40 cents in the dollar as a dividend"; Toddler Kindy (at [46]).

The estimate of the dividend payable to creditors if they agreed to a DoCA was based on a number of assumptions including:

• "Fees do not exceed $310,000 in best case scenario.
• Sino claim admitted for estimated amount of $161,647. If Sino disputes the assessment of its claim, then legal fees and administration fees are likely to be higher.
• No continuing or other litigation."; Toddler Kindy (at [44]).

The notice convening the second meeting of creditors was accompanied by the Administrators' Report (which recommended the proposed DoCA) and the Administrators' Remuneration Approval Report ("Remuneration Report"). The Remuneration Report sought approval for fees of $487,526 payable in the event of the DoCA being undertaken and on a "worst case" basis. This amount is to be compared with fees of $310,000, being the estimated fees used by the voluntary administrators when computing the dividend payable under the DoCA.

At the second meeting the company's creditors, the proposed DoCA was approved.

Application was made by Sino under s 445D for the termination of the DoCA on a number of grounds, including that the information provided to creditors in the Administrators' Report was materially misleading.

The Court granted the application on this ground. In doing so it identified a number of criticisms with the Administrators' Report.

Administrators' Reports must contain all Financial Information relevant to a Comparison of Options

The Remuneration Report included the estimate of costs payable on a "worst case" basis if the DoCA was undertaken. However, the Administrators' Report omitted to refer creditors to the Remuneration Report when considering the options available to them. In fact, the Court held that the Administrators' Report itself should have contained all of the information which creditors needed to have available to them in order to make that comparison: Toddler Kindy (at [95]).

Additionally, neither the Administrators' Report nor the Remuneration Report disclosed that Sino had commenced proceedings to remove the administrators. Nor did either of those Reports disclose the extent to which, if at all, those proceedings impacted the estimate of fees used by the administrators when computing the dividend payable in the event of the company undertaking a DoCA. In that regard the Court said (at [106]):

"The Administrators' Report was also misleading because it did not disclose that there was continuing litigation … and that costs had been incurred in those proceedings … that were not accounted for in the best case DOCA scenario estimate in the Administrators' Report."

Comparison between Available Options must be Fulsome and include an Assessment of the Probabilities of Outcomes

As noted, the administrators advised creditors that the estimated dividend payable in the event of a DoCA being undertaken was 100 cents in the dollar. There was no contrast between a "best case" and a "worst case" scenario and no attention was given to the likelihood of either of those cases eventuating. This omission was made worse by the administrators seeking approval in the Remuneration Report for remuneration of $487,526 in a worst case scenario because, in that event, it was estimated that the dividend would only be 38 cents in the dollar.

By comparison, the analysis of the dividend payable in the event of the company's liquidation did involve contrasting the "best case" and "worst case" scenarios. As to that circumstance, the Court said (at [91]):

"The approach taken in relation to the DOCA may be contrasted with the Administrators' approach to the winding up scenario. First, the estimated return to creditors on a winding up is expressly qualified by a statement that 'it is likely that'. In the case of the DOCA, the estimate was not qualified by any words expressing probability. This contrast leaves the reader with an impression that the DOCA estimate of 100 cents in the dollar is more than merely likely. Secondly, the estimated return in the winding up scenario is expressed as a range. In that way, creditors were able to readily compare the difference between the best and worse case scenarios for winding up. That comparison was not provided in the case of the DOCA, creating the impression that the worse case was not a likely outcome."

The Court concluded (at [107]:

"… the absence of a worst comparison in the DOCA scenario, in the context of the inclusion of a worst case comparison in the winding up scenario, was a material omission within s 445D(1)(c). The absence of a quantification as to probability or likelihood in the headline comparator of 100 cents in the dollar for the DOCA estimate was also a material omission".

Report Breach of Duty Claims including Insolvent Trading

Rule 75-225(3)((b)(vi) of the Insolvency Practice Rules (Corporations) 2016 requires that Administrators' Report include the following:

"whether there are any transactions that appear to the administrator to be voidable transactions in respect of which money, property or other benefits may be recoverable by a liquidator under Part 5.7B of the Act".

In addition to commenting on any such transactions, the administrators should be astute to the possibility that the company traded whilst insolvent and be careful to identify when the company became insolvent. That was an issue in Canstruct.

In Canstruct, the company incurred significant liabilities and relied on an informal arrangement with its parent company to fund its operations. The Court there held that to the extent that a company's solvency is dependent upon the financial support of a related company, administrators should address the question; "whether it could be said that [the company] was able to pay its debts because as a matter of commercial reality , the required funds were, at the relevant times, genuinely and realistically available from [the related company]?": Canstruct at [164]. It was decided in that case that a material omission from the information provided to the company's creditors involved; "the absence of a statement to the effect that there existed a real question as to whether [the company] had been trading whilst insolvent for a number of years, that this was a matter which a liquidator might properly investigate, and that there were avenues of recovery from both [the company's parent and its directors] of the amount of the debts incurred whilst the company was insolvent and which had not been satisfied.": (at [240])

In addition to insolvent trading claims, there may also be claims against directors in respect of transactions which were undertaken when the company was insolvent or near insolvent which involved a breach of duty to the company on their part as well as claims against third parties who took the benefit of those transactions with knowledge of the breach of duty or who knowingly assisted with the breach. Such claims might involve transactions which comprise an unfair preference, unreasonable director-related transactions, and creditor defeating dispositions, which took place outside the limitation periods stipulated in Part 5.7B of the Act. A failure to report potential claims of these kinds might also involve a material omission from the information provided to creditors when considering the options available to them.

Report should include Allegations of Misconduct

In McCabe, the Commissioner of State Revenue had made allegations that the companies had engaged in deliberate tax defaults and tax evasion. The failure on the part of the administrators to report those allegations resulted in there being a material omission from the information supplied to creditors.

It is submitted that, similarly, if another agency, such as ASIC or the ATO, had made allegations of misconduct against either the company or its directors, they are matters which should be reported to creditors by the administrators.

Ultimately in the McCabe, the Court declined to set aside the DoCA, holding that the were good reasons that the DoCA be upheld, including that a better outcome for creditors was being achieved through the DoCA and it was not clear that a liquidation would serve any purpose.

Authors: Richard Fisher, AM, Consultant and Emanuel Poulos, Partner.