When will a deed of company arrangement be set aside?

Introduction

When will a Deed of Company Arrangement (DOCA) be set aside? In the second instalment of the three-part series, we consider the circumstances in which a creditor successfully obtained the termination of a DOCA and winding up of the company in the case of R.W. Pascoe Pty Ltd v Crimson Fresh Produce Pty Ltd (subject to deed of company arrangement) [2023] FCA 705.

Background

The key background facts to the application were:

• Crimson Fresh Pty Ltd (Crimson Fresh) was a business operating in the vicinity of Mildura, Victoria engaged in the growth and export of produce.
• Crimson Fresh leased the land on which it grew produce from a related entity, held only limited assets, most of which were subject to security interests, and had no real property.
• Between 1 July 2018 and some point in 2022, Crimson Fresh traded at a loss and accrued liabilities in excess of $5.8 million.
• On 4 November 2022, voluntary administrators (Administrators) were appointed to Crimson Fresh by resolution of the company’s sole director.
• The Administrators’ investigations painted a bleak picture, identifying that:

1. 1. the company appeared to have been insolvent from at least 30 June 2020;
   2. the company had ceased trading prior to the Administrators’ appointment;
   3. any return to unsecured creditors was unlikely; and
   4. no DOCA had been proposed, such that the winding up of the company was recommended.

• In a liquidation scenario, the Administrators believed there were potential recoveries available, including:

1. 1. 21 preference claims totalling $530,000;
   2. unreasonable director-related transactions of $139,100; and
   3. an insolvent trading claim against the company’s director of $1.8 million,

resulting in an estimated return to creditors of 53.63 cents to the dollar.

• Subsequently, the company’s director proposed a DOCA contemplating a “Deed Fund” of $200,000 of his own contribution. However, this money was intended to be sourced from company assets, and contingent on the success of a farming venture. The estimated return to creditors under the proposed DOCA was about 2.35 cents to the dollar.
• In their supplementary report, the Administrators maintained their recommendation that Crimson Fresh be wound up, in circumstances where:

1. 1. Crimson Fresh had been insolvent for a significant period;
   2. the director had breached a licence agreement entered into by Administrators;
   3. the contribution of the Deed Fund was questionable;
   4. the company did not intend to resume trading; and
   5. the estimated return in a liquidation scenario (although downgraded to 23.72 cents to the dollar without satisfactory explanation), was still preferrable to the nominal return under the proposed DOCA.

• The DOCA was passed, and entered on 3 March 2023.

Considerations and findings of the Court

R.W. Pascoe Pty Ltd (Pascoe) applied that the DOCA be terminated under the Corporations Act (Act), specifically ss 445D(1)(e), (1)(f) and 447A.

Section 445(1)(e)

Section 445D(1)(e) provides that a DOCA may be terminated if “effect cannot be given to the deed without injustice or undue delay”. The Court observed that the provision was concerned with the objective effect of the DOCA, not its purpose.

In these circumstances, the Court was satisfied that giving effect to the DOCA would involve injustice to Pascoe and other creditors by reason of the proper investigation of antecedent transactions and potential claims for insolvent trading that had been identified by the Administrators being avoided.

Section 445(1)(f)

Pascoe additionally argued that the DOCA was oppressive, prejudicial, or discriminatory in relation to the company’s creditors and was not in their best interests within the meaning of section 445D(1)(f).

In applying that section, the Court had regard to the decision of Sydney Land Corp Pty Ltd v Kalon Pty Ltd (No 2) (1997) 26 ACSR 427, 430:

‘…when one is looking at what is oppressive or unfairly prejudicial under s 445D, one looks at it in the background of the general right of a creditor to be paid or to wind the company up, or to have the company administered by the administrator under the deed in a way which keeps the company’s business going and will see the creditor paid something out of the property of the company. If a scheme in a deed deviates from that, then the creditor is more easily able to say that it is operating oppressively, than otherwise…’

In light of that authority, the Court considered it significant that Crimson Fresh had ceased trading prior to the Administrators’ appointment, and that the DOCA did not contemplate the resumption of trade.

Additionally, any return under the DOCA was likely to be minimal, and substantially less than the return in liquidation, which would have the added benefit of exposing the company’s affairs to a liquidator’s investigative powers.

Section 447A

Pascoe also applied for the termination of the DOCA under s 447A of the Act as an abuse of process. The Court considered that the provision was enlivened in circumstances where a company enters voluntary administration:

“… not for a purpose envisaged by the legislation but with a view to installing an administrator who might be more compliant than a provisional liquidator”

or where the company’s director:

“… imposed voluntary administration with a view to the adoption of a deed of company arrangement by a decision of creditors of doubtful value, which would bar particular claims … being litigated against the company.”

The Court again looked to the fact that Crimson Fresh had ceased trading and the DOCA was not intended to support the resumption of trade as highly persuasive, holding that:

“Part 5.3A of the Corporations Act is not intended to assist companies in this position. The process of administration, and the execution of a DOCA, should not be used as a de facto winding up for the purpose of avoiding the real and important consequences of a properly conducted liquidation.”

The Court accordingly concluded that the DOCA was liable to set aside under each of ss 445D(1)(e), (1)(f) and 447A, and Crimson Fresh wound up in insolvency.

Key Takeaways

This case lends further support to the principle that DOCAs are intended to assist a company in continuing its operations with a view to providing a better return to creditors. Where a DOCA:

• does not serve the interests of creditors;
• aims to deny the processes of liquidation; or
• does not contemplate the continuation (or resumption) of trade,

there is a risk that it involves an element of injustice, was proposed for a collateral purpose or is contrary to the provisions of the Act and may therefore be set aside or terminated.

Attempts to use the voluntary administration process and DOCAs as a tool to avoid liquidation and its consequences in circumstances where no genuine restructure of the company is contemplated are likely to be met with successful challenges by disgruntled creditors.

Queries

If you have any questions about this article, please get in touch with an author or any member of our Restructuring, Turnaround & Insolvency team.

Disclaimer

This information and the contents of this publication, current as at the date of publication, is general in nature to offer assistance to Cornwalls’ clients, prospective clients and stakeholders, and is for reference purposes only. It does not constitute legal or financial advice. If you are concerned about any topic covered, we recommend that you seek your own specific legal and financial advice before taking any action.