A Bird In The Hand - Court Refuses To Terminate DOCA - Insolvency/Bankruptcy

This week's TGIF considers an appeal to the Full Court of the Federal Court for the termination of a deed of company arrangement , in circumstances where the appellants argued that liquidation of the company would provide a better return to creditors.

Key takeaways

A DOCA is not contrary to the interests of creditors simply because alternative courses of action have the potential to provide a higher return to creditors.
The question for the Court is whether, in all relevant circumstances, the DOCA was contrary to the interests of creditors.
These circumstances include certainty and timeliness of returns to creditors, and any risks associated with alternative courses of action to the DOCA.

Background

The appellants in this matter were creditors of a company in administration (the company). A deed of company arrangement (DOCA) was entered into by the company; the appellants sought to have the DOCA terminated pursuant to s 445D(1) of the Corporations Act 2001 (Cth).

The appellants argued that liquidation of the company would provide a better return to creditors than the DOCA. This was because of a potential claim that the company had against one of its shareholders which had executed a deed undertaking to pay a certain amount to the company in the event that the company was wound up.

The appellants argued that this claim, if pursued, would yield a greater return to creditors than what would be received under the DOCA. Therefore, they argued that the DOCA should be terminated as it was contrary to the interests of the creditors (s 445D(1)(f)(ii)).

Decision

At first instance, the application to terminate the DOCA was dismissed. On appeal, the appellants argued that the trial judge had erred in finding that there was not a likely prospect that liquidation would provide a better outcome to the creditors.

Principles

The Full Federal Court first addressed the way in which the appellants had framed this submission. The Court was not prepared to accept that proving a "likely" or "not unrealistic" prospect that liquidation would result in a better recovery to creditors justified termination of the DOCA.

The statutory test is not whether such a prospect exists but whether the DOCA is contrary to the interests of the creditors. This requires assessment of all relevant circumstances, such as the amount by which the potential recovery in liquidation would exceed recovery under the DOCA, how much longer the return may take to be realised in the event of liquidation, and the risks associated with achieving that return.

Therefore, it would not be enough to show that the potential claim against the shareholder meant that liquidation had the prospect of providing a better return than the DOCA. The appellants were required to demonstrate that the DOCA was contrary to the interests of the creditors in light of all circumstances.

Application

In applying these principles to the appellant's submissions, the Court accepted that the company did have a realistic prospect of obtaining a judgment against the shareholder. However, this did not convince the Court that the DOCA was contrary to the interests of the creditors.

The Court found that there were multiple risks associated with pursuing a claim against the shareholder. The shareholder had stated an intention to challenge any claim against it, having raised arguments against the enforceability of the deed it had signed.

Additionally, the shareholder did not hold assets in Australia, meaning that even if a judgment against the shareholder were obtained, it would need to be successfully enforced in a jurisdiction in which the shareholder did hold assets. Any proceedings against the shareholder would also take some time to conclude.

The appellants also argued that in comparing the potential returns of liquidation and the DOCA, the trial judge had erred in using the administrators' estimate of the recovery from liquidation. This estimate had been calculated based on the worst-case scenario of the claim failing against the shareholder. The appellants argued that since the claim had a real prospect of success, the rate should have been calculated based on the maximum possible return from the judgment. If calculated this way, the recovery rate in liquidation would potentially exceed that of the DOCA.

The Court also rejected this argument. The recovery rate provided by the administrators was the appropriate measure because it accounted for the risks associated with pursuing litigation against the shareholder. In addition to those highlighted above, these included the risks in relation to obtaining funding for the litigation.

Accordingly, the appellants were unable to demonstrate that the DOCA was contrary to the interests of creditors. The application to set aside the DOCA was dismissed.

Comment

This decision highlights the proper test that the Court will consider when deciding whether to terminate a DOCA. The fact that alternative courses of action may provide a potentially higher return to creditors than the DOCA is insufficient – the circumstances must demonstrate that the DOCA is contrary to the interests of the creditors. This requires consideration of factors such as the certainty of any return, its timeliness, and any risks associated with alternatives to the DOCA.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.